An escrow is a financial agreement controlled by a third-party to manage the trade deal payments. The trade deal can be for products or services. The third-party is often called an escrow agent or company. The third-party in such contracts is the financial guarantor for both parties.
What is Escrow?
In an escrow financial arrangement, the payment for a trade deal is held securely with a third-party. The third-party can hold the cash payment, assets, paperwork, or any other legal rights on behalf of the transaction parties. These assets are held with the third-party as long as the transaction does not complete.
Escrow services providers are known as escrow agents or escrow firms; hereafter will be called “the agent”. They help to facilitate risky financial transactions. Their prime purpose is to protect the trade terms and keep the assets safely until the transaction process completes.
Escrow service providers are normally specialists that do not directly relate the business of the two parties in the deal. They specialize in such services and aim to facilitate both parties against their fee or commission.
How Does It Work?
Two parties in a trade deal can agree on the terms and conditions of the deal. They can agree on the products or services’ delivery time, payment mechanism, and quality of the work. New parties in a trade deal often show reluctance for payment methods. One way of reducing the friction is to utilize an escrow account.
Both parties in the deal can agree on payment through this arrangement. A third-party specialist works as the manager of such an arrangement. The buyer makes the payment to the agent for the trade deal. The payment can be the full amount of the trade, advance, or partial payment.
The seller can then take confirmation from the agent for the payment. The seller can proceed with the product manufacturing or shipment of goods as per trade deal terms. Once the seller fulfills the trade terms, the agent confirms the buyer. The agent can then proceed with the payment held in an escrow account.
The prime objective of using an escrow office is to facilitate the trade deal as per the agreed terms. The agent ensures that both parties receive what they agreed on. Usually, it’s the buyer who confirms the quality and quantity of the goods received from the seller. The seller can also make sure to receive the right amount without any delay. An escrow account reduces the default risk of the buyer.
Important Points to Note with Escrow Arrangements
The payment under this arrangement is used to reduce the financial risk for both parties in a trade deal. The buyers are concerned with the quality of the goods or services. The seller side is always concerned with the default risk of the buyer. An escrow office works to reduce the risks of both sides.
Here are some important points to note with this arrangement:
- The responsibility of the agent is to receive the assets from one party and deliver them to the second one.
- The agent can hold the funds until both parties fulfill their requirements as agreed in the trade contract.
- This agent can hold cash, property, legal documents, or any other type of assets as collateral.
- The escrow office essentially works as a facilitator and cannot dictate the terms of the trade deal between both parties.
Important Uses
Escrow money is used to settle the payment terms between both parties. It works similarly to a letter of credit or a bank guarantee. It is used in trade deals with large transaction values. This arrangement can be used for trade deals of goods and services alike. Usually, it is used for a single large transaction but can also be used for an agreement with series of payments.
Here are some important applications of the escrow money.
Real Estate Escrow
The most common use of this is in the real estate sector. The buyer deposits the earnest money to the escrow agent at the beginning. The agent ensures the real estate deal completes smoothly.
The escrow office will inspect the property premises, verify the documentation, and other requirements for the deal. The buyer makes the deal payment to the escrow office. The seller can then proceed with the sale of property knowing the funds are securely held with the escrow office. It will release the funds once the inspection and documentation requirements are fulfilled.
Escrow in Stocks
The stock market and brokerage industry can also use escrow practices. Often it is used when large companies announce bonus stocks for their executives. These stocks come with covenants and the shareholders cannot sell the shares until a specific date. These shares are held in the escrow accounts until the specific date.
Online Escrow
The online escrow accounts are a recent trend. Online purchasing is often riskier. A private escrow services provider acts as the middleman for both parties. It is beneficial for large industrial and business transactions.
Both parties can agree on the goods/services delivery terms. The buyer can make the payment to the escrow office. The agent will release the payment to the seller once the buyer confirms the delivery.
Advantages
The use of escrow money offers several benefits to both parties in the trade deal. It also serves as a business for the service provider.
Here are some key benefits of using this arrangement:
- This arrangement reduces the default risk of the buyer in a large transaction.
- It also serves the buyer for the quality and quantity of the delivered goods or services.
- It facilitates trade deals with large transaction values.
- The escrow office oversees the full transaction cycle from receiving funds in the escrow account, delivery of the goods, and confirmation of the deal closing.
Disadvantages
Despite its many uses, an escrow arrangement can still come with some limitations.
- An escrow office can work only as a trade deal facilitator.
- The agent cannot forfeit or seize the funds in the escrow account that makes the arrangement less reliable than guarantees and letters of credit.
- Both parties need to agree on an escrow office.
- The third-party services can also be risky if the service provider is not reliable.
Conclusion
A third-party holds the assets received from one party and delivers them to the second party. An escrow is the use of holding assets with a third-party until all conditions in the trade deal are satisfied. It reduces the financial risks for both parties in the trade deal. Its most common use is in real estate but is also used in other sectors.
