This post is part of our First Year Associate series, where we’ll provide explanations to simple issues faced by first year corporate associates. We’ll focus on the basic problems that you might be embarrassed to ask a senior attorney. And if you already asked, the answer was so brief it provided just enough context to bring you here.
The Escrows — Part III of III
If you read Part II of this series, you know that parties in a corporate M&A transaction often put closing proceeds aside in an escrow fund for obligations that arise after the closing. This is where the escrow agent sneaks into the picture—sometimes as an afterthought as the deal approaches closing. But be careful, this small infiltration can still hijack the whole closing process!
So who is the escrow agent?
The escrow agent is typically an independent third party, and in most cases, it is a reputable bank or financial institution. Often the escrow agent is recommended by one of the parties as a result of a prior relationship (or sometimes the law firm will make the recommendation) and both parties will need to agree to use that institution. Its primary role is to accept the deposit of escrow funds into an independent account and distribute those funds in accordance with the instructions of the parties.
What do escrow release instructions look like?
Enter the escrow agreement—this is an ancillary document you will see in just about every corporate transaction. The escrow agreement details the responsibilities of the escrow agent, when they should release the funds in the escrow account and to whom those funds should be issued. Most importantly for the escrow agent, it will want to disclaim any liability it may have for the funds (such as disclaiming interest in the funds and any responsibility for determining authenticity of any claims it receives). Instead, it will require that the escrow agreement clearly sets out certain principles:
- How the funds will be invested. Funds are typically invested in a low-risk money market account.
- What is required for the escrow agent to distribute funds. This involves a claim to release funds submitted by one party, followed by an opportunity to dispute the claim by the other party. If the claim is disputed, then funds will are typically only distributed after the escrow agent receives joint written instructions from the parties.
- Which party will be treated as the owner of the fund for tax purposes. Don't be surprised if no one wants this responsibility!
- The bank account and notice instructions for the parties. So the escrow agent sends the money to the correct place.
- The escrow fees. Because of course, the escrow agent wants to get paid.
So how can the escrow agent throw a kink in the closing process?
- Keep in mind that the escrow agent has different incentives than the parties involved in the deal. As a result, it often does not operate with the same sense of urgency.
- The escrow agent may be a company that has several layers of approval between the banker you are communicating with and the lawyers reviewing the escrow agreement. That means even non-material changes to the escrow agreement may take time (days!) to get approved.
- Finally, some escrow agents are not very progressive. They will require other parties to sign the agreement and provide original signatures before they will provide their signature. So make sure to find out early what their signing requirements are!