What Is Escrow?
At its simplest, escrow refers to money or assets held by a neutral third party agent, who then follows written instructions and makes disbursements as contractual terms are met. Thus, an escrow account is used to protect all the various parties in a transaction to make sure that promised funds are available and disbursed appropriately.
When Is an Escrow Account Needed?
Escrow can be used for many reasons. Mergers and acquisitions, for example, often have a cash holdback requirement as part of the underlying purchase agreement. Real estate transactions commonly use escrow for down payment money or even to cover possible environmental cleanup costs. An escrow account can be used as part of a settlement arising from a court case involving individuals or corporate entities, or bankruptcy proceedings. It can be an important part of a Section 1031 like-kind exchange, in which capital gains taxes are deferred when a seller replaces one investment property with another.
What Skills Should an Escrow Agent Have?
A fast, accurate turnaround is probably at the top of the list of what individuals are looking for in an escrow agent. In fact, escrow accounts can be surprisingly complicated. An acquisition that involves multiple shareholders on the sell side, for example, may require a complex escrow agreement designed to provide tax reporting to multiple parties. In all cases, the agent must be able to provide the right escrow account structure, negotiate the escrow agreement, collect the appropriate compliance documents, accept deposits and invest them in accordance with the terms of the escrow agreement,report taxes and disburse funds.
Moreover, escrow agents often need to complete the aforementioned activities very quickly. To meet critical deadlines, escrow transactions may have to be established in as little as a single day. Compliance can be the biggest challenge in these fast turnaround situations, since the Patriot Act and other laws now require full disclosure of corporate and personal information. If lack of appropriate documentation then impedes the compliance process, the closing could be delayed.
How Is an Escrow Account Serviced?
Experienced escrow agents typically assemble teams to oversee the details and ensure all aspects of the escrow transaction are handled in a timely fashion. An effective team might include professionals from compliance, product management, new account processing, escrow and legal functions. Each team member lends the expertise needed to guide a particular aspect of the transaction.
Once the escrow account is opened and funded, escrow servicing becomes a critical part of the escrow agency process. In fact, accurate and timely reporting and disbursements are essential components of the servicing process.
What Are the Most Complex Escrow Transactions?
Cross border transactions—increasingly common in today’s global economy—require a higher level of security. If an offshore company is buying a U.S.-based company, for example, country-risk parameters need to be considered, with special attention paid to the offshore source of funding.
Where Is Escrow Money Kept?
Escrow accounts have an average life of between three months and two years. That means the money is invested for the short-term, and the primary goal is to keep those assets safe until needed. A number of investment options are commonly used for escrow funds, including bank deposit accounts, short-term Treasuries and money market mutual funds. To make sure funds stay safe, escrow monies often are placed in accounts covered by Federal Deposit Insurance Corporation insurance. When choosing the investment plan, individuals also take into account the credit rating of the financial institution where the money will be deposited.
What Is the Typical Size of an Escrow Account?
Firms that specialize in sophisticated escrow management commonly target accounts of $1,000,000 and more. However, escrow amounts often vary, depending on the underlying transaction purpose and size. The biggest escrows can range into hundreds of millions of dollars and require special expertise. Primary considerations for choosing an escrow agent include asset safety, level of expertise in handling a range of escrows including complex transactions, servicing capability, and pricing.
Corporate escrow agents are neutral to all parties of a transaction and have one primary purpose—to support the negotiation, administration and closing of a transaction according to the terms of its agreement. The escrow provider helps to protect the legal rights of all parties involved and provides expertise to a range of escrow agreements. Having an experienced escrow agent engaged early on in the process helps to ensure the best possible outcome for all parties involved.
Visit our Escrow Services page for information on BNY Mellon Wealth Management's escrow capabilities.