Escrow – What is it, and How is it Used?

If you are entering into a legal transaction, you have probably heard of the concept of escrow. However, many people often misunderstand or find it challenging to grasp this concept. Thus, this article will explain what it is and how and when to use it.

What is Escrow?

Escrow is a legal arrangement where the primary parties of a transaction (generally a buyer and seller) engage an independent and neutral third party (the escrow agent) to hold relevant assets. For instance, you can transfer:

• money;
• securities;
• real property (houses or land); or
• other business or personal assets

to an agent. The transacting parties will agree to the specific conditions that they must satisfy before the agent releases the assets or funds to the appropriate party. 

These specific conditions will often be the contractual obligations in the transaction agreement. While the agent is holding the assets or funds, they are held ‘in escrow’.

When is it Used?

Parties use escrow when they are in the process of completing a transaction. It helps to avoid fraudulent transactions and ensure each party can fulfil its obligations. 

People also frequently use escrow in business sales and mergers and acquisitions (M&A) deals. In these transactions, the agent may hold the purchase price, business assets or company shares until both parties satisfy all of their obligations under the transaction agreement.

The Escrow Agreement

The primary parties to the transaction and the escrow agent will usually enter into an escrow agreement. The agreement will include the terms on which the escrow agent must hold and eventually release the relevant assets or funds. The critical matters of an agreement include the:

• details of the account in which the agent holds relevant funds;
• conditions on which the agent must hold the assets and any fees;
• escrow conditions, which each party must satisfy before the agent releases the assets;
• process the agent must follow in releasing the assets; and
• process which allows the parties to instruct the agent to release the assets if the escrow conditions have not been met.

Example 

Suppose Fred has a very successful technology business that he wants to sell, and he has an interested buyer. Fred and the buyer have negotiated a sale agreement. However, due to the technical nature of Fred’s business, there are many complicated and time-consuming processes that must be carried out to transfer the business and its assets properly.

Both Fred and the buyer want certainty that the business transfer will finalise before they start transferring the assets. So Fred and the buyer agree to execute the sale agreement, and the buyer will pay a deposit to an escrow agent.

The escrow agent will hold the deposit until both parties have successfully transferred all of the business and its assets. Once all of the escrow conditions have been satisfied and the business sale is ready to complete, the escrow agent will release the deposit, and the buyer will pay the balance of the purchase price, to Fred.  

Key Takeaways

 In essence, escrow is the use of a third party who holds an asset or funds before they are transferred. The escrow agent holds the funds until both parties have fulfilled their contractual requirements. Escrow is generally associated with real estate transactions. However, it is frequently used in M&A transactions and significant business asset sales. Finally, you can also use escrow to secure transactions of personal assets (such as cars, jewellery or art).

If you need help with business transactions, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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