Insight of Escrow Agreements and their Use in Daily Transactions

Introduction

A Legal Contract/Agreement usually involves two parties that exchange goods and services in return for a consideration which may be in cash or in kind. One Party (seller) promises to deliver goods/services to the other party (buyer) which maybe property, dress, or any kind of financial assets such as bonds or shares.

However, in any transaction, both parties want to be assured that obligations related to the contract/agreement are duly fulfilled such as making of payment or delivering of goods/services.

For instance, two companies in India and England are into the business of selling/shipping crude oil now if a company in India ships the oil to England it would want to be sure that the payment is secured before the ship reaches England, after all the company in India would have heavily invested in producing and shipping the oil. Similarly, the company in England wants to be sure that the oil reached safely before making the payment.

Meaning of Escrow Agreements

Imagine you have spent a substantial amount of money to produce software/goods but you are doubtful whether the buyer has enough financial resources to pay you, would you wholly rely on the contract or would you prefer the assurance of payment? This is where escrow agreements come into the picture, it’s a legal contract where a neutral/independent third party/agent is appointed to hold back the money or asset till the conditions to the contract is fulfilled this ensures that the payment is already deposited by the buyer in the escrow agent amount and the seller may receive the amount after fulfilling the obligations.

As per the aforementioned example if the Indian company agrees to sell the oil, then the buyer company in England will deposit the money to the escrow party/agent. This party will hold back the money until the Indian company delivers the crude oil, and as soon as the crude oil is delivered the escrow party will transfer the amount to the Indian company’s account. If it wasn’t for the escrow agent, the Indian company would have always been doubtful about getting paid for the oil shipped.

Areas of use of Escrow Agreements

1. Internet: Internet escrow exists since the time e-contracts and internet commerce have come into existence. Escrow agreements build trust and facilitate smooth transactions between the parties. Before the transaction is completed between both the parties the payment is deposited to the escrow agent’s account which will be released by the escrow agent upon fulfillment/ verification by the parties that they have completed the transactions.

2. Intellectual Property: Whenever any software or any application is licensed to another party (i.e., the licensee) the source code is of the app or software is held in an escrow account just as cash is held, which is released when payment is made by the licensee. Examples include game app, antivirus apps, songs, lyrics, etc.

    

3. Law: Escrow is also known in the judicial context, where escrow funds are created and are used to distribute money in relation to the settlement of a class action or any environmental enforcement action. The defendant is not required to pay directly to the plaintiff, he can directly pay to an escrow fund from where the funds are distributed to the plaintiff/ plaintiffs (if there is more than one plaintiff)

    

4. Real Estate: Before the ownership is transferred to the buyer the amount may be deposited to an escrow agent’s account in order to provide assurance to the seller that the amount is secured.

    

5. Merger & Acquisitions: The buyer in M&A transactions generally holdbacks the portion of the purchase price as he concerns over the seller’s ability to pay post-closing obligations, however seller typically prefers this held back amount to be placed in the third-party escrow agent account rather than being with the buyer. This ensures timely and smooth transactions between both parties.

Who can be an Escrow Agent or the Qualification to become One?

There is no certain condition/qualification to be fulfilled for becoming an escrow agent, anyone can become one, even a partner in a law firm can become an escrow agent for keeping papers in safe custody often this stem from the trust level the person has with buyer and seller, However, when some consideration has monetary value typically a bank and financial institution is chosen as an escrow agent this because many times the money depositing party would like to keep the money in some interest-bearing account rather than having it idle, of course, there are some fees associated with providing the service.

Advantage of an Escrow agreement to the Sellers and Buyers

For Sellers:

1. Sellers are ensured of full payment for expenditure related to the goods produced, potential frauds by the buyer after service/goods received.

2. It significantly useful when it comes to internet transactions/e-contracts across the country and overseas markets.

For Buyers:

1. Buyers are ensured with an option to inspect the goods before the payment is released through an escrow agent’s account.

2. Buyers reserve a right to exchange/return/not pay if there is a deficiency in services/ goods.

3. Since the arrangement is smooth and security is predominant, there is less or no possibility of disputes between the parties.

How are the Escrow Agreements Drafted?

An escrow agreement contains details such as:

1. Identity of the Escrow Agent: The parties must clearly identify the escrow agent, it can be a bank, an attorney or any financial institution, or any independent third-party.

2. Expenses associated with appointing an Escrow Agent: the agreement includes clauses such as who will be bear the expenses of appointing an agent, and if the amount is held back more than the reasonable time for who will bear such additional expenses.

3. The responsibilities of an agent: The agreement specifies conditions and circumstances an agent can release the amount and whose authorization is needed for the same.

4. Reasonable/acceptable use of the fund by the agent: the agreement may also include how and when an agent can use the fund for investment or lending purposes and how much interest generated can be kept by the agent.

5. The jurisdiction for the legal action: there may be a situation where all three parties are from different countries so the agreement specifies jurisdiction where the legal issues can be resolved.

Conclusion:

Therefore, the appointment of a neutral third party or an escrow agent is instrumental to make a transaction free from hassles and uncertainty between the parties and ensures secured payment and delivery of goods/services. In reference to the internet fraud/risk, it is indeed the indispensable mechanism in today’s scenario where most of the e-contracts/business is done online.

To know more about, What is Escrow agreement and how it is made, see the video below -

BY -

Piyush Dabral