Earnest money

What it means

Earnest money is a sum of money or other value that one party gives the other when concluding a contract to confirm that it will perform. It is a security instrument regulated by the Slovak Civil Code and is used in practice mainly when buying property or cars and for reservations.

If the party that gave the earnest money fails to perform, it is forfeited to the other party. If the party that received it fails to perform, it must return double the amount. If the contract is performed, the earnest money is credited against the price or returned.

Earnest money must be distinguished from an advance payment or deposit received. An advance is merely payment ahead of time and is refunded if the contract is not performed, whereas earnest money acts as a sanction and motivates both parties to perform. The contract must make clear which it is.

How it works in practice

In contracts where a client pays or receives a larger sum upfront, such as a property purchase or reservation, we recommend stating expressly whether it is earnest money, an advance or a contractual penalty. Each has different consequences, and vague wording leads to disputes.

Earnest money is often combined with a preliminary contract. The buyer pays it on signing the preliminary contract, and both sides are motivated to conclude the main purchase contract. If one fails, the rules on earnest money apply.

In the accounts, earnest money received is carried as a liability until the contract is performed. If it is forfeited to the recipient, it becomes their income and the payer’s expense. For VAT, it must be assessed whether it is consideration for a supply or a penalty payment outside the scope of VAT.

What to watch out for

A common mistake is calling a payment “earnest money” while agreeing that it is refunded on withdrawal; in substance it is then an advance. Conversely, a contract referring to a forfeitable “advance” may be treated as earnest money or a contractual penalty. Substance decides.

With consumers, a court may review whether earnest money is proportionate. A disproportionately high amount forfeited to the business may be treated as an unfair term in a consumer contract and be invalid.