What is an Escrow?
An Escrow is a legal concept describing a financial Agreement or instrument whereby an asset or monies are held by a trusted third party (“Escrow Agent”) on behalf of two or more parties to the transaction. Escrow Agreements are utilized in a wide range of transactions including physical property, electronic transactions, international trade, funding transactions, intellectual property, banking, mergers, acquisitions and many more. Escrow accounts are normally established by a trusted third-party such as a law firm, bank or an Escrow Agency which hold the funds and/or the assets until receiving appropriate instructions from the contracting parties as determined under the Escrow Agreement or until the fulfilment of a predetermined contractual obligation. Cash, securities, financial instruments, assets such as intellectual property, software source code, and protocols, can be held in an Escrow.
In today’s world of technology, cross border sales (and for example recently the high risk of fraud in relation to the procurement of specialist personal protective equipment as a consequence of COVID-19), parties to international trading transactions in many instances do not know each other and are operating across large distances and cannot necessarily travel to conduct physical due diligence. Often large transactions are concluded on the basis of purchase orders and commercial risks are thus plentiful. A way of addressing these risks is for the buyer to have properly drafted purchase order terms and conditions and utilise Escrow Arrangements. Bank guarantees, performance guarantees and letters of credit can be extremely expensive and time consuming to set up, particularly in the world today where transactions must be concluded quickly, or the deal is lost. An elegant way to secure both the seller and the buyer is to put in place an Escrow Agreement. These can be complex Agreements depending on the application (as discussed further below). The Escrow Agreement is concluded between the seller, buyer and the Escrow Agent/law firm in terms of which the purchase price is held by the Escrow Agent/law firm in a special trust account and payment is made once the terms of the purchase order (or purchase and sales Agreement) have been fulfilled. The seller is assured of the availability of funds and payment, and the buyer is assured that payment will be made once the goods meet the requirements (quantum and quality) of the purchase order (or purchase and sales Agreement) have been delivered. Or put another way, the buyer only parts with the funds once the goods are received in good condition and the seller only parts with the goods once their condition is verified and the funds are released to the seller.
Mergers and Acquisitions
Escrow Agreements are utilized in many complex financial transactions such as acquisitions, whereby the funds are placed in Escrow for a period of time while the buyer is in the process of conducting due diligence on the assets/ business/ company to be acquired. Escrow Agreements are also used as a supplement to the warranties and indemnities offered by the seller, especially where the credit risk of the seller may be sub-optimal. The Escrow Arrangement may be designed to last for an extended period of time (as a measure of security) rather than to simply complete the transfer of an asset. The Escrow Agent may also have the power to adjudicate on the validity of a claim to the Escrow funds.
Escrow Agreements are very commonly used in property transactions and in the USA, they also are known to use a “Double Escrow”. A Double Escrow is a set of real estate transactions involving the sale of the same property to two different back-to-back buyers at the same price or two different prices due to close simultaneously. Once the Escrow is completed, all the parties including the buyers, seller, brokers and financiers are informed and the funds are dispersed.
In some cases, a shareholder is the actual owner of listed shares but has limited rights to dispose of the shares for example executives who receive shares as a bonus for compensation are often requested to maintain their stock in Escrow for a period of time. The Escrow manages the dealing or trading of the shares and may also be a tactic to retain the executive for the period of the Escrow Arrangement.
Escrows have been used since the development of Internet auctions and commerce websites to provide a trusted method of transacting in online commerce. The first Internet Escrow company to be licensed was Escrow.com founded in 1999. The payment services directive in the European Union commenced on the 1st of November 2009 and allowed the introduction of very low-cost Internet Escrow services that are licensed, and government regulated. The EU regulatory framework allows these web-based Escrow services which operate along the lines of letters of credit services (which would normally be provided at great expense) by international banks. A note of caution, there has been a proliferation and bogus “escrow services” on the Internet through the use of phoney websites. We would recommend that any websites offering the service need to be viewed with some caution. Strangely there are currently no online Escrow licenses offered by the US Federal Government but some US states like California and Arizona do have escrow licenses which can be viewed online.
One of the most common international uses of Escrow Agents is to hold the source code of the software. In this case, the Escrow Agent also does not own or have any rights to the Internet source code that it is holding. It is in fact a rather dormant service in which the Escrow Agent merely holds (and possibly updates/upgrades) the source code unless and until a technical problem arises e.g. a business interruption event, unexpected service interruptions, downtime, a loss of application functionality, data breach/data loss or a disaster as agreed to in the terms specified in the terms of the Escrow Agreement. Songs and lyrics, manufacturing designs and television and film scripts may also be held in an Escrow Arrangement. The independent Escrow Agent’s role is to attest to the information’s ownership, contents and creation date.
Escrow funds in law
Escrow funds are used to distribute money from a cash settlement in a class action, environmental enforcement, or similar action with a large group of claimants/plaintiffs. In this way, the defendant is not responsible for the distribution of the judgement monies to the individual claimants/plaintiffs. The court may appoint an Escrow Agent to distribute the money including settlement costs to the appropriate parties as determined under the judgement/settlement.
Specialisation in Escrows
Depending on the nature of the transaction, industry and parties involved, an Escrow Agreement may require complex provisions. We at BBP Law are able to assist buyers and sellers alike by drafting the Escrow Agreement and facilitating the safety of the funds by holding them in a special purpose trust investment account.
Please contact us and let us help you secure your business transaction dealings.