Introduction
When engaging in a transaction, particularly as a UK business entering into legal terms with a US counterpart, you may have come across the term “escrow.” Despite its importance, the concept is often misunderstood or considered difficult to comprehend.
This article aims to clarify what “Escrow” is, as well as when and how it should be used.
What is Escrow?
Escrow is a legal arrangement in which an independent and neutral third party, known as the “Escrow Agent”, holds assets involved in a transaction between the primary parties—typically a “buyer” and a “seller”. These assets might include:
- Money
- Securities
- Real property (such as houses or land)
- Other business or personal assets
The primary, transacting parties agree on specific conditions that must be met before the Escrow Agent releases the assets or funds to the appropriate party. These conditions often align with the contractual obligations outlined in the transaction agreement. While the Escrow Agent holds the assets or funds, they are said to be held “in escrow.”
When is Escrow Used?
Escrow is commonly used during the latter “completion” (or in the US “closing”) stage of transactions and the purposes are mainly to both (i) prevent fraud and (ii) ensure both parties meet their financial and other obligations.
The most common use, for instance, is in real estate transactions – both in the UK and the US – where an Escrow Agent (which, in the case of conveyancing or property deals will be the solicitor or attorney) may hold the property title and the deposit or purchase price until all conditions are fulfilled.
Similarly, escrow is widely used in US mergers and acquisitions (M&A) deals, where the agent might hold some or all of the purchase price, or occasionally business assets, or company shares until all terms of the purchase agreement and the connected escrow agreement, are satisfied.
Although escrow can be applied to any type of transaction, it is particularly valuable for those involving large sums of money or complex asset transfers that require multiple steps or additional safeguards.
Essentially, escrow arrangements – whether between parties’ lawyers, or third party agents – enable the safe facilitation of transactions and offer mutual protection to the buyer and seller by minimising the risk of counterparty non-completion, failure to deliver. From the buyer’s point of view, they offer a form security against the risks of contractual breaches of seller warranties and indemnities.
Role of escrow agreements in M&A transactions
Escrow arrangements in Corporate trasnactions are most common when conducting cross-border deals between the UK and USA.
There are many instances where one party in a transaction may face challenges in fulfilling specific obligations.
Escrow accounts can serve as a tool for buyers to demonstrate “proof of funds,” reassuring sellers that they have the financial means or financing required to complete the transaction.
In mergers and acquisitions (M&A), escrow agreements are often used to retain or “hold back” a portion of the purchase price—usually between 10% and 25%. The specific holdback amount is negotiable and depends on the deal’s nature and other factors, such as the buyer’s assessment of risks.
This retained amount is typically kept in escrow during a warranty period, allowing the buyer to verify that the seller’s representations and warranties in the transaction documents are accurate or to cover the Buyer for any agreed indemnities given by the Seller, which are typically specific to certain defined risks uncovered by the Buyers.
Sellers commonly request that the holdback amount be deposited into an escrow account.
This arrangement ensures that the Buyer has security to cover the risks and the Sellers have the comfort of knowing that the funds are automatically released if no warranty claims are filed or indemnity claims are made within the agreed timeframe.
The warranty period can vary, lasting from several months (usually no less than 6 or 9) to several years (usually no more than 3). During this time, undisclosed liabilities may come to light, such as those revealed during audits, tax filings, licensing applications, or legal disputes. If such liabilities emerge, the funds released to the buyer will depend on the escrow agreement’s terms, specifically the defined trigger events.
The Escrow Agreement
In most transactions, the primary parties and the escrow agent enter into an escrow agreement, outlining the terms under which the agent will hold and eventually release the relevant assets or funds. Key elements of an escrow agreement typically include:
- Account Details: Information about the account where the agent will hold the funds.
- Holding Conditions and Fees: The terms governing how the agent holds the assets and any associated fees.
- Escrow Conditions: The specific requirements that each party must meet before the agent releases the assets.
- Release Process: The steps the agent must follow to release the assets.
- Alternative Instructions: Procedures for the parties to direct the agent to release the assets if the escrow conditions are not fulfilled.
A third party, independent Escrow Agent will always require a formal agreement. Parties should beware of any independent Escrow Agents who do not have any form or engagmenet or other terms setting out the parameters of their involvement.
Contrast this with business sales or mergers and acquisitions (M&A), where the parties’ lawyers act as escrow agents for each other. In those situations, there is no “joint” appointment, rather the lawyers will work collaboratively, under their professional mandates to close the deal, e.g. by holding the purchase price in the law firm’s trust account or managing signed documents or assets “in escrow”; streamlining the process without a separate formal agreement with a third party.
Execution and timing of escrow agreements
Buyers and sellers occasionally postpone drafting escrow agreements until the final stages of a deal, after the sale documents have been completed. Unfortunately, this last-minute approach leaves little time to properly structure the escrow arrangement or prepare the agreement, even though these are critical to ensuring that payments are made and assets are transferred correctly.
To avoid potential complications, it is advisable to finalise escrow arrangements early in the transaction process, safeguarding the interests of both parties.
When drafting an escrow agreement, it is essential to define a clear and unambiguous list of events that will trigger the release of escrow funds or assets.
Once these conditions are met, the escrow agent will transfer the assets to the appropriate parties. Trigger events can range from straightforward actions, such as joint signatures from the buyer and seller, to more complex requirements, such as confirmation from third-party law or audit firms or references to publicly available information.
Escrow in US Corporate Transactions – Summary
Escrow is a commonly used process where the primary parties to a transaction jointly instruct a a neutral escrow agent under a clear set of negotiated terms to hold back a portion of the purchase price.
UK Sellers need not fear the involvement of a third party escrow agent.
If the transaction documents, being the Share Purchase Agreement or Asset Purchase Agreement are well drafted and the Escrow Agreement is similarly tailored to the trasnaction, then the Escrow should align with the parties’ joint intentions, to provide both comfort to the Buyer that they have some cover for a specific time post-closing and some degree of peace of mind to the Seller who knows that the funds will be released if there are no events of default.
The escrow agent ensures the security of these assets and releases them only after both parties fulfill their contractual obligations.
Escrow Agent Services – US Dollar Transactions
As a licensed US Attorney-At-Law, we provide independent escrow services as an alternative to banks and financial institutions:
- Professional Involvement: Attorneys understand the transaction process and are well placed to assist (in a neutral capacity) with the corporate, commercial and real estate deals.
- Professionally Regulated: Attorneys are regulated professionals and must be trasnparent at all times, acting in accordance with the professional ethics rules, with utmost integrity.
- Attorney Trust accounts:Lawyers can offer secure trust accounts that allow them to hold client funds and transfer them as instructed by the parties and documented in the Escrow Agreement.
- Timing: Lawyers trust accounts are already set up, and there is no requirement to open a new account at a financial institution. Further, the increased bureaucracy and heavy AML regulatory processes involve excessive involvement and of the parties and can cause delay to the deal process.
- Transactional efficiency:Law firms can manage and negotiate escrow agreements, which can lead to more efficient transactions, payment security, and increased confidence among the parties involved.
- Cost savings:Law firms can be less expensive than banks nd “professional” escrow agents.
ABRAMS LAW’S ESCROW SERVICES
At Abrams Law, as UK solicitors and US Attorneys, we have a deep understanding of US-UK Corporate transactions.
We operate anIOLTA account (Interest on Lawyers’ Trust Account), which is a type of trust account that lawyers use to hold client funds while earning interest on them.
The purpose of IOLTA accounts are to raise money for charitable purposes, such as legal aid programs and social justice initiatives.
In our case, our IOLTA is registered with the New York State Bar Association and interest earned on funds held in our account is remitted to them who then donate it to charitable cause