4.2 Handling Earnest Money & Security Deposits

Handling Earnest Money & Security Deposits

The handling of escrow funds—specifically buyer earnest money deposits in sales transactions and tenant security deposits in leasing operations—is subject to precise statutory timelines, strict fiduciary duties, and civil statutory liability in Texas. License holders must navigate two distinct regulatory frameworks: the administrative rules of the Texas Real Estate Commission (TREC Rule 535.146) and the statutory landlord-tenant provisions of the Texas Property Code (Chapters 92 and 93).

Candidates preparing for the Texas Real Estate Broker Examination must master the exact calculation of deposit deadlines, the legal requirements for security deposit accountings and refunds, bad-faith statutory penalties, and the formal judicial procedures required when escrow funds are disputed.

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1. Earnest Money Timelines: Broker vs. Title Company Escrow

In Texas real estate transactions, earnest money represents good-faith consideration deposited by the buyer to demonstrate serious intent to perform under the contract. The regulatory deadline for depositing or delivering earnest money depends entirely on who holds the funds.

┌────────────────────────────────────────────────────────────────────────┐
│                     EARNEST MONEY DEPOSIT DEADLINES                    │
├──────────────────────────────────┬─────────────────────────────────────┤
│ BROKER AS ESCROW HOLDER          │ TITLE COMPANY AS ESCROW AGENT       │
│ (TREC Rule 535.146)              │ (TREC Promulgated Contract Para 5)  │
├──────────────────────────────────┼─────────────────────────────────────┤
│ • Deposit by close of business   │ • Buyer delivers within 3 CALENDAR  │
│   on the 2ND WORKING DAY after   │   DAYS after the contract effective │
│   contract execution by parties. │   date.                             │
│ • Working days EXCLUDE weekends  │ • If 3rd day is Sat/Sun/Holiday,    │
│   and official state/fed holidays│   extends to 5:00 PM next bus. day. │
│ • Strict regulatory requirement  │ • Failure to deliver gives seller   │
│   enforced directly by TREC.     │   right to terminate under Para 5.  │
└──────────────────────────────────┴─────────────────────────────────────┘

The Broker 2nd Working Day Rule (TREC Rule 535.146(b)(1))

When a broker receives earnest money or other trust funds that the broker is designated to hold:

• The broker must deposit the trust money into the broker's trust account not later than the close of business of the second working day after the date the broker receives the trust money, unless otherwise agreed in writing.
• If the trust money is received in connection with an executory contract (such as a pending purchase contract), the broker must deposit the money not later than the close of business of the second working day after the contract is fully executed by all parties.
• Definition of Working Day: Working days include Monday through Friday, excluding official federal and state bank holidays. Saturdays and Sundays are never counted as working days.

The Title Company 3-Calendar-Day Rule (Paragraph 5)

Under Paragraph 5 of the TREC One to Four Family Residential Contract (Resale):

• The buyer must deliver the earnest money to the designated title company/escrow agent within 3 calendar days after the effective date of the contract.
• Calendar Days vs. Business Days: Unlike TREC Rule 535.146, contract Paragraph 5 counts consecutive calendar days (including weekends and holidays). However, if the final day of the 3-day period falls on a Saturday, Sunday, or legal holiday, the delivery deadline is automatically extended to 5:00 PM on the immediately following business day.
• Receipting: Upon receipt, the title company must execute the "Receipt" section on the contract and deliver copies to both buyer's and seller's brokers.

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2. Residential Tenant Security Deposits (Texas Property Code Chapter 92)

Residential leasing in Texas is governed by Texas Property Code Chapter 92, Subchapter C (§§ 92.101–92.109). When a property manager or broker collects a security deposit from a residential tenant, the deposit remains the legal property of the tenant throughout the tenancy, held in fiduciary custody.

┌────────────────────────────────────────────────────────────────────────┐
│               RESIDENTIAL SECURITY DEPOSIT STATUTORY RULES             │
├────────────────────────────────────────────────────────────────────────┤
│ 1. Mandatory Trust Account Custody:                                    │
│    Must be deposited into a segregated trust account (TREC 535.146).   │
│ 2. Dual Statutory Refund Triggers:                                     │
│    The 30-day statutory clock begins ONLY when the tenant:             │
│    • Surrenders physical possession of the premises; AND               │
│    • Provides a WRITTEN forwarding address to the landlord/broker.     │
│ 3. 30-Day Mandatory Accounting & Refund:                               │
│    Within 30 calendar days of satisfaction of both triggers, landlord   │
│    must refund the deposit balance OR deliver an itemized deduction    │
│    accounting with any remaining funds.                                │
│ 4. Normal Wear and Tear vs. Tenant Damage:                             │
│    Deductions for normal wear and tear are STRICTLY PROHIBITED.        │
└────────────────────────────────────────────────────────────────────────┘

Normal Wear and Tear vs. Actionable Tenant Damage

Under Texas Property Code § 92.001(4), normal wear and tear is defined as:

$\text{"deterioration that results from the intended use of a dwelling, including... breakage or malfunction due to age or deteriorated condition."}$

It does not include deterioration resulting from negligence, carelessness, accident, or abuse by the tenant, guests, or invitees.

| Permissible Deductions (Tenant Damage) | Prohibited Deductions (Normal Wear & Tear) | | :--- | :--- | | | Large holes, gouges, or unauthorized anchors in drywall | Minor pinholes or small nail holes from hanging pictures | | Pet urine stains and deep carpet burns | Faded or worn carpet traffic patterns from regular walking | | Broken window glass or shattered mirror panels | Minor scuff marks along baseboards and hallways | | Missing or broken light fixtures and ceiling fans | Paint fading or peeling due to sunlight or aging | | Clogged plumbing drains caused by foreign objects/grease | Leaking faucet washers or worn plumbing gaskets |

The Itemized Written Accounting Mandate

If the landlord or property manager retains any portion of the security deposit to cover tenant damage or unpaid rent, the broker must provide the tenant with:

1. A written itemized list describing every specific deduction; and
2. The exact dollar amount attributed to each repair item.

Exception: The landlord is not required to provide an itemized list if the tenant owes delinquent rent that is undisputed and there are no damages beyond unpaid rent.

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3. Commercial Tenant Security Deposits (Texas Property Code Chapter 93)

Commercial lease transactions operate under a separate statutory framework set forth in Texas Property Code Chapter 93 (§ 93.005). Candidates must remember the key differences between residential and commercial security deposit rules:

┌────────────────────────────────────────────────────────────────────────┐
│                   COMMERCIAL SECURITY DEPOSITS (CHAPTER 93)            │
├────────────────────────────────────────────────────────────────────────┤
│ • Refund Deadline: 60 CALENDAR DAYS (compared to 30 days residential). │
│ • Dual Trigger: Tenant must surrender premises and provide written     │
│   forwarding address.                                                  │
│ • Retention for Breach: Landlord may retain security deposit to offset │
│   future rent obligations or re-letting costs if permitted in lease.   │
│ • Bad-Faith Penalties: Identical treble damages structure ($100 + 3x   │
│   withheld amount + attorney fees under Tex. Prop. Code § 93.011).     │
└────────────────────────────────────────────────────────────────────────┘

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4. Statutory Penalties for Bad-Faith Retention

Under Texas Property Code § 92.109 (residential) and § 93.011 (commercial), the Texas Legislature established harsh statutory damages to deter landlords and brokers from wrongfully withholding security deposits.

                    ┌──────────────────────────────────────────────┐
                    │      STATUTORY BAD-FAITH PENALTY FORMULA     │
                    │          (Tex. Prop. Code § 92.109)          │
                    └──────────────────────┬───────────────────────┘
                                           │
         ┌─────────────────────────────────┼─────────────────────────────────┐
         ▼                                 ▼                                 ▼
┌─────────────────┐               ┌─────────────────┐               ┌─────────────────┐
│ STATUTORY FINE  │               │ TREBLE DAMAGES  │               │  ATTORNEY FEES  │
├─────────────────┤               ├─────────────────┤               ├─────────────────┤
│ • Flat $100 fee │               │ • 3 TIMES the   │               │ • Full recovery │
│   assessed by   │                 amount of the   │                   of tenant's   │
│   court         │                 deposit that was│                   reasonable    │
│ • Non-negotiable│                 wrongfully      │                   legal fees &  │
│   statutory base│                 withheld        │                   court costs   │
└─────────────────┘               └─────────────────┘               └─────────────────┘

Statutory Presumption of Bad Faith

If a landlord or managing broker fails to either return the security deposit or provide an itemized written accounting within 30 days (60 days for commercial), the law creates a rebuttable statutory presumption of bad faith:

• The landlord forfeits the right to withhold any portion of the deposit;
• The landlord forfeits the right to sue the tenant for property damages; and
• The landlord becomes liable for the full statutory bad-faith penalty: $100 + (3 × Amount Wrongfully Withheld) + Reasonable Attorney's Fees.

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5. Disputed Earnest Money & Judicial Interpleader Actions

When a real estate purchase contract terminates and both buyer and seller claim entitlement to the earnest money, a broker holding the escrow funds faces significant fiduciary and legal exposure.

┌────────────────────────────────────────────────────────────────────────┐
│                     ESCROW DISPUTE ABSOLUTE PROHIBITIONS               │
├────────────────────────────────────────────────────────────────────────┤
│ • A broker CANNOT act as a judge or unilaterally decide which party   │
│   breached the purchase contract.                                      │
│ • A broker CANNOT disburse disputed earnest money based solely on one  │
│   party's verbal or unilateral written demand.                         │
│ • A broker CANNOT disburse funds without:                              │
│   1. A fully executed Mutual Written Release (e.g., Form TAR-1801); OR │
│   2. A final, non-appealable court order from a court of jurisdiction. │
└────────────────────────────────────────────────────────────────────────┘

The Mutual Release Protocol

The standard, non-judicial resolution requires both parties to execute the promulgated Release of Earnest Money Form (TAR-1801 / TXR-1904). This document specifies the exact dollar allocation to the buyer, seller, and third-party service providers (e.g., title fees, survey costs), and releases the brokers and escrow agent from all future liability.

Judicial Interpleader Procedure

If the buyer and seller refuse to execute a mutual release and remain deadlocked, the broker or escrow holder must file an Interpleader Action in a Texas court of appropriate jurisdiction (Justice of the Peace Court, County Court at Law, or District Court depending on the disputed dollar amount):

1. Filing Interpleader: The broker files a petition naming the buyer and seller as competing adverse defendants, disclaiming any beneficial interest in the funds.
2. Deposit into Court Registry: The broker deposits the full disputed escrow amount into the official registry of the court.
3. Recovery of Attorney's Fees: Under Texas common law and civil procedure rules, an innocent stakeholder forced into court by conflicting claims is entitled to deduct its reasonable attorney's fees and court filing costs directly from the disputed escrow funds.
4. Judicial Discharge: The court issues an order dismissing the broker from the lawsuit with prejudice, leaving the buyer and seller to litigate ownership of the remaining funds.

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6. Escrow & Security Deposit Timeline Comparison Matrix