Interesting situation, buyer about to lose $10k in earnest money

[Derek Robinson]

I've got a house under contract, I'm the seller.  Buyers offered full price, $1,000 due diligence and $10k earnest money.  It is supposed to close Monday, the 31st.  We just found out Wednesday that their lender didn't realize it was an investment property, they thought the buyers would be living there.  They don't lend on investment properties, so their loan is dead.  They are qualified buyers, own other rentals, and where putting down around $100,000 on the $375,000 price.

It is a multifamily (one large house and two small cabins).  While we were in negotiations, I was in process of placing tenants in the house and cabin.  They strongly wanted me to leave them vacant, which I did for their benefit.

Now that they are wanting a 30 day extension to start over with a new lender, I'm asking for a slightly higher asking price to compensate for my lost rents over the past two months, the extra mortgage payment I'm having to make, and a few hundred for utility payments.  This number totals $7,740.

Now they are looking for ways to back out of the contract.  I'm not quite sure that they want to back out, but I guess they are worried about IF something happens, they don't want to lose their 10k earnest money.  The latest was they went to the county to see if permits were pulled for some work done to the house.  Apparently they think if all work ever done to the house was not permitted, that would constitute a breech of contract.  The house is 100 years old, so obviously over the years there have been additions and work done that was never permitted.  If you look at the county's GIS page, it shows the layout/floor plan of every unit on the property just as it is, complete with square footage, number of bathrooms/bedrooms, etc.  The county did tax reassessments 3 years ago and grandfathered everything in.

I've got a great realtor and their firm is one of the largest in the area.  The broker is pretty certain that lack of permits would not constitute a breech of contract, especially since the county's records match up to the property's condition.  It's not like the county says it's a 1 bedroom, 400sqft and it's actually 5 bedroom 3,000sqft.  I had it appraised to get refinanced not long ago and the current buyers had it appraised.  Both appraisals came back clean with no issues with the county.

Thoughts?  Anyone had a similar situation?

[Ryan Murdock]

@Derek Robinson Is the buyer's offer contingent on financing? I'd expect it would be, and if so, they are likely entitled to their EMD back unless maybe you can somehow show they willingly deceived you and their lender?

Also, is there specific language in the contract that spells out what the required course of action is if the initial lender is unable to fund? Something along the lines of "Buyer has x days to notify seller and x days to provide proof of application with another lender..."?