What is an Escrow Agreement?
The Escrow agreement is a financial agreement in which a third party holds the financial payment of a transaction between two parties. A third party is an independent person who holds the funds just to make sure the security of the transaction.
The payer may resist making payment to another party before the performance of the obligation whereas the receiver may resist performing the obligation before receiving the payment. To secure the trust factor among the two parties in a transaction, the third party acts as an escrow agent who holds the money to be transacted. The payer deposits some valuables in escrow account signing an agreement that does not allow refund before the performance of obligations. Such deposits secure both the parties from any fraud.
Escrow is a deposit of a document or formal instrument or a money deposit that has monetary value. Documents or formal instruments like deeds, written instruments, promise to pay, license, patents, checks, bonds, mortgage, etc.
In an Escrow Agreement, three persons are involved – depositor, beneficiary and escrow agent. It is basically an agreement between two partied that provides certain guidelines or directions for the party who accepts the escrow delivery.
How Does Escrow work?
Basically, the owner of the deposit is putting the escrow with the third party who is an independent party to both the parties involved and keeps it with him until the promise made by the depositor has been fulfilled. The third-party cannot return the property of the depositor without a performance of his obligation.
The two parties, buyer and seller initiate a transaction where the seller has to dispatch 1000 pieces of merchandise to the buyer. The seller is insecure about the dispatch of goods without receipt of payment whereas the buyer is insecure about making a payment without receipt of goods. They both agree to appoint an escrow agent and signed the terms and conditions of the escrow agreement. The buyer deposited the required amount of money in escrow with the agent and verification shall be sent to the seller. The seller shall dispatch the ordered merchandise and provide the tracking information to the agent and the buyer. Then, on receipt of goods by the buyer, the agent shall release the deposited amount to the seller.
Components of Escrow Agreements
The main components are as follows –
- Details of the 3 parties involved
- Important details of the promise to be fulfilled
- Deposits made in escrow
- Conditions to the release of escrow funds
- Obligations and liabilities of the escrow agent
- Expenses and fees associated
- Legal Jurisdiction
Who is Using Escrow Agreements?
These agreements are a secure mode of financial transactions. These agreements are used by various businesses.
This is the most fundamental type. Internet escrow allows the deposit of money with an independent licensed third party to protect both buyer and seller.
Types of Internet Escrow Agreements
There are various types:
- Third-Party Agreement: This is the most basic type where parties to the agreement are a software vendor, a licensee, and a software escrow agent. This agreement is suitable when there is a single licensee who needs a software escrow agreement and the vendor doesn’t provide such agreements to other licensees.
- Multiple Party Agreement: When a software vendor provides escrow arrangements for all licensees, the software vendor keeps one escrow account for all the licensees. It becomes easier for the vendor to manage all the escrow payments through one common account.
- When multiple licensees are spread over multiple software with a single software vendor, one central agreement for all licensees and software is developed for effective management.
- When a single licensee buys software from multiple vendors, they face problems with multiple escrow account. So, licensee creates one single escrow account for all software vendors which becomes flexible for the licensee to manage the transactions.
- Minimum Service Escrow: This agreement is used when a software vendor does not charge fees from the licensee for the software to provide minimum service or use of the software. So, they develop a common escrow account for multiple licensees to add or remove them without any notification when the minimum service period is over.
Below are the seven types which are as follows:
#1 – Banking
To protect automatic banking and vending equipment like ATMs, escrow is used in banking businesses. The money is deposited in the vending machine (ATMs) before completion of the transaction between the customer and the bank.
#2 – Law
Escrow is used in the judiciary cash settlements also. The defendant deposit money with the escrow fund of law and the fund distributes the money as per the settlement of the law.
#3 – Real Estate
Escrow payments are mostly done in real-estate transactions due to the heavy amount of payment. The buyer makes earnest money checks to an escrow to show his credibility to buy the properties. These agreements are used for attorneys, title agents and notaries as well.
#4 – Mergers & Acquisitions
Escrow agreements are used in M & A arrangements to secure warranties and indemnities offered by the seller because of the high credit risk on the seller to be able to recover all the money. These agreements do not only complete the transfer of assets rather are extended to longer periods.
#5 – Gambling
Since gambling is a game based on the contingent future event. Such agreements are mostly used in these transactions where a disinterested person becomes a stakeholder to hold the money until the event takes place and distribute the money accordingly.
#6 – Securities Industries
These agreements are famous in securities industries also for initial public offerings, under stock option plans, depositories, etc. to secure the allotment money or deposits amount of the investors.
#7 – Businesses
These agreements are commonly used in various transactions of businesses for their financial security.
In today’s era, Escrow agreements have proved to be important for secure transactions among various businesses. It avoids insecurities and maintains trust among unknown parties which enhances the smooth working of businesses.
This has been a guide to what is an escrow agreement. Here we discuss how escrow agreement works along with examples, components, types, and uses. You can learn more about financing from the following articles –
- Contingent Liabilities Definition
- Loan Servicing Meaning
- Trust Account Meaning
- Restricted Cash Examples
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