Legal Blog

The Risk is Real: Customer Deposits Lost in Bankruptcy (Part 2 of 3)

This is the second post in the three-part blog series, The Risk is Real. Click here to read Part One.

What should you do?

  1. Read your contractReally read it!  If you do not understand it, or parts of it, then ask a friend or relative who is a lawyer to read it and explain it to you.  If you do not have a friend or relative who is a lawyer, then hire a lawyer to read the contract and explain it to you.  In the case of the home builder, the provision regarding the deposit is set forth below, and it is by no means a model of clarity.  In speaking with the customers, most read the first sentence and assumed their deposits were put in escrow.  However, the contract stated that no escrow was required if the builder posted a sufficient bond or letter of credit:

“The Deposit either shall be held by Seller in an escrow account as required by Section 10-301 of the Real Property Article of the Annotated Code of Maryland, which shall not earn interest; or in lieu of holding the Deposit in a special escrow account, Seller may post a bond or letter of credit to the State of Maryland in accordance with the provisions of Section 10-301 et seq. of the Annotated Code of Maryland Real Property.  The Deposit, notwithstanding any escrow, shall become property of the Seller when and as it is paid, subject only to Seller’s pre-Settlement obligations under this Contract…”

  1. Now, forget about what your contract saysYour contract is probably worthless if the company goes broke!  A typical consumer contract is an agreement with another party to provide a service to you or to sell you a product. If the contract requires you to put down a deposit, then your deposit is at risk from the moment you pay it until the company fully performs its end of the bargain.  It takes a home builder several months after a contract is signed to complete the construction of a new home.  In the case of a wedding venue, it is likely to be at least a year from the day you pay the deposit to your wedding date.  The contract may require the other party to put your deposit into an escrow account.  By the terms of the contract, your deposit appears to be safe.  However, when a company is cash starved, the owners will be sorely tempted to take risks to stay afloat, often at their own detriment, such as failing to pay sales or payroll taxes, or dipping into funds held in escrow that the company may not be legally entitled to spend.  Despite your contractual protections, if the company goes broke, you are left with a broken promise by a defunct company. Notwithstanding the importance of reading and making sure you understand your contract, you also have to realize that the contract is simply a promise to do or not do certain things. The promise is only as good as the financial health of the promisor.
  2. Ask about any insurance or bond in placeYes, Ask!  Before you sign the contract and write that big deposit check, ask the company if there is an insurance policy or bond in place to protect your deposit.  If the company assures you that they are insured and/or bonded, do not take their word for it.  Ask to see the  policy or the bond.  According to some accounts, if a nervous investor whose entire financial savings was invested with Bernie Madoff paid a visit to ask about their portfolio, he would write them a (worthless) check to return all of the investment and give them a warm, reassuring smile as he handed them the check.  Amazingly, legend has it, these investors fell for his bluff, ripped up the check and apologized for bothering him.  Ask to see copies.  Read the documents.  What is the total coverage?  Keep in mind, you are not going to know how much risk is outstanding that is also covered by the policy or the bond, but at least you have some idea.  If the total coverage is $100,000 and you are dealing with a home builder, you can safely assume the company has substantially more in unearned deposits than $100,000 in coverage.  Also, does the policy or bond expire or are any large premiums due during the time period of your contract?


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