As a long-time transactional lender, I frequently encounter this situation. Just days before the wholesaler’s closing with himself as the seller and his end buyer in place, the end buyer decides not to close. Sometimes, the end buyer happily forfeits their Earnest Money Deposit (“EMD”), and at other times, they fight to get it back. The issue is that the investor now faces the dilemma of what to do to replace the end buyer.

In an actual incident this week, a wholesaler and realtor® called me to ask what he should do, as we had a double closing scheduled to close in two days. The issue was that his end buyer called and cancelled his contract, instructing the investor to retain the EMD, which was $5,000. Because of the purchase price of the property from the original property owner, the investor had $10,000 EMD in place. He stood to lose money even if he got the end buyer’s EMD.

The investor put the property back on his buyers list and got another investor to make an offer. Unfortunately, this offer was $20,000 lower than the investor’s first buyer. The investor’s profit, although significantly reduced, was still a profit, and he had an additional $5,000 EMD from the defaulted buyer. He agreed to the new price and sent the new buyer an unsigned contract just in case the original buyer changed his mind.

As bad luck would have it, the first buyer came back in one day and said he had changed his mind and was ready to close. That’s the good news; the bad news was that the second buyer had to be informed that his offer would not be accepted. Of course, the second buyer was, to say the least, angry. However, the investor had not signed the contract he sent to the second investor. This should be standard practice for precisely this reason, or include a clause stating that the contract is a “backup” or “contingent” on the first buyer not closing.

How often does the end buyer default? Based on my personal experience, having been involved in over 10,000 closings, the issue of the end buyer or original seller defaulting occurs in approximately 35% of all closings. If you are lucky enough not to have any defaults, get ready, as they will be coming. You have options to be prepared for this eventuality, with the most often used being:

  1. Have your seller sign a “Seller Warning” that states that other investors have tried to get another contract from them and how these investors don’t close but renegotiate the price at the closing table. It is also illegal.
  2. Stay in constant contact with the seller and end buyer with every bit of helpful news your closing agent can give you. When asked to resolve an issue by the end buyer, address it immediately or negotiate a credit at closing if the work takes too much time or the seller is uncooperative.
  3. Make sure your contracts with the seller and end buyer have “extended liability” clauses in the event of either default. This way, you get paid if the seller defaults, in addition to getting your EMD back, and the end buyer will owe you more than their EMD if they default.
  4. Make sure the end buyer has his EMD deposited with you or the closing agent when you sign your contract. It’s a common practice among “Black Hat” wholesalers never to put up an EMD, so when they default, you get nothing.
  5. Communication, or lack of it from your seller and buyer, is a sign that something isn’t right, and you need to take preemptive action to replace the end buyer or to make sure the seller comes to closing.
  6. Prayers help…

In summary, the options listed above are knee-jerk responses to try to save your deal. The most decisive measure for this potentially expensive problem is to have a massive buyers list. When you email your deals to your list members, you have competition among them, which will always help you secure more and better offers. You’ll discover that when you email a specific deal for a second or third time, make the subject line say, “Discounted Deal!”, the response rate should be 2 to 3 times your regular inquiries.

Frequently Asked Questions

A default on a real estate contract means the buyer or seller of a property decides not to abide by the terms of their contract. The default or “breach of contract” can be as simple as not coming to the closing, or as complicated as a legal dispute with the terms of the agreement. The most common defaults we see come from buyer or seller remorse about the amount they were being paid, or paid for a property.

In our personal experience of over 10,000 closings, we find that about 25% do not close because of buyer or seller default. Another 15% have defaults or breaches that are resolved before closing and by negotiation between the buyer and seller.

Of the twenty reasons that buyers and sellers default before closing, the most common is seller’s remorse. The second most common is that end buyer financing from a hard money lender has failed to materialize. We find that seller’s remorse can be substantially reduced by threatening and taking legal action. The failure of hard money lenders is tough to resolve quickly.

The most common reasons for sellers to default after accepting an offer and signing a contract are, first, because of seller’s remorse. Usually, a neighbor or well-meaning relative encourages the seller not to proceed with the closing. The second issue is that black hat wholesalers offer the seller more money and encourage the seller to cancel their contract.

Sellers who default can be sued for “breach of contract” and face legal fees for themselves and the plaintiff (investor) buyer. We have had a few of these lawsuits where we were the plaintiff, and they can take one to two years to resolve in our favor. An end buyer can lose their escrow deposit (EMD) and, if the investor seller is savvy, face extended contractual liability if this purchase contract is properly written.

An EMD is contractually obligated to be returned to the seller or the end buyer. Usually, both parties disagree why the other party didn’t perform up to the contract requirements. The escrow agent will only give the EMD to the appropriate party if both the seller and buyer agree in writing. If the dispute continues, usually mediation is called for by my contract, or the parties sue each other in a civil proceeding – the winners are always the attorneys.

We have been involved in many defaults by sellers or buyers. In most of these cases, we were able to negotiate with either party to resolve the dispute. The usual solutions involved providing a repair credit at closing, reducing the purchase or sale price, and covering the opposing party’s closing costs. Communication is the best way to resolve defaults as soon as there is any suspicion of a problem.

You can reduce your chances of a seller’s default by recording a Notice of Interest (“NOI”) or Memorandum of Contract (“MOC”)when you sign your purchase agreement. Your contract with a seller is as powerful as a deed if you use available contract law to support your position. A buyer’s default is best handled by continuing to take backup contracts from additional buyers.

If you determine that you may have a possible default coming, notify the party by text, email, and certified letter that you will have to take appropriate legal action if they don’t come to closing. Plan on taking legal action, no bluffing. Attempt to negotiate a solution via a third party, either your “good cop” partner or your attorney. 75% of the time, the ‘good partner’ will be able to resolve the issue in dispute if he listens to the opposing party and is sympathetic.

Dispute resolution will either be in one or two days, probably 80% of the time, if you listen to the seller’s or buyer’s reasoning and come to a mediated solution. If you have to sue the opposing party, approximately 20% of the time, it can take six months to two years or more to resolve the issue, with no guaranteed outcome and substantial legal fees. Being in the right doesn’t mean you will win, as there are too many variables against you, and if the other party has a lot of money, get out early.

There are three methods of dispute resolution, and we have used them all. First is the initial negotiation between the parties. Second, mediation is required by the contract you sign. Mediation is not inexpensive and doesn’t guarantee a solution. Finally, sue the opposing party in civil court, which is the most expensive option. Govern yourself accordingly and remember that being ‘right’ doesn’t mean success in the end.