I have to agree with Terri and add,
Is the loan contingency for FUNDING or is it for APPROVAL?
Every state and every CONTRACT is different depending on WHO wrote it regarding modifications and interpretation. You could have two identically written contracts being decided by the same person. But when arbitration comes into play, the person making the decision will look at ALL the facts and hear testimony (and quite frankly they are human) and even rule based on whether their dog crapped on the rug that morning or whether the deciding person found out they were going to have a baby after years of trying. This wild card in contracts is called "intent" or "good faith".
So, what I have learned after spending TONS of time on Trulia, is that the protocol I have experienced in IL IN THE PAST is that the loan APPROVAL contingency is usually removed before the house is even considered being sold and heading toward escrow closing. But in other parts of the country (such as CA) or smart buyers or buyer's agents will leave that contingency in place until FUNDING has actually occurred. To me, this is a Catch 22. Funding occurs when the funds are secured by ownership of the property, but ownership of the property requires funding. It's a hostage negotiation. Both parties have to trust that on the count of three, the other party will trade. If one pretends to do this, the other party no longer has any leverage.
Since I really don't understand California's escrow procedures, my comments are really based on theory as opposed to practice. If the buyer's "change of heart" is due to a memo that layoffs are occurring at work and the lender requires proof of future employment, yes this IS a LEGITIMATE way for them to get out. If the buyer's simply refuse to sign the paperwork, then they are in breach of the contract and you ARE entitle to the earnest money. The big question is, is it really the buyers who are having a "change of heart" or is it the lender? Disclaimer, I'm not an attorney - please seek legal advice.