What Is an Escrow Agreement?

An escrow agreement is a legal document that outlines the terms and conditions between parties involved, and the responsibility of each. These agreements usually involve an independent third party, called an escrow agent, who holds an asset of value until the specified conditions of the contract are met.

In an escrow agreement, one party—usually a depositor—deposits funds or an asset with the escrow agent until the time that the contract is fulfilled. Once the contractual conditions are met, the escrow agent will deliver the funds or other asset to the beneficiary.

Escrow agreements are commonly used in different financial transactions—especially those that involve significant dollar amounts such as real estate or online sales.

Escrow agreements provide security by delegating an asset to an escrow agent for safekeeping until each party meets his or her contractual obligations.

How Escrow Agreements Work

Escrow agreements must fully outline the conditions between all parties involved. Having one in place ensures all the obligations of the parties involved are met, and that the transaction is conducted in a safe and reliable manner.

An escrow agreement normally includes information such as:

  • The identity of the appointed escrow agent
  • Definitions for any expressions pertinent to the agreement
  • The escrow funds and detailed conditions for the release of these funds
  • The acceptable use of funds by the escrow agent
  • The duties and liabilities of the escrow agent
  • The escrow agent's fees and expenses
  • The jurisdiction and venue in the event of a legal action

Most escrow agreements are put into place when one party wants to make sure the other party meets certain conditions or obligations before it moves forward with a deal. For instance, a seller may set up an escrow agreement to ensure a potential homebuyer can secure financing before the sale goes through. If the buyer cannot secure financing, the deal can be called off and the escrow agreement canceled.

For certain transactions such as real estate, the escrow agent may open up an escrow account into which funds are deposited. Cash has traditionally been the go-to asset that people entrust to an escrow agent. But nowadays, any asset that holds a value can be put into escrow including stocks, bonds, deeds, mortgages, patents, or a check.

Escrow Agreements and Real Estate

As mentioned above, escrow agreements are frequently used in real estate transactions. Title agents in the United States, notaries in civil law countries, and attorneys in other parts of the world routinely act as escrow agents by holding the seller's deed to a property.

Payment is typically made to the escrow agent. The buyer can perform due diligence on his potential acquisition—like doing a home inspection or securing financing—while assuring the seller of his capacity to close on the purchase. If the purchase goes through, the escrow agent will apply the money to the purchase price. If the conditions set forth by the agreement are not met or the deal falls through, the escrow agent can refund the money to the buyer.

Key Takeaways

  • An escrow agreement is a legal document outlining terms and conditions between parties as well as the responsibility of each.
  • Agreements usually involve an independent third party called an escrow agent, who holds an asset until the contract's conditions are met.
  • Escrow agreements are commonly used in real estate transactions.
  • The escrow agreement generally includes, but is not limited to, information about the escrow agent's identity, the funds in escrow, and the acceptable use of funds by the agent.

Other Uses of Escrow Agreements

There may come a time during a business transaction when it is in the best interest of one party to move forward only if it knows with absolute certainty that the other party can fulfill its obligations. This is where the use of an escrow agreement comes into play.

For example, a company purchasing goods internationally wants to be certain its counterpart can deliver the goods. Conversely, the seller wants to ensure it gets paid if it sends the goods to the buyer. Both parties can put an escrow agreement in place to ensure delivery and payment. They can agree the buyer will deposit the funds in escrow with an agent and give irrevocable instructions to disburse the funds to the seller once the goods arrive. The escrow agent—likely an attorney—is bound by the terms of the agreement.

Stocks are often the subject of an escrow agreement in the context of an initial public offering (IPO) or when they are granted to employees under stock option plans. These stocks are usually in escrow because there is a minimum time limit that needs to pass before they can be freely traded by their owners.