Escrow agreements: uses and terms

Service page: Commercial contracts lawyer: drafting, review and enforcement.

What is an escrow agreement, and why does it exist?

Two parties to a transaction: a buyer and a seller. Both want security before they move. The buyer will not pay until it is sure the asset is clean. The seller will not transfer ownership until it is sure it will get the money. An escrow agreement solves this dilemma: a third party, the escrow agent, holds the money, and releases it only when all the conditions are met.

In Israel, an escrow agreement creates a trust “under a contract with a trustee” (section 2 of the Trust Law, 5739-1979), and contract law applies to it too. In transactions to buy an apartment from a contractor, the Sale (Apartments) (Assurance of Investments of Persons Acquiring Apartments) Law, 5735-1974 (חוק המכר (דירות) (הבטחת השקעות של רוכשי דירות), התשל״ה-1974) requires the seller to secure the buyer’s money with one of the securities in section 2 of that Law, and this is not necessarily a trust.

When exactly do you use an escrow agreement?

Buying an apartment from a contractor: the law does not require the consideration to be held in trust. Under section 2 of the Sale (Apartments) (Assurance of Investments of Persons Acquiring Apartments) Law, 5735-1974, a seller will not receive more than 7% of the price unless it has secured the buyer’s money in one of the ways in the Law: a guarantee, an insurance policy, a mortgage in favor of the buyer, a cautionary note or transfer of ownership to the buyer’s name.

Sale of a business or shares (M&A): the buyer releases part of the price only after a warranty period. The escrow agent holds part of the consideration as a “holdback” to secure the seller’s obligations that come to light after the transfer.

Export, import and international trade: an escrow agent abroad releases money to the supplier only after the shipment and the shipping documents (clean bill of lading) are received.

Settlement agreements: an escrow agent holds the settlement amount until all the terms of the agreement have been carried out, which prevents a breach at a later stage.

Source code escrow (software escrow): a software supplier deposits the source code and the documentation with an escrow agent, and the agent hands them to the customer only on the events set in the agreement, such as the end of support for the software or the supplier ceasing business. It is worth setting in advance what the customer may do with the code handed to it, and how to make sure the deposited version is up to date. On ownership of code developed to order, see IT outsourcing agreement.

The release conditions: the clause that decides everything

The most important clause in any escrow agreement is not the escrow agent’s name but the release conditions. The more specific they are, the fewer disputes.

Do not write “when the transaction is completed”; write “when written confirmation is received from the buyer’s lawyer that the apartment was delivered without defects, together with a certificate of ownership issued by the Land Registry in the buyer’s name.”

Other clauses that must be defined in the agreement: identification of the escrow agent and its legal qualifications; the escrow agent’s errors and omissions (E&O) insurance; the escrow agent’s remuneration and who pays it; the duration of the escrow and what happens if it expires; and what happens in a dispute: who decides, and by what mechanism.

Who can serve as the escrow agent?

Banks: they operate under the supervision of the Bank of Israel and keep segregated accounts. Suitable for large transactions; the charges are relatively high.

Lawyers: the most common in commercial and real estate transactions. They must keep a separate bank account for money deposited with them in trust (rule 39 of the Israel Bar Association (Professional Ethics) Rules, 5746-1986), and they release it according to the terms of the agreement. They are subject to professional liability.

Dedicated trust companies: suitable for complex transactions with many components. Medium charges.

The Trust Law requires the trustee to hold the trust assets separately from its own assets, or in a way that allows them to be told apart (section 3(c)), and prohibits it from deriving a benefit for itself from the trust assets (section 13). A trustee that breached its duties is liable for the damage caused (section 12(a)).

What are each party’s rights?

The depositing party (in a sale, usually the buyer, who deposits the money) can demand regular reports on the state of the assets, make sure the conditions are met before release, and get the assets back if the conditions were not met.

The receiving party (usually the seller) is entitled to receive the assets as soon as the conditions are met, without delay. It may sue the escrow agent if the agent released money unlawfully.

Both parties must: pay the escrow agent’s remuneration as agreed; not pressure the escrow agent to release early; and keep confidential the information they received from the escrow agent.

Common disputes, and how to avoid them

Vague release conditions: the most common dispute. One party argues that the condition was met, the other disagrees. The solution: clear, measurable conditions, with a specific document that confirms they were met.

An escrow agent who made a mistake: the Trust Law requires a trustee to act “faithfully and diligently as a reasonable person would act in the same circumstances” (section 10(b)), and it is liable for damage caused by a breach of its duty (section 12(a)); the court may release from liability a trustee that acted in good faith (section 12(b)). An escrow agreement may include a clause that limits the escrow agent’s liability: read it before signing, and note that the duty of diligence in section 10(b) is not among the provisions that the Law makes subject to the terms of the trust (section 11).

A dispute over charges: who pays the escrow agent’s remuneration? Usually the party that initiated the escrow, sometimes half and half. Anything not written in the agreement leads to an argument.

Pressure to release early: an escrow agent who listens to one party and releases money before the conditions were met is liable for the damage caused by the breach of its duty (section 12(a) of the Trust Law).

A checklist before signing an escrow agreement

Choose an escrow agent with E&O insurance: check that the lawyer is registered with the Israel Bar Association and that there are no disciplinary proceedings against them. A bank: check directly with the branch.

Write release conditions that a stranger would understand: “when the buyer pays NIS X into account Y and a bank confirmation is sent”, not “when the parties agree.”

Get written confirmation that the escrow agent received the assets: do not rely on an oral promise. A written description of the assets the escrow agent holds is a must.

Ask for regular reports: once a month or once a quarter, so you know the money is there. Do not assume and move on.

Keep signed copies: the original agreement with signatures plus the escrow agent’s confirmation of receipt, for both parties. Not one document in the hands of one party only.

The default rules in the Trust Law: what applies when the agreement is silent

1. Interest and income: the income from the trust assets is part of the trust assets (section 3(a) of the Trust Law). Set to whom it is released together with the principal.
2. Investment: money that is not needed for current needs is held or invested by the trustee “as is efficient for preserving the principal and producing income” (section 6). A lawyer who received money in trust asks the person for whom they hold it for detailed instructions on handing it over and investing it (rule 41(a) of the Israel Bar Association (Professional Ethics) Rules).
3. Reporting: the trustee gives the beneficiaries an account once a year and at the end of its term, and further information at their reasonable request (section 7(b)). Want a monthly report? Write it in.
4. Remuneration and expenses: the trustee may repay itself its remuneration and expenses from the trust assets and withhold them as security (section 8(c)). If the remuneration is paid separately, write that down.

These provisions apply subject to the terms of the trust (section 11), so the agreement can provide otherwise.