What do buyers and sellers need to consider when apportioning due diligence fees and earnest money deposits?

QUESTION: I handle residential sales and take filling out our contracts very seriously. I need some guidance regarding how to set a due diligence date when there is no earnest money deposit and how to advise clients when negotiating the DD fee and EMD. What is the relevance of a due diligence period in contracts that do not have any EMD and what should clients know when negotiating these fees and deposits in the standard purchase agreement?

ANSWER: First, you know that leaving the due diligence date blank can create ambiguity as we discussed here, while inserting N/A was discouraged here. Nevertheless, when there is no earnest money deposit, there would be no difference in the outcome of disputes between the parties if they had entered the Effective Date, the Settlement Date, or any date in between. In all cases, the buyer can terminate any time prior to the closing and the seller’s damages are limited to the due diligence fee paid. Further, we know from our article here that buyers who pay nothing in due diligence fees continue to possess all the due diligence rights to inspect and investigate the property. Even after a due diligence period ends, buyers continue to have the right to do inspections and perform their due diligence as discussed here.

Initially, a seller may think it best to negotiate all fees as due diligence, as those fees are typically nonrefundable. However, when the seller does not apportion some amount to earnest money, the buyers can walk away at the closing table and leave the seller knowing they just went through the expense of moving all their belongings out of the property. With an earnest money deposit and reasonable due diligence period established, a seller can keep the buyer invested and more likely to decide whether to proceed before the end of the due diligence period rather than just before closing. Additionally, large due diligence fees are more likely to be litigated by buyers who claim some material misrepresentation was used to induce them into contracting with the seller. Conversely, a large earnest money deposit that could have been refunded after a diligent inspection of the property puts both parties in a better position to weigh their options before closing.

Buyers certainly prefer to have the ability to recoup an earnest money deposit after undertaking inspections and other due diligence rather than committing to the due diligence fee at the outset. Rather than leaving the due diligence date blank, both sides of the transaction should seriously consider apportioning the initial payments between due diligence fees and earnest money deposits. In sum, the best practice is to discuss with your clients the advantages of having both a due diligence fee and an earnest money deposit in their purchase agreement.