What’s an Escrow and why it is important for payments

Introduction

An Escrow results from a written, binding agreement between two parties. An agreement whereby in a business arrangement certain sums of money or asset are deposited with a third party as collateral. The sums are released upon the occurrence of a termination condition expressly defined by the parties. 

Purpose of the Escrow

In complex business negotiations the parties may wish to protect themselves in an enhanced manner. For this reason it is common practice to include Escrow Agreements in contracts. These are guarantee agreements which may consider the establishment of an account to guarantee the transaction. This is known as an Escrow Account.

The purpose of an Escrow is to bring an independent third party into the business transaction.

The Escrow Agreement

The agreement that will be signed to establish an escrow account is a legally binding contract that sets forth the terms of the business transaction for which the money is being paid. The agreement will define the terms of the transaction and any conditions that require to be met. It will need to specify how each party will notify the person in charge of the account so that the money can be released. This means that the parties to the agreement may be in different countries and may rely on an independent third party.

A very important aspect concerns the consequences in the event of default by one of the parties.

As with any contract, it is crucial to regulate every aspect, including those relating to breach of contract. For example when the buyer refuses to accept the goods.

The Escrow Agent

Very often, a financial institution or a lawyer will act as guarantor. An escrow account is opened in a bank, and it will act as a guarantee for the deposit of a sum of money. This is a sum of money that must pass between two parties in return for a commercial transaction. Once the transaction has taken place the bond on the guarantee is released and the money is transferred from one party to the other.

The relationship between escrow agent, depositor and beneficiary is a trust relationship.

The third party status and independence of the escrow agent with respect to the parties to the main relationship means that the escrow agent cannot claim any rights with respect to the asset (goods) being escrowed.

The escrow agent is considered to be the agent of both parties who can only revoke the mandate jointly.

Advantages

The advantage of the escrow thus assures the contracting parties that an asset is held by an independent third party. The third party holds the goods in accordance with the parties’ instructions and will deliver them to the entitled party only and exclusively when the pre-established condition is met.

The third party is responsible for the custody of the asset, which remains in its management until the conclusion of the commercial transaction.

Costs 

It is necessary to take into account the costs involved in making such an arrangement. Banking institutions, in fact, for the deposit and custody of these sums of money (or assets), require a fee that must be considered.

For this reason, before starting an agreement like this and opening an Escrow Account at a banking institution, it is essential to evaluate the costs associated with the operation. It is true that this is not a small guarantee, but it is also true that the costs associated with this type of agreement are often significant for small companies.

Practical examples

Business transaction

A company is buying a large quantity of goods from a remote company for the first time. The parties do not yet know each other well enough and both want to protect their business transaction. The buyer sees the risk of the seller’s lack of reliability. Similarly, the seller does not know the financial strength of the client company. In this case, the deposit of sums of money in a bank to be released at the moment of the arrival of the goods is a security clause widely used in the commercial field.

Purchase and sale of artwork

In the case of sale and purchase of artworks, it is very frequent that a third party is involved. It holds the artwork under custody and guarantee. Once the commercial transaction between the buyer and the seller has taken place, the escrow agent gives the buyer access to the artwork being held.

Conclusions

Escrow are a very useful tool to enhance the reliability of business transaction between parties who do not know or do not trust each other. It is also used for transactions between parties based in different countries.

The Escrow Agent will play a neutral role keeping the money or the assets as long as the condition defined in the Escrow Agreement are met.

Of course, the service or the Escrow agent has a cost that must be considered before entering such an arrangement.

Uniscrow is developing an innovative, blockchain-based way to make escrow digital and disintermediate.

Our mission at Uniscrow is creating solutions for people and companies that want to make business remotely and securely. This is why we are building a blockchain-based escrow software that will provide a new level of transparency, security and control for users without the need to have a bank or an escrow agent as intermediaries.