An agreement to sell should lay down rules governing the payment and forfeiture of earnest money in the interests of both buyers and sellers
In many transactions of sale of immovable property, parties execute an agreement to sell (ATS) as a precursor to the sale deed. Unlike a sale deed, execution of an ATS does not pass title of ownership in favour of the buyer. In an ATS, parties set out terms such as advance sale price, total sale price, manner and timelines of payment and time period within which the sale deed is to be executed. Terms pertaining to obligations to be performed by the parties before the sale can take place are also laid out. A necessary and important clause is the contingency of buyer committing a default or breach of terms (of the ATS) mainly pertaining to payment and timelines. In this respect, parties usually provide that if the buyer defaults or breaches terms of the ATS, the transaction stands cancelled and earnest money deposited by the buyer is forfeited by the seller. Parties usually also lay down a converse situation that if the seller fails to per- form or breaches the ATS, the buyer shall be entitled to receive twice the earnest money.
Earnest money is basically the deposit paid by a buyer at the time of entering into a contract for purchase of property, showing the buyer’s faith in the transaction. Earnest money essentially represents a guarantee that the buyer will fulfil the obligations laid down in the contract. Thus, giving earnest money serves two key purposes – first, it acts as part-payment of the purchase money and second, it acts as security for the performance of the contract. An important question regarding earnest money recently came up before the Hon’ble Supreme Court in the matter of Satish Batra v Sudhir Rawal (October 2012).
In this case, the main question was whether a seller was entitled to forfeit the earnest money whereby the sale of an immovable property fell through due to the buyer’s fault. Often, what is called as only part-payment/advance money may actually be earnest money and what is termed as earnest money may only be advance money. In this regard, the Hon’ble Supreme Court observed that in order to determine whether the amount paid by a buyer can be treated as earnest money and is liable to be forfeited by the seller, the mere description of words used in the agreement are not sufficient. Rather, courts would take into account the nature of the sum paid, the terms of the contract, intention of the parties and surrounding circumstances relevant to each case.
The Hon’ble Supreme Court held that in order to justify forfeiture of earnest money, the terms of the contract should be clear and explicit. Part payment of purchase price (ie earnest money) cannot be forfeited by the seller unless the amount has been given as a guarantee for the due performance of the contract. In other words, if the payment is made merely as advance/part payment of the total sale price, then the seller is not entitled to forfeit such part payment made by the buyer. However, if the payment is made as a guarantee for performance of the contract, the seller is entitled to forfeit earnest money in the event of a default by the buyer, if nothing contrary has been agreed by the parties in the contract. This judgment has important implications for both buyers and sellers in transactions of sale of immovable property. To protect their rights and interests, the terms of payment and forfeiture of earnest money should be clearly set out in the ATS.