Escrow Agreements — A Matter of Form
Friday, April 28, 2023
What is the point of an escrow agreement

An escrow administered by an independent, third-party agent can play an important role in ensuring security and alleviating risks to parties engaging in a business transaction. As the number and type of complex and innovative financing mechanisms increase, the use of escrow arrangements to implement these transactions has also increased. Maintaining a carefully drafted (and regularly updated) form or template escrow agreement is an important tool for a bank to provide comprehensive and streamlined escrow services while also adhering to internal risk management guidelines as an ongoing concern.

By its very nature, the escrow arrangement is ancillary to a separate, underlying transaction that generally does not involve the escrow agent. Therefore, even the most thorough and complete template escrow agreements that an escrow agent might provide to the other parties at the outset of a transaction will always, to some extent, have a certain bespoke quality in order to address the specifics of the transaction at hand, such as the identification of the particular escrow property, the terms of maintenance or investment of the escrow property, and the escrow release conditions.

Of these transaction-specific terms, the parties’ agreement and understanding as to the conditions for releasing the escrow property are perhaps the most important considerations when negotiating an escrow arrangement. From the perspectives of the depositor and beneficiary, the inclusion of detailed release mechanics in an escrow agreement is crucial to capturing the intent and purpose of the escrow. From the perspective of the escrow agent, the inclusion of detailed release mechanics in an escrow agreement is essential to the escrow agent’s ability to perform its obligations and minimize its liability. The inclusion of thorough escrow release conditions and mechanics and the elimination of any and all semblances of decision-making and/or discretionary powers with respect thereto is necessary for an escrow agent to strike a balance among the risk-reward considerations when undertaking a third-party administrative role for a relatively nominal fee when the stakes for the greater transaction can be incredibly high.

Even the most seemingly noncontroversial, straightforward escrow release conditions may lack the necessary clarity when the time for action by the escrow agent arises. And despite the inclusion of significantly detailed release conditions in an escrow agreement, there may be certain nuanced questions and concerns in terms of actual performance that the parties did not consider at the outset of the transaction. As a result, a bank administrator may ultimately be tasked with making certain decisions, determinations, and judgment calls that are not within the purview of the escrow agent’s engagement (not to mention authority), thus jeopardizing the escrow agent’s critical liability limitations. Even when the escrow release conditions are robust and thorough, questions may still arise in the course of administration, such as:

  • Are joint written instructions sufficient for release if they do not contain specific references to transaction milestones when those milestones have been described in the escrow agreement as explicit release conditions?

  • Is a letter from an engineer saying that a project was operating as of a certain day equivalent to a certificate from an independent engineer confirming that the project has been completed in conformity with the project documents?

  • Does a legal opinion that contains numerous and multiple carveouts and qualifications meet the requirement for delivery of a legal opinion confirming compliance as a condition to release?

Because an escrow agreement form will always require some individualized drafting and the addition of transaction-specific provisions in respect of an important obligation of the escrow agent as it relates to the escrow release conditions, consider adding to the escrow agreement a form or forms specific to the escrow release. As long as any form of release instructions or documentation be attached to the escrow agreement, the onus on determinations as to acceptability and agreement vis-à-vis the business terms of the transaction appropriately remains with the depositor and beneficiary as the interested parties.

For example, you might add a provision stipulating that the escrow cannot be released unless the depositor and beneficiary deliver joint written instructions, which are attached as an exhibit to the escrow agreement. This will ensure that the substantive release language tracks the parties’ intent and can also provide certainty as to any other addressees or recipients, as well as clarity as to the signatory requirements in terms of number and authority of officers. If a legal opinion must be delivered to the escrow agent as a condition of release, consider including the form of opinion as an exhibit to the escrow agreement. Financing-related legal opinions are frequently highly negotiated transaction documents, oftentimes well in advance of closing; this is not something that a third-party administrator should be assessing for acceptability or for conformity with accepted standards in the relevant transaction market.

By requiring the depositor and beneficiary to agree as to the form of any escrow release documentation at the time of execution, the escrow agreement will provide a more complete picture of the parties’ expectations for the transaction and allow for effective, reduced-risk administration by the escrow agent.


NLR Logo

We collaborate with the world's leading lawyers to deliver news tailored for you. Sign Up to receive our free e-Newsbulletins


Sign Up for e-NewsBulletins