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.
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:
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’.
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.
For example, you can commonly see escrow in real estate transactions. In this case, an agent will hold the title to the property and the deposit or purchase price.
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.
Essentially, you can use escrow in any transaction. However, it is most useful concerning transactions that involve significant sums of money (which you cannot transfer easily or immediately), or where transferring the assets is difficult and requires numerous steps.
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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:
However, the escrow agreement does not always need to be formalised. For example, in business sales or M&A transactions, each party’s lawyers will act as escrow agents. They will hold the purchase price in the law firm’s trust fund or hold signed documents or assets in escrow.
Suppose Fred has a very successful technology business that he wants to sell, and he has a n interested buyer. Fred and the buyer have negotiated a sale agreement. However, due to the technical nature of Fred’s business, there are m any 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.
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).
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An escrow agreement is a document that will contain the terms on which the escrow agent must hold and release the relevant assets or funds.
What is an escrow agent?An escrow agent is a neutral third party to a transaction who is in charge of holding and releasing relevant assets. They can provide certainty for transactions involving high-value assets.
