Based on this question about wholesaling homes - what happens if somebody purchases a home at auction, places their down-payment, cannot find a buyer, and backs out of the auction? I'm assuming they would forfeit their down-payment, but what else happens, in general?
It depends on the circumstances of the sale, the jurisdiction, and the auctioneer. It also depends somewhat on when or how the buyer backs out. Skip to the very bottom if you just want an answer to the exact scenario you've presented in your question.
Given your mention of real estate, my answer focuses on real estate auctions specifically, and is written from the perspective of working for a financial institution that has a big slice of the local mortgage market. Because of that local mortgage presence, we are involved in a large portion of the foreclosures and subsequent auctions within our market. We are often taking the role of the seller in local real estate auctions to sell properties we've had to repossess. And, since we finance many of the local real estate investors and individual homeowners, we are also often involved with buyers at auctions, as well (either giving them loans, or because they're using a line of credit or deposit account we hold to make the purchase). This involvement from both sides of the process gives a very holistic view on behaviors around, and after, real estate auctions.
It's important to point out that there are a whole spectrum of situations even within real estate auctions. A government-run auction for land that's been seized because the owner failed to pay property taxes will behave differently than a government-run foreclosure auction, and different again from a private auction where the seller is a bank trying to sell property it essentially bought from itself for a dollar because no one showed up at the foreclosure auction, which will be different still from a private auction for a private owner who is just trying to get rid of a home as quickly as possible for whatever reason. Upfront requirements (such as whether or not a wholesale-style deal can even happen) and behaviors with respect to buyers backing out will vary significantly among these different types of real estate auctions. This makes it hard to extrapolate a general case for all real estate auctions, much less for all auctions in general.
In many cases, buyers at real estate auctions are expected to demonstrate up front that they have assets to cover the expected sale price for the property being auctioned, before even being allowed to bid. Buyers will also usually be required to sign a contract specific to the terms of that auction before being allowed to bid. Real estate auctions are often for large amounts of money and real estate transactions involve significant paperwork and process, so everyone involved likes to protect themselves upfront. Especially the seller.
In an auction that allows wholesaling, these various provisions are essentially used for putting the wholesale investor in a position where they can (at least theoretically) be held liable to actually purchase the home if they can't flip it. Often, a buyer attempting to wholesale will have to put assets sufficient for the purchase price in escrow at or before the auction. They may also have to sign a contract that essentially says they're taking out a short term balloon loan from the seller, to be paid in full when the actual closing happens.
With all that said, let's get to your question:
what happens if somebody purchases a home at auction, places their down-payment, cannot find a buyer, and backs out of the auction? I'm assuming they would forfeit their down-payment, but what else happens, in general?
Before covering your exact scenario, let's cover some other "I'm backing out" scenarios for real estate auctions, just to paint the full picture:
- If the seller backs out early - after placing a bid but before any money changes hands, it will likely be the case that the property is just put right back on the block, or sold to the next highest bidder, and the worst thing that happens is that the buyer is blacklisted (which is common for real estate auctions even though it's uncommon for general auctions). Sometimes this all happens immediately and/or behind the scenes and people who aren't paying attention might not even realize what happened. This is essentially the case covered so well in blankip's answer.
- If money has changed hands (i.e. a down payment) and then the buyer backs out, that money is almost always forfeit. Some auctions require you to place your down payment amount in escrow before bidding as a way to discourage people from backing out.
- In some cases, the seller (not the auction house) may decide to pursue the buyer for breach of contract if they back out, even if they don't attempt to legally "force" the buyer to complete the purchase and buy the home. It's a pretty easy case to demonstrate that the buyer's failed purchase cost the seller in various ways, and it's typical for these lawsuits to be for an amount to cover the auction costs and any appraised loss in value. For many foreclosed homes, these numbers can represent a significant portion of the purchase price. If a bank owns a home that they can only sell for $50,000, and a failed bidder (who's assets they may even have easy access to) has cost them $5,000 in losses, that's a pretty attractive lawsuit from the bank's perspective. You don't want to walk away from 10% of your asset, just because someone changed their mind.
- Finally, in the case of a wholesale transaction, as in the thread you've linked, the common "failure" scenario is that the investor will fail to find a buyer. In those cases, if the buyer tries to back out, it's essentially "after" the auction, and even if the deal hasn't closed, it's pretty much considered locked in. As such, the seller is much more liable to take legal action than in the above cases. They will try to collect on the outstanding balance owed and/or repossess the property (if ownership has legally changed hands) so they can sell it again and recoup their loss.
To expand on that last point, if what you're really interested in is people who attempt to wholesale a home, place the highest bid, sign the contract at the auction, make their down payment, but then subsequently fail to find a buyer, the usual way this plays out is as follows:
- Big investors who have a portfolio of real estate they're managing will almost always just follow through and buy the house themselves, rather than literally try to back out. Ultimately this is easier (and much better for their reputation) than actually trying to back out of the sale and getting hassled by collectors, lawyers, and the repo man. And, at any rate, an investor being "forced" into buying a house isn't always a bad thing. Sometimes they can still actually sell the house for a profit, just not in time to literally wholesale it without fronting the full purchase price. Ultimately it may still be a good deal, but they just lose the leverage inherent of the wholesale process. Other times they may lose a lot of money because the house needed a lot of repairs or had other issues.
- Small time investors behave less predictably. Sometimes they too will just buy the house, if they don't find a buyer. Sometimes they then flip it and make a profit. But other times, they do try to back out, and because they do so late in the process they usually end up on the hook in one way or another. Depending on how the deal was written and what jurisdiction it was sold in, the property may have legally changed hands as of the auction itself, and/or there may be an actual outstanding debt already on the books (essentially, a loan due in full at the future closing).
If a wholesale buyer tries to back out, that's roughly equivalent to walking away from a mortgage. There are a number of repercussions:
- The seller will repossess the house, auction it or otherwise sell it again,
- The seller will then go after the (original) buyer for any difference between the second auction and the first one, plus costs involved.
- The buyer will see a defaulted loan on their credit report, which will ruin their credit history
- The buyer will almost certainly be blacklisted from participation in future auctions and/or any future business with the seller they caused the loss to.
I know this was a long winded answer, and a significant edit based on your comments above, but I hope it helps clarify the differences between reneging at an auction in the general case, versus walking away from a partially-completed wholesale deal.
I grew up working in auction houses in a rural area - family owned on most of them. I was young - so I was not the auctioneer, nor the management staff. But I did see how things work and I did help sell - mobile homes, regular homes, cars, kids toys, business liquidations, clothes, antiques, paintings, rugs, seasonal business leftovers - whatever. I met Sam Walton at 12 years old arranging a deal to drop of truckloads of Walmart goods to our auction houses and flea markets.
People at all levels renege. There is simply nothing you can do about it. Item gets offered to the next highest bidder (not counting any of the person who backed out bids) or it goes back up for auction again, sometimes the same day/time slot. Yes this includes houses.
It is very hard to near impossible to enforce someone raising their hand or bid card in the court of law. I had uncles who had been in the business for 50+ years that explained this to me many times as there was always this type on a weekly basis. Simply if you tried to sue someone the person could either play dumb or just say they were drunk/drugged up (cannot enforce a contract with an inebriated)... So as a business you would never think about taking someone to court unless you could prove that there was a ring of people trying to deceive or preconceived conspiracy to ruin your business. It just doesn't happen as it would never work out cost-wise - it would cost you more to sue them then the difference in price from another auction plus you may be suing a person with no money. No business does this.
So why do people do this?
Sometimes regret, sometimes drunk, sometimes they didn't realize they didn't have the money, sometimes their wife won't let them buy it... whatever.
What about big things like cars and houses?
It is up to the auction house to manage their clients. You put up something at an auction house because of its reputation coming through - people use Christie's or Sotheby's because they have a history of selling big items and having people pay for them. When we sold houses we either personally vetted for each bidder (if grandma knows you, you are good) or you come with a minimum 20% down in form of cashiers check. I am telling you if you show up to buy a house and no one knows you, and even if you look the part... there will be a thorough inspection of your check and good chance they call the bank to verify. Know too that the smart bidders that are there to flip bigger things will stay until close and basically verified everything has been paid for. Many times a person did not pay and someone comes in after and just personally offers something to seller. Deal done - again auction house may waive all or part of commission.
Don't people go nuts if they don't get paid?
It is usually in the contract with auction house. The auction house liability ends at a certain demarcation and the sellers know. The auction house wants to sell the item for the most amount and get the buyer to pay so they can get commission. The auction house will quickly work out what is the best way to make profit when an issue arises (talking to others that bidded, getting item up for bid again and so on).
What happens to people who welsh?
A lot of the time nothing. You don't know how many times an honest person didn't buy something for whatever reason. As long as the management thought it was honest and not a big deal (wife doesn't want it was a big one) then item simply goes back up for reauction - sometimes auction house sells it without commission. It is the cost of doing business. You do not want to kick out a guy who has bought 50 things from you because he wants to welsh on a painting. For bigger things like houses the person might get banned or have to provide a higher down payment. There is no exile island thing... Again you want more bidders.
Why not escrow?
Well we tried this with both cashiers check and credit card. The fact is without lawyers or the law on your side you have the same issues. Maybe there is the psychological effect where a bidder understand the auction house already has my credit card on file... however you have the same issue. The bidder can go home without item, refuse it, and dispute with credit card company. Then if you fight with them, they never come back or you have to kick them out. Plus you may lose that fight or may pay way more to fight it than it is worth. There is a good answer here for government auctions, which are more straight laced. But these requirements usually mean lower selling prices as it takes out a lot of buyers. Someone auctioning their house would choose private auction vs govt. almost all the time.
So the right answer is the exact opposite. You don't sue, you let the bidder back in - with way more verification on paying (which could be prepayment).
As @dwizum points out in their answer it will depend on the circumstance of the sale and the jurisdiction.
Aside from the down payment, the auctioneer will typically require evidence that you have sufficient assets to cover your full bid. If you don't come through with the payment, they can come after those assets. If the auctioneer thinks it's worth pursuing, they could get a debt judgment against you in court. With the debt judgment the auctioneer could then seize bank accounts, seize property, and garnish wages. If you own a business, they can walk into your business with a sheriff's deputy, open your cash register, and take all cash on hand. They can keep doing that until the debt is satisfied, or you get a court to declare you bankrupt.
If you lied to the auctioneer about your assets, then you are possibly looking at criminal fraud charges.
Here's a small glimpse of the general overlay of this concept from a government land perspective: https://www.governmentauction.com/ViewUserDefinedPage.aspx?pn=FinanceLand
Now, private organizations, banks, and the likes may have other arrangements that need to be met according to their own terms of service. But in the first statement from the government land auctions states that the buyer is automatically assumed a loan regardless of credit history and is held to that loan as far as the law is concerned.
Generally that means the same things happen that would happen for a conventional home loan. You lose and the property is seized. You will no doubt lose your investment as typically the auction values reflect the owed value on the property. Your new flip prospect likely did not appreciate so there will not likely be anything to return to you once the debt is settled. So no, you are most likely not going to be sued.
Most likely stems from the concept that many property holdings can own the properties and auction at their terms, which may have other rules and agreements that will no doubt be buried in the fine print. However, you have to remember that the goal of property auctions is not to retain property. They want the cash, so they are not going to construct a system beyond the management of your average buyers, and it will be based on averages as is just about all financial risk assessment.
So to round back a bit. If someone buys a house on a conventional loan and it's foreclosed, the auction value tends to begin at the recovery value. That's why you see such wild varying rates for opening bids, and why a lot of newcomers to the field get dissuaded from the whole thing. They thought property auction was like that classic film where (i think gregory peck) buys a house at a silent auction for some tiny sum of money. That does happen, but through blind luck mostly. Financial institutions that tend to foreclose on properties also have infrastructure in place to offload those assets quickly and efficiently. That means they usually have a third party retained to bulk purchase the properties or manage them while they are still in the institution's holdings. Those organizations don't have to follow the outline in the link I provided as they are not government institutions auctioning off government land.
However, this does not mean they haven't calculated this scenario. They will have something on paper binding you to the sale no differently than any other piece of property, with their own financing options as a possible presence to fall back on the cases where the funding was not clear as day. This could vary from state to state, and from organization to organization.
That being said, the best way to know for sure is to attend a property auction and ask the auctioneers what the rules on this subject are for that particular auction.
Like any major investment, you are going to want to go in informed. There will be no all inclusive book to read in the comfort of home. You'll have to get out there and ask around. Even if you don't have the funding for even the downpayment right now, you should start your research now while amassing as much as you care to outright lose on an investment that can make or break you. If your state, or the property holding company spells out the financial details, then it is up to you to secure your own structure based on the limitations and allowances they define for you. And that includes the notion of "backing out" of an auction, which you may want to clarify specifically because that does happen. 2 people representing a development company authorized to buy one property accidentally bid on a second while assuming they lost the first and then get surprised to find they now have to cough up a down payment for a second. What happens then? See Dwizum's answer for that because they are not wrong. Especially the part about being blacklisted. Fool me once, as they say.
But don't be wholly alarmed. Almost all of these places have the payment structures laid out by the greediest lawyers this side of the mississippi. It is a LOT easier to make someone pay what's effectively a "restocking" fee, or service fee, than trying to sue them. That is often much less than the deposit you pay to even be allowed to enter the auction - in my state you bring a cashier's check for $10k. I have never seen that number vary, but I don't attend every auction that swings my way anymore. Nor have I bothered looking at the fees for backing out because we always went with actual intent and financing secured. But alas, it is a valid question and one that can really only be trusted from the mouth of the horse itself.
Hopefully this helps a little. The TLDR version is simply that you have to ask the auctioneers when you go.