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Handling of Deposits

Real estate broker's obligations in the handling of deposits are governed by both statutes and the common law of agency and contracts. This legal update reviews the general principals applicable to a broker's handling of deposits in real estate transactions.

1. Due Care in Handling of Deposits. As a licensee a broker is subject to the mandates of Article 12-A of the Real Property Law, which requires that a broker be trustworthy and competent. As an agent, a broker is a fiduciary charged with fidelity and diligence in the conduct of his responsibilities. Brokers are accordingly obligated to exercise due care in the handling of deposits.

2. Purpose and Disposition of Deposits. Generally speaking, there is no requirement that deposits be utilized in real estate transactions. With the exception of court-ordered sales, no laws mandate that deposits be made or specify the size thereof. Deposits are not necessary for a valid contract to exist. Obtaining a significant deposit is, however, generally considered to be desirable. It indicates that the buyer is acting in good faith and has financial resources. It can provide a means of securing the broker's commission. The parties to a transaction are free to determine whether and/or to what extent deposits will be made.

a. Listing Broker - Seller Relationship. The listing broker and the seller typically enter into an express agency relationship for a limited purpose: the procurement of a buyer who meets the seller's requirements for the sale or lease of the seller's premises. As between the seller and the listing broker, the parties are free to establish the rules governing the broker's entitlement to deposit monies to satisfy the seller's obligation to pay a brokerage commission.
As a result of the broker's obligations as a licensee, commission agreements must be fair and reasonable. For an agreement regarding the use of deposits to satisfy commission claims to be enforceable, it is required that a) the broker's commission must have been earned, and b) the provisions must not be oppressive or patently unfair.
The arrangements made by the seller and listing broker with respect to the application of deposits only come into play when the deposits become the property of the seller. This depends upon the contractual dealings of the principals to the transaction: the buyer and seller.

b. Buyer - Seller Relationship. The parties to a real property purchase contract typically provide for various deposits to be made prior to closing. Where purchase offers are utilized, frequently a deposit is tendered by the would-be buyer as an incentive to the seller's acceptance. In any event, the contract entered into between the buyer and seller is likely to provide that certain sums of money be advanced prior to closing.

The contract of the parties is the instrument which governs the property rights to any deposits prior to closing. Until a purchase offer is accepted, a deposit tendered therewith remains the property of the buyer making the offer. Unless the listing broker has been specifically authorized to accept deposits on behalf of an owner, the listing broker's custody of the tendered deposit has no binding effect on the prospective seller. A listing broker's authority to bind the seller in a real estate transaction is required to be in writing (General Obligation Law, §5-1111).

Upon the seller's acceptance of a purchase offer or contract, the property right to any deposits is governed by contractual agreement of the parties. Unless the purchaser has made a written irrevocable offer (General Obligations Law, §5-1109), the prospective purchaser can revoke the offer, prior to the seller's acceptance, and reclaim any tendered deposit.

The buyer and seller are free to make whatever arrangements they desire with respect to the ownership of any deposits prior to closing. The listing broker's rights to claim the deposit are derivative of the seller's rights thereto and further dependent upon the listing agreement between the seller and the listing broker.
Purchase contracts are frequently conditioned upon the fulfillment or waiver of various contingencies. The Secretary of State recognizes that there are situations where it is not possible or appropriate for a broker to make an evaluation as to the entitlement of the buyer or seller to a deposit. In contrast, the Secretary of State has indicated that brokers should act responsibly where there is no bona fide question regarding who is entitled to the deposit. Where the situation is clear, such as when an offer has been rejected by the seller, a buyer is entitled to the return of his deposit. Similarly, where the buyer refuses to go forward, without any claim of justification under a contract, under most purchase contracts the seller would be entitled to the deposit. The seller's rights are then subject to the rights, if any, of the listing broker, under the applicable listing agreement.

In the event of any genuine issue as to entitlement to the deposit, the broker should continue to hold the deposit in escrow while advising the parties that it will be released upon the determination of a court of competent jurisdiction or the mutual agreement and releases of those involved.

3. Escrow Accounts. The Secretary of State has plainly set forth in the publication "Real Estate Brokers' License Law" the requirement of separately maintained escrow accounts:
"In handling deposits, there should be consciousness that the monies placed in the broker's hands are trust funds and that with relation to such monies the broker is a trustee and fiduciary. Of course, the monies cannot be commingled with the broker's personal funds and must be kept in a separate special bank account."

4. Interest on Deposits. There is no generally statutory requirement that deposits in real estate transactions are required to be placed in interest-bearing accounts. The notable exception is that rental security deposits, in buildings containing six or more units, must be placed in accounts bearing interest at the prevailing rate in the area (General Obligations Law §7-105[2]).

a. Deposits on Purchase Contracts. As a matter of contract law, the buyer and seller can provide for deposits to be made in interest-bearing accounts. The parties may make such arrangements as they determine are appropriate with respect to any deposits.

When a broker is entrusted with any deposits, he should place them in an escrow account. The Secretary of State has plainly declared that a) such deposits are "trust funds", and b) any interest earned on purchase contract deposits is not the property of the broker.

According to the policy of the Department of State, if interest-bearing accounts are utilized, the broker is responsible for properly allocating the interest earned on a deposit which is entrusted to him. The parties are free, as a matter of contract law, to require the use of interest-bearing accounts and to specify the entitlement to interest which is earned. In the absence of a contractual agreement, according to the Department of State, the would-be buyer is entitled to the interest which accrues on the deposit prior to acceptance. After acceptance, interest which accrues is the property of the seller. Due to the problem of such allocations and the further complexity of proper allocations under contracts with various contingencies, the Department of State recommends that brokers place purchase contract deposits in non-interest-bearing accounts except in cases in which the parties have made contractual arrangements regarding interest-bearing deposits.

If the parties have provided that interest-bearing accounts be utilized, the Department of State recommends separate accounts for each transaction, bearing the name of the prospective buyer and his/her social security number. This will facilitate proper tax reporting of the transaction.

B. Security Deposits on Rental Properties. With respect to rental property, a statutory provision governs the requirement for interest-bearing accounts (for buildings containing six units or more) and the disposition of any interest accruing on a deposit. Pursuant to the provisions of Section 7-103 of the General Obligations Law, entitled "Money deposited or advanced for use or rental of real property":
"such money, with interest accruing, thereon, if any, until repaid or so applied, shall continue to be the money of the person making such deposit or advance and shall be held in trust by the person with whom such deposit or advance shall be made and shall not be mingled with the personal monies or become an asset of the person receiving the same..."

Thus, where security deposits for leases are placed in interest-bearing accounts, the interest thereon accrues to the benefit of the lessee. The recipient of the deposit is required to provide written notice to the party making the advance, specifying the name and address of the banking organization involved, which shall have a place of business in New York State. The person making the deposit in an interest-bearing account is entitled to receive an administrative and custodial expense (General Obligations Law §7-103[2]). This one percent per annum administrative fee is not permitted on purchase contract deposits.

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