Understanding Due Diligence and Earnest Money on the NC Offer to Purchase and Contract

Posted by Chad Hendrix on Thursday, December 8th, 2011 at 5:28pm.

In 2011, the North Carolina real estate commission introduced a revised Offer to Purchase and Contract (always seeking to protect consumers) and with that, a new term called "due diligence".  Well, change doesn't come easy for many folks and this new concept and contract didn't come easy for many NC Realtors either.  However, once you understand it, it's pretty cool and is definitely designed to protect both real estate buyers and sellers.

Prior to 2011, "earnest money" was the only money that was put up, up front.  Earnest money was put in place primarily to show "earnestness" from the buyer and to help compensate the seller for their lost time and opportunities (from other prospective buyers) if the buyer "flaked out" basically.  As long as everything went fine and the deal went to closing, the earnest money would be credited back to the buyer at closing and everyone was happy.  However, things didn't always go smoothly and buyers and sellers were sometimes left out in the cold.  Let me explain...

Due Diligence Fee

See, the earnest money would be returned to the buyers if their financing fell through for any reason.  This could be due to the loss of their job, them going out and buying a car or furniture (on credit) at the last minute and throwing their debt to income ratios off, or even a mistake by their lender.  Now, this is where the big problems came for the sellers.  Their home had been off the market (while under contract) for 3 weeks-a couple/few months waiting for this deal to close and at the last minute the buyer's financing could fall through and the seller would be left standing there with nothing to show but hardship, lost time, lost opportunities, etc.  And the buyer would be on their way...with their earnest money in hand.  You can probably imagine how devastating this could be to sellers.

On the flip side, sellers were not the only ones that could be hurt.  Buyers could also get their earnest money back if inspections had been done (the buyers cost), requests for repairs were given, and the seller refused to fix one or more things that were requested by the buyer.  Great for the buyer, right?  Well, not exactly.  See, while the buyer had a right to back out of the contract AND get their earnest money back, they were still left with lost time and were still responsible for the cost of the inspection ($350+), the cost of the lender ordered appraisal ($300+) if it had been ordered, survey if already done ($350+) and any other arrangements or incurred costs.  The buyer could "stick in there" and continue on but they're left with one or more things that will eventually have to be fixed on their dime.

Well, to help remedy these situations and others, the NC real estate commission came up with a revised Offer to Purchase and Contract in 2011.  The new offer still implemented earnest money but also introduced a "due diligence fee" and "due diligence period".

NC Offer to Purchase and Contract

The due diligence fee is an amount paid by the buyer directly to the seller that is theirs to keep, period.  If the deal closes, the buyer will have that amount credited back to them at closing but either way, that amount up front is the seller's to keep.  In addition to the due diligence fee, there is an agreed upon due diligence period.  The DD fee allows the buyer to conduct  "due diligence" at buyer's expense (inspections, appraisals, review of documents, survey, financing, obtaining insurance, etc) within the due diligence period and gives them the right to back out for any reason whatsoever...whether they flake out, simply fall out of love with the home, their financing falls through, etc.  The kicker is that, if they're going to back out of the contract for whatever reason, they need to do so prior to the end of the due diligence period.  Otherwise, they will not only have lost their due diligence fee but also their earnest money that was put up (and held in escrow) as well.  This is because with the new contract, there is no longer a financing contingency.  If the buyer backs out prior to the end of the DD date, they will at least get their earnest money back.

With the new contract, the buyer is given more freedom and the seller is protected from being left empty handed at the last minute if financing falls through.

 

Strategies for dealing with and negotiating the due diligence fee/amount and earnest money amount

As a NC/SC buyers agent:

When representing the buyer(s), I want the dd fee and earnest money amount to be as low as possible without insulting the seller or giving the appearance that we're just floating around wasting people's time.  The lower the amounts, the lower the risk of loss for my buyer.  In addition, I want the dd period to be extended out as far as possible.  The longer the period, the longer my buyer has to do his/her due diligence and feel comfortable that everything will be just fine with their loan, etc.

Home Buyer

What if inspections are done and my buyer is responsible for the cost of those inspections and then the seller says "I'm not fixing anything so you can just take your earnest money and go"?  Well, because of this, I DON'T typically order inspections right away.  I might have inspections scheduled 2-3 weeks out so that if the seller does end up refusing to fix one or more things, at least they've got a few weeks invested of their home being off the market and might be more inclined to work with the buyer in terms of getting those things fixed/repaired instead of having to go through that all over again with another buyer.  In addition, this gives my buyer more buffer room to get comfortable that his/her financing will be secured.  Hopefully, they have a really good idea of the likelihood of their financing going through prior to having inspections, appraisal, and survey ordered.  If that's the case, then they've only really lost the due diligence fee.

It's very important to ALWAYS keep track of this dd date (I put it in my calender with reminder notifications).  If more time is needed, go back and try to negotiate a date extension with the seller (they'll usually work with you if you've been proactive) PRIOR to the dd date ending.  Otherwise, you risk losing your earnest money.

Also, please note...prior to ever even submitting the initial offer for my buyer, I've already asked the listing agent many questions and probed the best I can.  I try to find out the sellers motivation for selling, what their situation is so that I can determine how eager they are, and have even asked the listing agent if they feel that the seller will be prepared for the repair requests that will likely be coming their way.  I do my own due diligence so to speak.

 

As the listing agent:

When representing the seller, I want the dd fee and earnest money amount to be as high as possible.  This says to me that the buyer HAS some cash, is serious (earnest) about making this work, and is willing to risk higher amounts.  And of course, if something does happen, my seller will be compensated just a little bit better.  Also, I want the due diligence period to be as short as possible.  A shortened dd period gives me confidence in the buyer's willingness and abilities to make things happen and it shortens the length of time that my seller's home is off the market should the deal fall apart.

Home Seller

Please note...the greater the amount of dd fee, the longer dd period my seller might entertain.  The smaller the amount off dd fee, the quicker my seller will want to see the buyer conducting their due diligence.

 

We hope that this helps you understand due diligence a little better.  
Please feel free to comment below if you have any questions, comments, strategies of your own to share, etc. and contact us directly if you'd like more information.

20 Responses to "Understanding Due Diligence and Earnest Money on the NC Offer to Purchase and Contract"

Sharan wrote: Well, doesn't this just open the door to buyer manipulation and abuse!!!

Posted on Sunday, June 29th, 2014 at 5:39pm.

Chad Hendrix wrote: Well, Sharan, all of these terms are negotiable and have to be agreed upon before there's a contract. A seller can always 1) ask for MORE due diligence money up front to help protect them in case the buyer backs out and/or 2) ask that the due diligence period be shorter so that the contract isn't tied up for too long before buyer backs out. And then if the buyer still backs out AFter the due diligence period ends, the seller would also get the earnest money.
The NC real estate commission works hard to protect consumers and I think they did a real good job enacting this. Once you truly understand it, you'll be able to see how it can really clean things up, protect both parties, and even expedite certain actions. I thank you for your comment :-)

Posted on Sunday, June 29th, 2014 at 5:49pm.

Cynthia wrote: I just signed a contract with all intentions of buying the property.[I have been looking for over a year with this realestate agent.I was told the buyer wanted $500. due diligence money and I love the property so much I agreed.the contract was binding on 7/15/2014 I did the inspection on 7/19/2014 I had to terminate the contract on 7/21/14 just as I got the report.There was so many things wrong with the property to do repairs would be very stressful.I wish I can share this report.I feel the owner knew that many things were wrong and she should not have asked for $500.00.I would like to know why I had to pay $500.00 for 6days.can anyone justify this.

Posted on Tuesday, July 22nd, 2014 at 10:59pm.

Chad Hendrix wrote: Cynthia, did you speak with your Realtor (your buyer's agent representing you) about this? I would start there and if you're not happy with what they have to tell you, you may consider speaking with their "broker in charge" who is kind of the one who oversees actions of other Realtors in the office. You can also speak with the attorney that you had lined up to do the closing. I hesitate to give any advice here because I do not know all the details of your transaction nor do I want to step of the toes of another Realtor who is working for you. I wish you the best in figuring this out and moving forward :-)

Posted on Wednesday, July 23rd, 2014 at 8:33am.

Heather wrote: I signed a contract for a brand new home on July 28th, 2014 with the following being part of the contract "Any unfinished work witin this new home must be completed prior to closing and at no cost to the buyer." On August 5th, 2014 I was forced to terminate this contract becuase the seller (builder) said within an E-mail that he was "unwilling" to complete many unfinished items throughout this new home. Wouldn't this be considered a "seller's failure to comply"? To add to this, he did not even sign the contract until after the Expiration of Offer time. I feel this is misrepresentation on the sellers part and I should receive my $750 Due Diligence back which he states he is unwilling to return. His home was off the market 8 days.

Posted on Thursday, August 7th, 2014 at 1:57pm.

Chad Hendrix wrote: Heather, I appreciate you writing in and hate that you had a bad experience. To answer your question, builders often force buyers to use THEIR contracts so I'm not sure if you're using one of their contracts or the standard NC Offer to Purchase. There is also a special Offer to Purchase specifically for New Construction but on that, there is no Due Diligence process so i'm assuming y'all either used the standard NC Offer or one provided by the builder. But, on the standard NC Offer to Purchase that I'm accustomed to using, the Due Diligence Fee is explained this way:

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"Due Diligence Fee": A negotiated amount, if any, paid by Buyer to Seller with this Contract for Buyer's right to conduct Due
Diligence during the Due Diligence Period. It shall be the property of Seller upon the Effective Date and shall be a credit to Buyer at Closing. The Due Diligence Fee shall be non-refundable except in the event of a material breach of this Contract by Seller, or if this Contract is terminated under Paragraph 8(l) or Paragraph 12, or as otherwise provided in any addendum hereto.
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And then, when I look at what Paragraph 8(l), it states:

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(l) Seller's Failure to Comply or Breach: If Seller fails to materially comply with any of Seller's obligations under this Paragraph
8 or Seller materially breaches this Contract, and Buyer elects to terminate this Contract as a result of such failure or breach, then the Earnest Money Deposit and the Due Diligence Fee shall be refunded to Buyer and Seller shall reimburse to Buyer the reasonable costs actually incurred by Buyer in connection with Buyer's Due Diligence without affecting any other remedies. If legal proceedings are brought by Buyer against Seller to recover the Earnest Money Deposit, the Due Diligence Fee and/or the reasonable costs actually incurred by Buyer in connection with Buyer's Due Diligence, the prevailing party in the proceeding shall be entitled to recover from the non-prevailing party reasonable attorney fees and court costs incurred in connection with the proceeding.
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I'm not lawyer but if everything is as you explained it and you were using the NC Offer to Purchase, it seems to me that you have a legitimate case here. Again, I don't know all the details surrounding you and I don't want to ever be perceived as someone giving you legal advice because since I'm not a lawyer, I cannot do that.

I hope you have a Realtor working with you as your buyer's agent. If so, did you speak with her/him? Have you spoken with the attorney that was set up to do the closing? Those are the first routes I would take (after carefully reviewing what your contract says of course).

I really wish you the best and would love for you to come back and give us an update on your situation. Will you do that?
Chad

Posted on Thursday, August 7th, 2014 at 2:15pm.

Heather wrote: Regarding seller's failure to comply comment:
Thank you for your reply. I was using the NC Offer to Purchase. My real estate broker initially stated to me personally that he should return my Due Diligence, but after he refused she has nothing more to say. He stated that he had until closing to finish anything unfinished, and because I did not give him until closing, it is therefore his by NC law. Now, if I were to have waited until closing for him to finish any unfinished items and then pull out, I would have also lost my Earnest money totaling $20,000.
I did not have a lawyer yet, because when I found this out I was only 6 days into the signed contract. In addition these were unfinished items which were obvious to the eye because I had not even had it inspected yet. I would like to consult with a lawyer but they are so expensive and if I lost I would have to pay his fees. Although, I do have his E-mail in which he states he is "unwilling" to fix certain unfinished items.

Posted on Thursday, August 7th, 2014 at 2:58pm.

Lydia wrote: What if a NC OTP is used and the due diligence clause is in there but the date was left blank? Is the contract even still binding if everything wasn't filled out? If there is no date then is the settlement date used as the expiration date for due diligence? What are the NC laws on this?

Posted on Tuesday, September 9th, 2014 at 11:15am.

Chad Hendrix wrote: Lydia, is this just a hypothetical or did this actually happen? Holy cow, how did this get past 1-2 Realtors?! Was there a DD amount listed and just no date or was there not even a DD amount listed at all? Now, I've seen some Realtors, especially early on, try to get past this and simply use the Earnest Money clause but in those cases, they would put N/A in there or simply put -0$- in the DD space with no DD date listed.

But, if in your case, they put a due diligence amount and no date, I would "guess" that the DD date would simply be the closing date or date of recording. However, this is something I'd ask the attorney about (if you're under contract then surely a closing attorney has been lined up) because I'm not a lawyer, just a Realtor with some understanding of contracts but will never claim to know the law :-)

Posted on Tuesday, September 9th, 2014 at 12:55pm.

Chad Hendrix wrote: Heather, are you still there? How did your situation turn out?

Posted on Tuesday, September 9th, 2014 at 12:57pm.

Siva N wrote: Chad, I am not sure how this change establishes a fairness between 2 parties. Sellers do not disclose everything about their home (even if they know it). The buyer has to take a chance and if they are like me, probably can't tell the structural integrity of the house, roof condition or any hidden plumbing issues. During inspection all skeletons (or most) come out and the buyer's have a limited choice - loose DD fee or buy it. I was in the market this year for a SF home and the first house I was interested, the seller did not disclose anything. The deal fell through as they didnt accept my offer, so I recovered my DD fee. Had they accepted it and I found more issues during inspection, how is it my fault and why should I loose the DD money for a defective product they are selling? Anything we buy these days have atleast 1 year manufacturer's warranty. When people invest thousands of dollars on their home, dont they have a right to expect a quality product? The seller may loose a few days of opportunity, but the buyer looses as well (in terms of time, inspection, appraisal costs etc). Most of the problems we have today is because of the lack of disclosures and assumptions the buyers have to make.

Here is how it could work. The sellers do an independent inspection and disclose everything they know, so the buyer's know what they are getting into before making an offer (still not 100% perfect, but it will be a much more educated decision from the buyer than an assumption). Seller can add that inspection fee to their selling price. This will force the sellers to price their property based on it's condition and the buyers know what they are getting into. Then they can negotiate an agreeable price. To be fair, the buyer's should be willing to forfeit the earnest money, if the financing don't go through, since it's is a buyer's problem and not the seller's.

Posted on Thursday, September 25th, 2014 at 2:58pm.

Chad Hendrix wrote: Siva, I appreciate your comments and thank you for "writing" in.
So, you definitely have some experience in this being that you were recently a buyer yourself. And from what you've said, you don't think it's fair.
Well, the first thing I want to point out is that this DD fee actually gives you a right to back out for ANY REASON whatsoever. There's freedom in that. By putting up a negotiable (and let me emphasize NEGOTIABLE) fee, you then get the right to back out You could back out if you don't like the way the sun rose that morning. You could back out even if the sellers agreed to fix every single item found on the inspection report. You could back out if you became a little unsure of your job security or for any personal reasons....and as long as you back out prior to the NEGOTIABLE due diligence date, you would only lose your DD fee and not your earnest money.

Think about it...as a buyer, you pay a DD fee (kind of like an option fee) and you get to sit on that home and have first right of refusal for as long as YOU like as long as it doesn't exceed the agreed upon DD date that you and the seller have already agreed upon.

Also, in case you're wondering about this "extra" fee being on top of or in addition to the earnest money that you also typically put down. Well, think of it this way....Let's say, hypothetically, that in the old days (prior to 3 years ago when there was no such thing as due diligence) you would have put down $1500 earnest money. Well, perhaps now you'd try putting down $500 of that towards the DD fee and then just $1000 towards the earnest money...just a thought.

And to address another one of your concerns, the buyer has always had some risk because they're always responsible for the cost of the inspection(s) whether it's with this DD clause or done like we used to do it.

Lastly, you mentioned a possible solution to much of this being that the seller could go ahead and have the home pre-inspected so to speak. Well, getting a pre-inspection is certainly a good idea and sometimes sellers do that but you can't require all sellers to agree to that. They may not be able to afford it up front and regardless, buyers will often want to get their own inspections anyway.

Oh, and regarding buyers losing their earnest money if the financing falls through....well, that's exactly what happens now IF the DD date has already come and gone and the financing then falls through. The buyers lose their earnest money too. As a matter of fact, they lose their earnest money regardless if they don't close and the DD date has already passed (unless seller breaches contract). In the old days, the sellers had NO protection if this were to happen. It could be the morning of closing and the financing could fall through at last minute and the sellers would still have to give the earnest money back and wasted allllll that time and other opportunities and have nothing to show for it.

Do you have any thoughts on what I've said, Siva? Shoot away because I love the dialog and opportunity to explore this further and have folks learn from it....

Chad

Posted on Monday, September 29th, 2014 at 2:44pm.

Andrew Lineberger wrote: I am a Realtor and I just represented both the buyer and the seller on a large and very expensive historic home. We added an addendum for a delayed due diligence fee because there were so many unknowns with the appraisal, and inspection because of the homes uniqueness. After the inspections and satisfactory appraisal was completed, then a large due diligence fee was collected. I think the Realtor Association should implement a standard addendum for delayed due diligence.

Posted on Sunday, October 5th, 2014 at 8:24am.

Chad Hendrix wrote: Andrew, I thank you for writing in with your comments on your recent experience. In response, couldn't you have simply put "$0" or "$250" (hypothetically) due diligence money in while still keeping the due diligence date in and then avoid having to add unnecessary paperwork?

Part of the reason this DD aspect of the contract is in there is to also protect the seller. In your case, the buyer was obviously apprehensive about putting non-refundable (even though it IS a credit at closing if closing happens) money up and the seller was obviously okay with the DD monies being paid at a later day. As long as the seller was okay with allowing the buyer to go ahead and proceed with inspections while home was "tied up" and them not accepting any compensation for it, then why not just put $0 in as the DD amount instead of yet another addendum? And then, instead of DD monies at a later day, just increase the amount of the earnest money.
Think about it...in this case, the buyer got everything they wanted. They were able to do all the inspections they wanted to do while having the freedom to back out if they weren't happy with the results. However, IF that had happened and the buyer HAD backed out, the seller would be left there with nothing but lost time off the market because their home was tied up under "pending" status with these buyers. The important thing in your case is that both parties agreed to this and that's what's really important. It's all negotiable.

Any thoughts?

Posted on Sunday, October 5th, 2014 at 8:52am.

Andrew Lineberger wrote: Every deal is different and this home was not on the market and it was also not being shopped around for buyers. If it were then the option you propose would be suitable. The current NC contract while they provide a blank for additional earnest money at a later date does not have an additional due diligence fee at a later date option. I have found in some situations that it would be helpful.

Here is another point to consider; Earnest money is held in trust and the person holding it cannot release it without both parties consent. If there was a breach by the buyer, the seller would not immediately receive the funds even though the contract says they are entitled to them. If the buyer refused to sign the money over it is not in dispute at which point it goes to court if the issue isn't resolved by the seller and the buyer but by the local judge. With a due diligence at a later date option it protects both the buyer and the seller in certain situations.

Like you said, it is all what people are willing to agree to and it is our job to find the best solution for our clients and tailor the paperwork and dates to the specific deals.






Posted on Sunday, October 5th, 2014 at 9:58am.

Janet wrote: When the buyer loses the DD money, does this become income to the seller? Can the buyer write this off as a deduction on income taxes?

Posted on Saturday, January 24th, 2015 at 2:31pm.

Chad Hendrix wrote: Hey Janet, thanks for writing in. I sure wish I had an answer for you but I just don't and can only suggest the obvious which would be to speak with an accountant or bookkeeper. As a matter of fact, I've been sitting here for the past 10 minutes pondering that and can't even hazard an educated guess. Will you please come back and let me/us know what you find out?

Posted on Saturday, January 24th, 2015 at 2:41pm.

S Lee wrote: I understand the concept that the due diligence period helps both the buyer and seller, but as a seller I feel it has me totally paralyzed. We received a contract asking for 3 weeks due diligence and 5 weeks to move in, with a $400 deposit. Our agent had not previously told us about due diligence and did not even then explain the period and amount are negotiable. We did counter with a later settlement date, which was agreed to. But we are now essentially sitting here waiting for the due diligence period to expire and unable to arrange for a new home or even do any packing (since the house may go back on the market). There were many other interested parties who won't even look at it now. We are watching houses we are interested in get purchased and are unable to even sign a lease on a rental because we would lose a lot more than the due diligence amount. A buyer's agent who thinks it's in the buyer's best interest to have a small deposit and long due diligence period may be encouraging frivolous, easily-canceled offers with virtually no consequences. My husband and I have bought and sold several houses in NC and other states and have found that the best prevention for contracts falling through is a pre-qualified buyer and a statement in the contract covering extent of repairs.

Posted on Saturday, February 7th, 2015 at 7:27pm.

Chad Hendrix wrote: Hey "S Lee", I really appreciate you chiming in with your experience. You're definitely right about feeling paralyzed. I think that there is going to be an element of that anytime a home is under contract because you never really know what COULD happen. In your case, do you think you'd feel a little more comfortable if there had been a higher due diligence amount given to you? I realize that you didn't understand that those were negotiable amounts (I'm disappointed to hear that) but had you known and negotiated a higher DD amount, you may have felt more protected and free to go ahead and make a move on something else, right?

Regarding your last sentence, my initial thoughts on that is that a "pre-qualification" never has any guarantees. However, the reputation of the mortgage company it's coming from is something to take note of. And a "statement in the contract covering extent of repairs" can leave openings for a buyer or seller to get out too easily I'd think...for instance, a repair guy who quotes repairs on the extreme high side might give the buyer an easy out when the repairs really shouldn't cost as much (If I'm understanding where you're going with that).

Again, I appreciate you writing in. Please keep me in mind if you know of anyone in the Charlotte region looking to buy or sell a home. We cover our bases well and work hard to protect our clients best interests. Keep me posted if you'd like and good luck!

Posted on Saturday, February 7th, 2015 at 8:11pm.

S Lee wrote: Chad, I don't think a higher due diligence deposit would have made me feel better in this instance, although maybe. A shorter period would have helped. Or a combo. The buyers are not flakes and our realtor says it's about as strong a contract as she's seen. In actuality, we are 2 weeks plus into the due diligence period (9 days to go) and had a very clean inspection. But we have yet to hear from an appraiser and the buyers are on a cruise. Presumably the realtors will sort this all out but under the best of circumstances something could go wrong and the buyers back out. Meanwhile, we run the risk of losing a lot of money ourselves.

Posted on Monday, February 9th, 2015 at 4:45pm.

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