What is an Escrow Contract?
An escrow contract is an agreement used to protect the commitment of a buyer and a seller during a real estate transaction. Specifically, an escrow contract establishes the condition under which ownership of real property will be transferred – typically, the payment of a stated amount of money by the buyer to the seller. Escrow contracts are formalized when the buyer and seller, in the presence of a third party escrow agent, deposit all necessary transaction information and funds into the office of the escrow agent.
Escrow acts as a neutral third party between the buyer and seller, and is not authorized to release escrowed funds or documents until the agreed upon terms have been satisfactorily met . Depending on state laws, escrow agents may be real estate brokers, banks, title or escrow companies.
Among other benefits, an escrow contract can provide buyers and sellers peace of mind as it reduces the risk that one party may pull out of the transaction after the other has already committed the escrowed funds or documents – the escrow agent is not authorized to release the funds or documents to either party prior to fulfilling the terms of the agreement. However, an escrow contract is not fool proof, and buyers and sellers should each consult an attorney before signing such an agreement.
Essential Elements of an Escrow Contract
The key elements of an escrow contract are the escrow funds, parties, terms, and conditions.
Escrow funds are the assets placed into escrow by the parties to a transaction for the benefit of one another upon completion of the conditions outlined in the escrow agreement. Non-depositary recipients of escrow funds could include intermediaries (non-depository agents, such as brokers, agents, or managers) who have possession of the funds, or non-intermediary recipients (e.g., close relatives) who have received the funds in the customary and ordinary course of actions. As stated above, there are usually three parties in an escrow. The owner holds exclusive control over what happens to the funds during the escrow period. The purchaser is unable to exercise the same unilateral control over the funds. The third party is a contractual agent of the purchaser who has a stake in the success of the transaction. The most significant elements in an escrow contract are the terms and conditions of release written in the escrow agreement. Terms can be very simple or complex. Terms generally outline basic components of the overall transaction, such as prices, number of units, timelines, and unit improvements. Conditions are more complicated than terms as they must create a specific event or state of affairs that must occur before payoff, failure of which would allow the funds to revert to the individual who placed them in escrow. A common escrow legal form will include a list or schedule of conditions requiring the purchaser not to bind, damage, or otherwise harm the property held in escrow. A secondary schedule or list will outline requirements for release other than notifying the holder for disbursement.
Advantages of an Escrow Contract
The use of an escrow contract in various transactions has many benefits, the most obvious being security and trust between parties. In basic terms, an escrow arrangement means that a third party will hold funds or property for a seller until the buyer has paid all debts owed to the seller. An escrow contract outlines the obligations of the parties to the agreement and the third-party agent. This provides security for all parties involved.
An escrow contract is commonly used among real estate agents, web hosts, software publishers, and other businesses to hold confidential documents, money, or property until the other party completes a particular obligation. Depending on the type of transaction, some escrow contracts may require the seller or buyer to deposit these items into the account, or others that distribute the funds or property as specified in the terms of the contract. A common use of an escrow contract is a pre-sale holding of money, which includes holding the full price of the item sold until the payment clears. As an example, if you sell a car to a person who sends a check, both the buyer and seller could agree to an escrow contract that releases the vehicle to the buyer only after they have fully paid for the car.
There are other situations where an escrow contract is required. For example, many online sellers are concerned about fraud or privacy issues, and online escrow contracts are frequently used for this type of protection.
Although escrow contracts are typically used for business purposes, anyone can use them. If you selling your home, for example, both the buyer and seller can benefit from using an escrow contract to hold the funds related to the sale of the property. This simple legal agreement can save a lot of hassle down the road.
Situations Where an Escrow Contract May Be Used
One of the most frequent uses of an escrow contract is in a real estate transaction; that is, when an individual or ternary has entered into a binding contract to purchase a piece of real estate from one of our real estate clients. The real estate client requires the purchaser to deposit a specified portion of the total price with the escrow agent for holding pending the closing of the transaction. The real estate client’s lawyer is the "primary" contact with the purchaser’s lawyer and the law firm always end up negotiating an escrow agreement as a key stuck point of the deal. Once each side has signed the agreement, the funds are exchanged, for the most part electronically, through an electronic transfer or wire transfer. This can occur only once the buyer’s funds are in the bank account of the intermediary law firm or escrow company. The bank account is similar to a savings account, in which the funds cannot be extracted (i.e., until a warrantee deed has been executed and recorded so that the proceeds of the sale can be released). Our clients find that having an escrow contract in place offers greater security for both them and their buyers (due to its conditional nature) – because the buyer knows funds cannot be extorted by the seller, they are guaranteed a refund and can have greater confidence in the legal validity of the transaction.
As is typical in M&A deals, the deposit required is often large sums from the purchaser (in the millions and tens of millions of dollars). The purchaser will also require an escrow contract to protect him or her from the risk that the seller hides something in the business being sold (such as a well created C.B.C. tax credit) so that any loss suffered by the buyer caused by any non-disclosure, the seller will be liable to return or set off the appropriate amount from the purchase price that is owed to him.
An example of a standard in use escrow agreement is found in ware housing and supply chain transactions. For instance, if a Purchaser is ordering a number of shipping containers that are being manufactured and shipped internationally, the Purchaser may be obliged to pay 100% of the value of the goods in advance via wire transfer. If instead they arrange for an escrow agent that would hold on to the funds in a separate account with respect to a warehousing and supply chain transaction, the Purchaser can ensure that the funds are only released to the vendor, or his agent (as the supplier would be the actual owner), when the supply chain process has been completed. As the parties can be located in different jurisdictions, an appropriate choice of laws and Jurisdictions clause should also be included in the contract.
Sample Escrow Contract Template
ESCROW AGREEMENT
THIS ESCROW AGREEMENT (this "Agreement") is at [Date], by and among [Depositor] ("Depositor"), [Escrowed Securities Owner or Buyer] (the "Purchaser" or "Purchaser"), whose address is at [Purchaser’s address], and [Escrow Agent] (the "Escrow Agent"), whose address is at [Escrow Agents address].
NOW THEREFORE, the parties hereto agree that:
1. Appointment. The Purchaser agrees to appoint the Escrow Agent to act as the escrow agent with respect to the subject matter of this Agreement, and Depositor agrees to delegate such appointment to the Escrow Agent upon the execution of this Agreement by the Depositor, Purchaser and Escrow Agent.
2. Escrow Amount. Depositor agrees to deliver the following described securities to the Escrow Agent which shall be deemed to be a part of the Deposited Property hereunder (and the Purchaser agrees to deliver the balance, if any), on or before the fourth schedule day following the date first written above or at such other time as the parties hereafter agree upon in writing, in exchange for a check favoring Purchaser in a like amount by the Purchaser to be made available for immediate collection for the benefit of Depositor (the "Escrow Amount"):
[Identify securities]
All dividends, interest and other distributions, of every kind or character received by the Escrow Agent on account of the Deposited Property or the proceeds thereof received by the Escrow Agent shall be deposited in a special segregated interest bearing account (the "Account") maintained with a financial institution acceptable to Purchaser (as to credit risk). The Purchaser shall become entitled to the earnings on the Account. The Escrow Agent shall not be obligated to segregate any funds for the benefit of the Depositor or Purchaser except as expressly provided in this Agreement.
- Special Purpose Requirement. The Deposited Property shall only be used for the purpose of securing the performance by Purchaser of its obligation under this Agreement, or for the purpose of any other obligation as the parties hereto may thereafter mutually agree in writing, and for no other purpose or reason. In the event that the Escrow Agent shall receive any request or demand or shall be served with any legal process or notice by a third party to this Agreement, the Escrow Agent shall give prompt notice thereof to Purchaser and Depositor, and Purchaser and Depositor shall have the right, at their own expense, to resist and to or on the Escrow Agent’s behalf, to protect and defend against any such request, demand or legal process or notice with respect to the Escrow Amount, or otherwise to institute or defend any litigation, at their own expense, concerning the Escrow Amount; provided, however that the Escrow Agent shall be entitled to comply with all requirements of law with respect to any legal process or notice even though the same are contrary to the terms of this Agreement.
- Distribution Upon Performance. Upon the performance, by Purchaser, of all of its obligations under this Agreement, or as thereafter mutually agreed upon in writing, the Escrow Agent shall honor Purchaser’s instructions , if consistent with the terms hereof, and shall assemble and deliver the Deposited Property to Depositor as Depositor may direct.
- Outside Professional Advice. It is acknowledged and agreed by all parties hereto that each of Depositor, Purchaser and Escrow Agent has the right to consult with attorneys and/or accountants and other outside professionals of its own choice, for the benefit of such party or parties, at the expense of such party or parties, with respect to the interpretation or application of this Agreement and the rights of such party hereunder, but that, except as set forth in the next sentence, the Escrow Agent is not qualified to give investment advice to either Depositor nor Purchaser and shall not be responsible for making any determinations as to tax benefits or consequences, including, without limitation, eligibility for or the amount of any deductions, depreciation or amortization or the basis of the Deposited Property to either Depositor or Purchaser. Notwithstanding the foregoing, the Pump Court may, but does not have to, engage the services of counsel for the construction of this Agreement and specifically as to the rights and obligations and/or powers and duties of the Escrow Agent in connection with the performance of its functions under this Agreement and the determination of the scope thereof, and the fees and expenses of such counsel shall be paid as follows: 50% by Depositor, 50% by Purchaser.
It is acknowledged and agreed by Depositor and Purchaser that the foregoing fee split as to the fees and expenses of counsel was arrived at between them in good faith and in a commercially reasonable manner and with knowledge of the duties and responsibilities of the Escrow Agent and of Depositor and Purchaser, and that this allocation was reached with recognition of the fact that the protection of the interests of Purchaser and the positions of Depositor are of equal importance and relatively equal in cost to the Escrow Agent and the other parties hereto.
- Termination. This Agreement terminates upon the final disposition of cash or property, or any portion thereof, of the Deposited Property to Depositor, or Purchaser as herein provided, if any, or in accordance with a final non-appealable decision of a court of competent jurisdiction.
- Indemnification. Purchaser and depositor, on behalf of themselves and their officers, directors, members, employees, and agents, agree to indemnify and hold harmless Escrow Agent from and against all loss, claim, personal injury, liability, damage, action, cost, expense or charge suffered or incurred by Escrow Agent as the direct or indirect result of the performance by Escrow Agent of its functions and duties hereunder, unless caused by the willful misconduct or gross negligence of the Escrow Agent. This provision shall survive the termination of this Agreement.
- Counterparts. This Agreement may be executed in four separate counterparts, each of which shall be treated as an original document.
- Waiver. This Agreement may be waived, altered or amended only by a writing signed by the parties hereto, or the Escrow Agent.
Legal Terms or Clauses for Inclusion in an Escrow Contract
Each escrow contract is unique and subject to specific state law requirements and general contract law principles. The author believes that the following should be considered in every escrow contract regardless of whether the parties are represented:
Mental Capacity. Are the parties mentally competent to contract? Escrow agents generally do not deal with competency issues but do need to consider the mental capacity of the parties to the contract. Often, medical professionals will "clear" an escrow agent in a letter for the purposes of complying with the contract or successful closing.
Consent. Consent of the buyer, seller, investor, owner or any other party who may have an interest in the subject matter of the contract should be obtained separately from the escrow contract to avoid a assertion of a claim against an escrow agent after a closing. Consent may be required if the escrow agent is out of state or out of jurisdiction, requiring a license or registration to receive or distribute trust money in another state.
Compliance with Law. The escrow agent should be familiar with the requirements of the law under which the escrow agent is licensed and registered and all other applicable law.
Duty of the Agent. Escrow agents should be mindful of a duty of full disclosure when representing a party in an escrow contract. If the escrow agent is aware of the breach, the agent has a duty to disclose and notify the parties. Often the escrow agent is privy to what many clients think is confidential information. Just because the information is confidential, does not mean it can be withheld from other parties to a contract or transaction. Failure to disclose material facts may result in a claim against the escrow agent for breach of fiduciary duty, breach of contract, negligence, negligent misrepresentation or fraud.
How to Select the Right Escrow Service Provider
When considering the use of an escrow contract for your online transactions, it is important to begin with the right escrow agent. The escrow agent is the service provider who holds the deal funds in a trust account until the conditions for releasing them are met. Accordingly, this should be a licensed bank, a government-approved title/escrow company or an independent escrow agent.
Escrow services are not all created equal. It is important to make sure that the escrow provider you use is properly licensed. If not, you may be risking the very security you’re seeking by going the escrow route. Here are some things to consider when selecting the appropriate escrow service provider:
Licensing
The first thing you should consider is whether the escrow agent or escrow company (which may also act as the closing or settlement agent) is properly licensed. In order to be considered qualified, the individual or company you choose to hold the deal funds should be governed by the Department of Business Oversight and required to have an escrow license in place, as well as be insured. If the escrow contract approves the use of a third-party escrow agent (like a licensed bank), then the escrow agent should also be an insured third-party participant. There are some companies that claim to be licensed to serve as an escrow agent but are not actually regulated or insured. Your escrow agent should be bonded, regulated by the Department of Business Oversight and carry at least $1 million in errors and omissions insurance.
Reputation
Make sure the company you hire has a good reputation. Read the online reviews , check their standing with the Better Business Bureau, and ask current customers whether the company has performed satisfactorily. Make sure the company’s configuration matches your needs and check with the state to ensure that they are currently licensed and operating legally (meaning that the company has not been ordered to desist or has not received a cease-and-desist order).
Fees
It is important that you understand how fees will be charged, since those fees can vary drastically between companies. Generally, escrow fees are paid at the time real estate deals close. Also, in some cases, fees are based on the selling price for real estate, while other fees are based on how much the service provider spends on credit reports, work records and the like.
Accessibility
It is also advisable to evaluate the accessibility of and fees charged by the escrow service provider. If you plan to use the escrow service for a number of transactions, it may be worthwhile to set up an escrow account. It is a good idea to make sure that the escrow agency you select has a toll-free number and emails that connect directly to that specific agency. Check references and find out if the fees are clearly disclosed and competitive with others in the industry or if these fees are clearly defined in the engagement letter (which all proposals should have). Also find out if the escrow agency has an established management system and if they send statements to clients every month.