Escrow is a legal concept in which a financial instrument or an asset is held by a third party on behalf of two other parties that are in the process of completing a transaction. The funds or assets are held by the escrow agent until it receives the appropriate instructions or until predetermined contractual obligations have been fulfilled. Money, securities, funds and other assets can all be held in escrow.
Escrow comes into play 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.
For example, a company selling goods internationally wants to be certain that it will get paid when the goods reach their destination. Conversely, the buyer wants to pay for the goods only if they arrive in good condition. The buyer can place the funds in escrow with an agent and give instructions to disburse them to the seller once the goods arrive. This way, both parties are safe, and the transaction can proceed.
Escrow accounts are used in real estate transactions so that the buyer can perform due diligence on a potential acquisition while assuring the seller of his capacity to close on the purchase. For example, an escrow account can be used for the sale of a house. If there are conditions 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. This assures the seller, in the process of allowing the house to be inspected, that the buyer is capable of making payment. Once all the conditions to the sale are satisfied, the escrow transfers the payment to the seller, and the title is transferred to the buyer.
Stocks, especially those of public companies, are often issued in escrow. This means that while the shareholder is the real owner of the stock, he is limited in his rights to dispose of it. For example, executives who receive stock as a bonus to their compensation often have to wait for an escrow period to pass before they can sell the stock. This is used as a tactic to retain top executives.