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Escrow Agreements – the concepts.

A legal contract usually involves two parties who exchange money for goods/services. One party pays a certain amount to the other to receive goods/services such as property, dress or even a financial asset such as bonds & stocks.

However, parties in a contract may want to be assured that other party will fulfill its obligations such as making payment or delivering goods/services.

For example, if an Australian company sells gold to a Canadian company, it may want to be sure that the payment is secured before it ships the goods to a foreign country. After all, the Australian company would have to spend a lot of money in producing goods and shipping its product.

Because of similar worries, the Canadian company may also want to be sure that it will receive the gold before it makes the payment.
Another example might be a software licence agreement -the buyer may want assurance that the software product should be kept in a safe place so it can comfortably make the payment and get the product.

What is an Escrow Agreement?

In other words, every party to a contract wants to be absolutely certain that the other party will keep its promise.

This is where the escrow agreement comes in: it is an agreement to assure one of the parties that the other party will fulfill its contractual obligations.

An Escrow agreement is a legal contract where an independent third party holds the money or the asset (i.e. in ‘escrow’) until certain conditions such as delivery or payment, are met.

For example, when you agree to sell gold to a Canadian company, the buyer will deposit the payment to the escrow party. This escrow party will hold the money until you deliver the goods and will tell you that it holds the deposit for you. Once you deliver the goods, the escrow party will transfer the money to you.

Thanks to this arrangement, you can safely ship the gold to Canada without worrying about getting paid.

Examples of Escrow Agreements

Other examples of escrow agreement include:

  1. Internet: Before a transaction is completed between buyer and seller, the payment is deposited to an escrow agent. The payment will be released only after the parties verify that they completed the transaction.
  2. Intellectual Property: When a software product or an app is licensed to another party (i.e. the licensee), the source code of the software product is usually held in escrow until the payment is made. This is where escrow agreements are most commonly used.
  3. Real Estate: Before the property is transferred to the buyer, the payment may be held by the escrow to provide assurance to the seller.

When do I need an escrow agreement?

Escrow ensures that your counter party will perform its obligation such as payment or delivery of goods/services.
Normally, the contract is based on the mutual trust of the parties. However, there is always the risk that your counterparty will not pay you or deliver the goods/services to you.

Imagine that you spent thousands of dollars to produce a software product, but you are still unsure if the buyer has the financial resources to pay you. Would you rely on the contract or would you prefer a stronger guarantee?

Escrow agreement ensures that the payment is already deposited to escrow account, so your payment is safe. You will receive your payment once you fulfill your part of the agreement.

Escrow eliminates the risk and guarantees that contract is fulfilled. Escrow is especially useful when you don’t know the other party or they are a foreign partner and you are doing business with them for the first time.

What sort of clauses should be in an escrow agreement?

  • Identity of the escrow agent: You must clearly identify your escrow agent, will it be an attorney, a bank or another third party?
  • Escrow agent’s fees and expenses: Who will pay for the costs of escrow? If the escrow agent holds the deposits longer than expected because of the mistake of a party, who shall be responsible for additional expenses?
  • The duties and liabilities of the escrow agent: You must clearly define what the escrow agents should do. For example, you should state how and under what conditions escrow can release the payment. Will it require the authorization of both parties simultaneously?
  • Acceptable use of funds by escrow: You can include a provision in your agreement about what your escrow agent can do with the money. Can he/she invest it or lend it? Interest on the deposits: You should also specify whether your escrow agent is able to keep any interest that is generated because it is holding funds on escrow.
  • The jurisdiction for legal action: You, your counterparty and the escrow agent may all be in three different country. In fact, this situation frequently occurs in international contracts. For any dispute about the escrow funds and liabilities of your escrow agent, you should choose a jurisdiction to resolve your legal issues.

If you have any questions about an Escrow Agreement or in general please feel free to get in touch!

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