Escrow is an arrangement in which transacting parties retain a third party, an escrow agent or escrowee, whose job is to safeguard funds and assets according to conditions that have been agreed upon in advance. Such an arrangement protects the transacting parties in the deal, providing that neither has an unfair advantage and that both are earnest about the deal.
In the event that the terms of the agreement are not adhered to, it is generally easier to unwind the escrow and make the parties whole than it would be if the parties were merely contracting directly with one another. Take the simple example of a buyer placing money into an escrow account as a gesture of good faith regarding a transaction. Should the conditions set forth in the escrow agreement not be met by the seller, it is easy to pay the deposit back to the buyer. Similarly, should the buyer default under the terms of the agreement, the seller would have access to the deposited funds.
What is escrow used for?
The subject matter of an escrow can take almost unlimited forms. Some common examples include:
- Sales of real estate or other assets
- Mergers and acquisitions of businesses
- Construction being done by a contractor
- Intellectual property such as source code
Escrows in Sales of Real Estate or Other Assets
The most common escrow agreements consist of a contract in which one party is selling something, such as real estate, and the other party is buying. The buyer’s earnest money deposit is often held in an escrow for the reasons mentioned above. Similarly, in sales of other assets (including vehicles, equipment, mineral rights or collectibles), escrows may be utilized to protect the interests of all parties.
Escrows in Mergers and Acquisitions
Escrows are sometimes used in connection with mergers and acquisitions or in other situations where a seller may make representations, warranties and indemnifications that the buyer is not able to confirm prior to the sale. The term of the escrow in this instance may be longer than in the case of an escrow used in connection with the sale of real estate.
An escrow can be helpful when engaging a contractor for construction services. With an escrow in place, the contractor knows that there is a ready source of funds to draw upon for the payment of labor and materials, and there are significant safeguards to the person hiring the contractor to make sure that the work is completed in a satisfactory manner and in conformance with their agreement. Contractors usually make use of subcontractors, and those subs also need to be paid by the contractor. If the contractor fails to pay the subcontractors, the subs can place a lien on the property in the amount of the payment due. To make sure that this does not happen, the escrow may have a provision that a lien waiver from the subcontractors must be delivered to the escrow agent before payment can be made to the contractor. As in other cases, the escrow can be an important tool to ensure that all parties have their interests protected.
Software Source Code Escrow
As technology continues to evolve, the use of an escrow to hold source code is a rapidly evolving area. Such escrows hold software source code to ensure that the licensee of the software is not left without recourse should the software licensor declare bankruptcy or otherwise be unwilling or unable to support the product. This allows the licensor, who does not wish to provide this information to the licensee in an unrestricted manner, to nevertheless guarantee the source code’s availability under any circumstances.
Use of an escrow can greatly facilitate many types of business arrangements. An escrow can benefit both parties to it and give each peace of mind that their interests are protected. Escrows can involve holding money or other assets, and the terms of the escrow can be made to best fit the parameters of the particular transaction.