What Is Escrow?
Escrow is a legal concept describing a financial instrument whereby an asset or escrow money is held by a third party on behalf of two other parties that are in the process of completing a transaction. Escrow accounts might include escrow fees managed by agents who hold the funds or assets until receiving appropriate instructions or until the fulfillment of predetermined contractual obligations. Money, securities, funds, and other assets can all be held in escrow. A similar process would be a fully funded documentary letter of credit. It is often suggested as a replacement for a certified or cashiers check.
- Escrow is the use of a third party, which holds an asset or funds before they are transferred from one party to another.
- The third-party holds the funds until both parties have fulfilled their contractual requirements.
- Escrow is associated with real estate transactions, but it can apply to any situation where funds will pass from one party to another.
Escrow is a process used when two parties are in the process of completing a transaction, and there is uncertainty over whether one party or another will be able to fulfill their obligations. Contexts that use escrow include Internet transactions, banking, intellectual property, real estate, mergers and acquisitions, and law, and many more.
Consider a company that is selling goods internationally. That company requires assurance that it will receive payment when the goods reach their destination. The buyer, for their part, is prepared to pay for the goods only if they arrive in good condition. The buyer can place the funds in escrow with an agent with instructions to disburse them to the seller once the goods arrive in a suitable state. This way, both parties are safe, and the transaction can proceed.
Escrow is typically linked to real estate, but it also extends to other financial transactions where either party seeks assurance that the transaction can be completed.
Escrow and Real Estate
Escrow accounts apply to real estate transactions. Placing the funds in escrow allows the buyer can perform due diligence on a potential acquisition. Escrow accounts also assure the seller that the buyer can close on the purchase. For example, an escrow account can be used for the sale of a house. If there are conditions attached to the sale, such as the passing of an inspection, the buyer and seller may agree to use escrow.
In this case, the buyer of the property deposits the payment amount for the house in an escrow account held by a third party. The seller can proceed with house inspections confident that the funds are there, and the buyer is capable of making payment. The amount in escrow is then transferred to the seller once all the conditions for the sale are satisfied.
Escrow and the Stock Market
Stocks are often issued in escrow. In this case, while the shareholder is the real owner of the stock, the shareholder has limited rights when it comes to disposal of the stock. For example, executives who receive stock as a bonus to their compensation often must wait for an escrow period to pass before they can sell the stock. Stock bonuses are a tactic used to retain top executives. (For related reading, see "Understanding the Escrow Process and Requirements")
Internet escrow emerged along with Internet auctions and commerce. On July 2, 2001, the U.S. California Department of Business Oversight allowed Internet escrow companies to function as a licensed class.