What is Earnest Money?

It is the money given by the buyer to the seller in order to show that the intention of purchase of the property is bona fide. It binds both the parties to the contract (agreement to sell) and insures the interests of both the parties in the case of a default by either party. It is part of the purchase price and is deducted from the total value of the property while making the payment later. Unless there is anything contrary in the terms of the contract, the seller can forfeit the earnest money.

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Benefits of Earnest Money

To the seller: It serves as a guarantee for the seller in case the buyer backs out of the contract. The seller can retain the earnest money in that scenario unless there is a specific clause in the contract that states that even the earnest money will be refunded in case of non-performance of the contract.

To the buyer: There is often a clause in the contract that the buyer will be paid back twice of the earnest money, in case the seller is not able to fulfil the contract and deliver the property to the seller. The buyer must make sure that there is such a clause in the contract that entitles him or her to compensation in case of non-performance of the contract by the seller.

Case Law on Earnest Money

In the case of Satish Batra Vs. Sudhir Rawal (2012), the buyer had paid INR 7 Lakh to the seller as earnest money for the purchase of a property worth INR 70 Lakh. He was unable to pay the rest of the amount and the contract stood forfeited. The seller retained the earnest money which was challenged by the seller in court. The Hon’ble Supreme Court held that the seller can retain the sum of INR 7 lakh as it was earnest money the seller was allowed to keep in case of non-performance of the contract due to a fault of the buyer and there was no clause in the contract which stated that earnest money will be refunded. 

Illustration 1

A is an NRI who lives in Canada. He comes to India for 2 months and enters into a contract with B to sell his house for INR 1 crore. B pays INR 8 lakh as earnest money and agrees to pay the remaining amount after 6 months. B has not paid the amount even after a year, so A is entitled to keep the earnest money. However, B tells A that he needs a refund of the earnest money and files a court case against A for refund of the amount. In such a scenario, A is fully entitled to retain the earnest money and hire a lawyer to have the case against him dismissed while also claiming damages from B for frivolous litigation. 

Illustration 2

B enters into a contract with A to buy a property worth INR 50 Lakhs and pays INR 4 lakhs as earnest money. B is willing and ready to pay the amount but A calls B and says he cannot sell the property anymore. There is a clause in the contract that B is entitled to twice the earnest money in case the contract is forfeited by A. In such a scenario B has the right to demand INR 8 lakhs back from A and if A refuses to pay the money, B can file a case in court against A to recover the amount by hiring a lawyer.

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Conclusion 

Earnest Money is important as it justifies the intent of the buyer to purchase the property and provides assurance to the seller about the purchase. It also acts as a guarantee for the buyer to claim compensation of the agreement does not go through due to the actions of the seller.