escrow account

The most basic definition of escrow accounts is that they are tools that assist in planning for escrow payments. In general, people set up escrow accounts to help keep money set aside for a particular reason.

With that said, what does the word escrow even mean? This article will shed some light by explaining what it is and what the other components related to it are.

What does it mean?

‘Escrow’ is a legal concept that describes a financial instrument. It’s where a third party entity holds an asset on behalf of two additional parties who are currently in the middle of completing a transaction. An escrow agent (more on this later) will typically hold the funds or assets until it receives the appropriate instructions, or until fulfillment of the contractual obligations. Escrow accounts can hold assets such as money, securities, and funds.

One of the several key takeaways from this concept is that escrow is with useful transactions related to real estate. But really it can apply to any situation where funds will pass from one party to another. The escrow acts as the holding account until both parties have fulfilled their side of the deal.

There may also be a sense of uncertainty over whether one party or another party will be able to properly achieve their obligations. Situations that use escrow include Internet transactions, banking, intellectual property, real estate, mergers and acquisitions, law, and many others.

Let’s take into consideration a company that sells goods internationally. That company would understandably need assurance that it will receive payment as soon as the goods reach their destination. The buyer, as per the procedure’s customs, is prepared to pay for the goods only if they arrive in good condition. The buyer is able to place the funds in escrow with the use of an agent with instructions to distribute them to the seller once the goods arrive in a satisfactory state.

With this system, both parties are guaranteed to be safe and the transaction can proceed accordingly.

Specific considerations

Here are some special considerations when it comes to escrow:

Escrow Accounts & Real Estate

Escrow accounts commonly apply to real estate transactions. By placing funds in escrow, it allows the buyer to perform ‘due diligence’ on a potential acquisition. Due diligence involves an investigation or audit of a potential investment or product in order to validate all of the facts. It might also include the examination of financial records.

Escrow accounts also assure the seller that the buyer can easily close on the purchase. For instance, an escrow account can be a tool during the sale of a house. If there are any sale conditions, such as the passing of an inspection, the buyer and the seller may both agree to the usage of escrow.

In this particular case, the buyer of the property deposits the payment amount for the house in a third party escrow account hat is being held by a third party. The seller can then proceed with the house inspections while feeling confident that the funds are there. On the other end, the buyer is fully capable of making payment. The amount that’s in escrow is then transferred to the seller as soon as all of the conditions for the sale are met.

Escrow & the Stock Market

Stocks are frequently issued in escrow. In this case, the shareholder is the real owner of the stock. But they have a limited range of rights when it comes to the disposal of the stock. Take, for example, an executive who receives stock as a bonus. They often have to wait for an escrow period to pass before they can go forward with selling the stock. Stock bonuses are a tactic generally used to retain top executives.

escrow account

The Escrow Agreement

The formal definition of an escrow agreement is it is a legal document that outlines the terms and conditions established between the parties that are involved in an escrow account arrangement. These agreements outline the arrangement in which one party – sometimes referred to as the depositor – deposits an asset with the aid of a third person called the escrow agent. The agent will, in turn, make a delivery to another party (the beneficiary) if and when the specified conditions of the contract have been met.

An escrow agreement is required to fully stipulate the terms and conditions of the escrow arrangement between the participating parties. The following items are usually included within each escrow agreement:

Information in an escrow agreement

  • The identity of the appointed escrow agent
  • Definitions for any expressions that are considered pertinent to the agreement
  • Escrow funds
  • Detailed conditions for the release of said funds
  • The acceptable usage of the funds by the escrow agent
  • Both the duties and liabilities pertaining to the escrow agent
  • The agent’s fees and expenses
  • The jurisdiction and venue in the event legal action needs to take place.

Practical uses of escrow agreements include business transactions and the securities industry. There may come a time in which it is in the best interest of one party to move forward. But only if it is absolutely certain that the other party can fulfill its obligations. This is exactly where the utilization of an escrow agreement comes into play.

Stocks are commonly the subject of an escrow agreement. This may be in the context of an initial public offering (ICO). Alternatively it may apply when stocks are granted to employees under stock option plans. These particular stocks are usually in escrow due to there being a minimum time limit that needs to pass before they can be freely traded by their respective owners.

Escrow Agent

The ‘escrow agent’ is a person or entity that holds property in trust on behalf of third parties during the finalization of a transaction or while resolving a disagreement. Often the escrow agent an attorney (or a notary in civil law administrations). The escrow agent has a fiduciary responsibility (i.e. someone or an organization that acts on behalf of another individual or individuals to manage assets) to both of the parties involved with the escrow agreement.

These agents essentially function as neutral middlemen within the execution of an escrow agreement. An escrow agreement is a contract between two parties wherein they agree that a third party should hold onto an asset. This agent holds the asset in the escrow account on their behalf up until the conclusion of the transaction. Essentially, the agent will hold the assets until they obtain the right instructions or until the contractual necessities have been properly met.

Investopedia editor, James Chen, describes the difference between the role of an escrow agent and a ‘trustee’ as this:

“…a trustee has a duty toward the beneficiary (or beneficiaries) of the trust and must act in their best interest. In contrast, an escrow agent’s duty is toward both parties of a transaction, and he is tightly bound by the terms of the escrow agreement.”

Conclusion

Escrow accounts relate to a concept that branches out into different topics (such as escrow agreements and escrow agents). But it’s important to understand these various topics in order to properly comprehend how escrow accounts work.

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