Often when people hear the term escrow they immediately conclude that a real estate transaction is contemplated and a title company will occupy the role of escrow office, though what duties are imposed on an escrow officer may be somewhat vague to them. Thinking that escrow relates only to real estate is a common error. This misconception is based on the fact that most real estate transactions in the United States do use escrow accounts and escrow officers thus most Americans experience an escrow in that context. In reality, use of escrow accounts can occur in any type of transaction and quite often is a useful tool to accomplish business goals.
In its most basic form, an escrow is a transaction in which one person in a contract with another delivers a written instrument, money, evidence of title to real or personal property, or other thing of value to a third person to be held by such person until the happening of a specified event. The third party or the neutral person with whom the property is kept in trust is known as an escrow agent or a depositary. The principal parties are the grantee and the grantor. The property given in trust for deposit is known as escrow property.
The transaction in which an escrow is created can be sale, transfer, encumbering, or leasing of real or personal property to another person. Securities, funds, and other assets also can be held in escrow. On the happening of the specified event, the property is to be delivered by the third person to the grantee, grantor, promisee, promisor, obligee, obligor, bailee, bailor, or any agent or employee of the grantee. The funds are held by the escrow service until it receives the appropriate written or oral instructions. In financial escrows, the fund is held until obligations are fulfilled. The property is to be redelivered to the other party to the transaction upon performance of the specific condition/conditions in the agreement. Normally, the escrow office has a fiduciary duty to the grantor and grantee and the arrangement is created in a written contract.
The Basic Law:
For an escrow to be valid there must be:
- a binding contract between the parties to a transaction, and
- conditional delivery of transfer instruments or money to a third party
Generally, there are two or more underlying transactions, and two or more related escrows in an escrow transaction. An escrow agent is a limited agent of the parties to the transaction in that he or she acts as the agent but only for a specified purpose as directed in the escrow instructions. His/her position is like that of a trustee.
The primary duties of an escrow agent are:
- duty to follow the escrow instructions;
- duty to use good faith and reasonable skill; and
- duty to redeliver goods on the completion of conditions.
Delivery before the performance of the condition or happening of a contingency is unauthorized. Moreover, prior delivery is a violation of the depositor’s rights. Griffin v. Gay, 223 Ill. App. 420, 432 (Ill. App. Ct. 1921). Delivery of a deed by a grantor to a third person with unconditional instructions to keep the deed and delivered to the grantee upon the grantor’s death is a valid delivery. However, there must not be reservation by the grantor of dominion over the deed. Turner v. Mallernee, 640 S.W.2d 517, 521 (Mo. Ct. App. 1982). Prior to closing of an agreement, an escrow agent is the dual agent for both parties. After closing, an escrow agent is an individual agent for each party.
Escrow instructions are written directions to an escrow agent which state the duties of the parties and the escrow holder. Note that an existing agent or an attorney of grantor or grantee cannot act as an escrow agent due to the conflict of interest in the duties.
The selection of the escrow holder is normally done by an agreement between the principals. An escrow agent who breaches duties to the parties to the escrow agreement can be held liable in tort and for breach of contract. Commercial Escrow Co. v. Rockport Rebel, Inc., 778 S.W.2d 532 (Tex. App. Corpus Christi 1989).
Creation of the Escrow:
Usually State law determines the required escrow documentation and law, but if Federally regulated financial institutions are involved, Federal law can apply and also as to transactions involving interstate commerce.
Federal Law on Mortgage Requirements
Pursuant to 12 USCS § 3500.17, an escrow account means any account that a servicer establishes or controls on behalf of a borrower to pay taxes, insurance premiums (including flood insurance), or other charges with respect to a federally related mortgage loan, including charges that the borrower and servicer have voluntarily agreed that the servicer should collect and pay. The definition encompasses any account established for this purpose, including a “trust account”, a “reserve account”, an “impound account”, or other term depending on the locality. An “escrow account” includes any arrangement where the servicer adds a portion of the borrower’s payments to principal and subsequently deducts from principal the disbursements for escrow account items. For purposes of this section, the term “escrow account” excludes any account that is under the borrower’s total control.
The statute sets out the requirements for an escrow account. Accordingly, a lender establishes an escrow account in connection with a federally related mortgage loan. It sets limits for escrow accounts using calculations based on monthly payments and disbursements within a calendar year.
If an escrow account involves biweekly or any other payment period, the requirements in that section are modified accordingly. A HUD Public Guidance Document entitled “Biweekly Payments-Example” provides examples of biweekly accounting and a HUD Public Guidance Document entitled “Annual Escrow Account Disclosure Statement-Example” provides examples of a 3-year accounting cycle. A HUD Public Guidance Document entitled “Consumer Disclosure for Voluntary Escrow Account Payments” provides a model disclosure format that originators and servicers are encouraged, but not required, to provide to consumers when the originator or servicer anticipates a substantial increase in disbursements from the escrow account after the first year of the loan.
The following are the limits on payments to escrow accounts:
(1) A lender or servicer (hereafter servicer) shall not require a borrower to deposit into any escrow account, created in connection with a federally related mortgage loan, more than the following amounts:
(i) Charges at settlement or upon creation of an escrow account: at the time a servicer creates an escrow account for a borrower, the servicer may charge the borrower an amount sufficient to pay the charges respecting the mortgaged property, such as taxes and insurance, which are attributable to the period from the date such payment(s) were last paid until the initial payment date. The “amount sufficient to pay” is computed so that the lowest month end target balance projected for the escrow account computation year is zero. In addition, the servicer may charge the borrower a cushion that shall be no greater than one-sixth (1/6) of the estimated total annual payments from the escrow account.
(ii) Charges during the life of the escrow account: throughout the life of an escrow account, the servicer may charge the borrower a monthly sum equal to one-twelfth (1/12) of the total annual escrow payments which the servicer reasonably anticipates paying from the account. In addition, the servicer may add an amount to maintain a cushion no greater than one-sixth (1/6) of the estimated total annual payments from the account. However, if a servicer determines through an escrow account analysis that there is a shortage or deficiency, the servicer may require the borrower to pay additional deposits to make up the shortage or eliminate the deficiency.
(2) Escrow analysis at creation of escrow account: before establishing an escrow account, the servicer must conduct an escrow account analysis to determine the amount the borrower must deposit into the escrow account. Upon completing the initial escrow account analysis, the servicer must prepare and deliver an initial escrow account statement to the borrower. The servicer must use the escrow account analysis to determine whether a surplus, shortage, or deficiency exists and must make any adjustments to the account
(3) Subsequent escrow account analyses: for each escrow account, the servicer must conduct an escrow account analysis at the completion of the escrow account computation year to determine the borrower’s monthly escrow account payments for the next computation year. The servicer must use the escrow account analysis to determine whether a surplus, shortage, or deficiency exists, and must make any adjustments to the account.
(4) Aggregate accounting required: all servicers must use the aggregate accounting method in conducting escrow account analyses.
(5) Cushion: the cushion must be no greater than one-sixth (1/6) of the estimated total annual disbursements from the escrow account.
(6) Restrictions on pre-accrual: a servicer must not practice pre-accrual.
(7) Servicer estimates of disbursement amounts: to conduct an escrow account analysis, the servicer shall estimate the amount of escrow account items to be disbursed. If the servicer knows the charge for an escrow item in the next computation year, then the servicer shall use that amount in estimating disbursement amounts. If the charge is unknown to the servicer, the servicer may base the estimate on the preceding year’s charge, or the preceding year’s charge as modified by an amount not exceeding the most recent year’s change in the national Consumer Price Index for all urban consumers. In cases of unassessed new construction, the servicer may base an estimate on the assessment of comparable residential property in the market area.
(8) Provisions in mortgage documents: the servicer must examine the mortgage loan documents to determine the applicable cushion for each escrow account. If the mortgage loan documents provide for lower cushion limits, then the terms of the loan documents apply. Where the terms of any mortgage loan document allow greater payments to an escrow account than allowed by this section, then this section controls the applicable limits.
Where the mortgage loan documents do not specifically establish an escrow account, whether a servicer may establish an escrow account for the loan is a matter for determination by other Federal or State law. If the mortgage loan document is silent on the escrow account limits and a servicer establishes an escrow account under other Federal or State law, then the limitations of this section apply unless applicable Federal or State law provides for a lower amount. If the loan documents provide for escrow accounts up to the RESPA limits, then the servicer may require the maximum amounts consistent with this section, unless an applicable Federal or State law sets a lesser amount.
(9) Assessments for periods longer than one year: some escrow account items may be billed for periods longer than one year. For example, servicers may need to collect flood insurance or water purification escrow funds for payment every three years. In such cases, the servicer shall estimate the borrower’s payments for a full cycle of disbursements. For a flood insurance premium payable every 3 years, the servicer shall collect the payments reflecting 36 equal monthly amounts. For two out of the three years, however, the account balance may not reach its low monthly balance because the low point will be on a three-year cycle, as compared to an annual one.
State Law:
Each state also has various legal requirements for the creation and maintenance of an escrow and the duties of an escrow office and for those transactions only within the particular state, state law should be reviewed by competent counsel. Do not assume federal law automatically applies.
Who May Be An Escrow Officer?
As noted above, an escrow is the process by which a document, real estate, money, or securities are deposited with a neutral third party to be delivered upon fulfillment of certain conditions. The neutral third party is known as an escrow agent or depositary. In the creation of an escrow, there must be a depositary with instructions from the parties. Instruments are deposited with a depositary by an agreement between the parties. Instructions to the depositary constitute the rules governing an escrow agreement. An escrow agreement is different from the instrument placed in escrow. It contains conditions agreed upon by the parties. A depositary accepts an instrument upon the terms of the agreement. Kennedy v. District-Realty Title Ins. Corp., 306 A.2d 655, 657 (D.C. 1973). A valid escrow agreement requires that the proposed escrow agent know of and agree to perform the function of receiving a deposit. Essential elements of a valid escrow arrangement are:
- A contract between the grantor and the grantee agreeing to the conditions of a deposit;
- Delivery of the deposited item to a depositary; and
- Communication of the agreed conditions to the depositary.
The depositary of an escrow must be a third person. A grantee can be made an agent of the grantor for the purpose of transmitting escrowed property to a depositary. However, a grantee cannot be made a depositary of an escrow. Cincinnati, W. & Z. R. Co. v. Iliff, 13 Ohio St. 235 (Ohio 1862). A depositary is not an agent of the grantor or grantee. A depositary is a trustee of an express trust. Foulkes v. Sengstacken, 83 Ore. 118, 128-129 (Or. 1917).
The rights and duties of a depositary are determined by the escrow agreement. Marathon U.S. Realties v. Kalb, 244 Ga. 390, 392 (260 S.E.2d 85) (1979). A depositary’s duty is only to fulfill the terms of the escrow agreement. Moreover, title of the escrowed property remains with the depositor. The depositor surrenders property to the depositor. When all conditions of the escrow are accomplished, a depositary delivers the property. Roberts v. Porter, 193 Ga. App. 898, 900 (Ga. Ct. App. 1989). A depositary has a fiduciary duty to the escrow parties to comply strictly with the party’s instructions. The holder assumes a fiduciary duty by agreeing to execute the escrow. Often the depository will seek to limit that fiduciary duty in the escrow agreement but certain duties cannot be waived depending on the State.
Usually, a depositary undertakes the following duties under an escrow:
- to exercise reasonable skill and diligence in carrying out the escrow instructions; and
- to comply strictly with the depositor’s written instructions.
Moreover, a depositary is under a duty to communicate to the principal any knowledge acquired in the course of escrow. The knowledge so acquired must be with respect to material facts which might affect the principal’s decision as to a pending transaction. Axley v. Transamerica Title Ins. Co., 88 Cal. App. 3d 1, 9 (Cal. App. 4th Dist. 1978).
When a depositary acts negligently, s/he is ordinarily liable for any loss occasioned by breach of duty. However, no liability attaches to the escrow holder for his/her failure to do something not required by the terms of the escrow. Additionally, a depositary is not liable for a loss incurred while obediently following escrow instructions. Axley v. Transamerica Title Ins. Co., 88 Cal. App. 3d 1, 9 (Cal. App. 4th Dist. 1978).
The escrow agent will deliver the document to the benefited party when the conditions of the contract are met. The depositor has no control over the instrument deposited in escrow. Upon performance of the condition, the grantee or obligee is entitled to delivery of the escrowed property. Delivery can be enforced by a decree of court. When a depositary refuses to deliver, the remedy is not usually against the other party to compel specific performance of the escrow contract. Action can be brought against the depositary to obtain possession of the instrument. When a depositary refuses to make the delivery and claims the escrow, the depositary can be held liable for conversion. Angle v. Bass, 169 Okla. 120, 122 (Okla. 1934).
When an instrument is deposited in escrow, the instrument passes beyond the control of the depositor. A depositor cannot recall it. Upon the performance of the condition, the depositary must deliver the property to the grantee. A deposit in escrow amounts to a conditional delivery.
An escrow is not invalidated by the death of a depositor prior to performance of the condition of the escrow. The parties can substitute another depositary for the same purpose. A substituted depositary will be bound by the terms of the original contract.
Duty of Depository:
A depositary, also sometimes referred to as an escrow agent, is a person with whom parties to a contract deposit escrowed property in an escrow. The duties of a depositary are generally defined in the escrow agreement. Any deviation from the agreement without the requisite authority is unreasonable and cannot be done with reasonable prudence. A depositary’s duties are fixed and limited according to the terms of the agreement. The depositary must carry out the terms of the agreement as intended by the parties. S/he cannot perform acts with reference to handling the deposit, or its disposal, not authorized by the escrow agreement. Gomez v. Huntington Trust Co., 129 F. Supp. 2d 1116, 1123 (N.D. Ohio 2000).
A depositary is not edit or to inappropriately interpret or construe a contract where s/he has a duty to perform. The depositary must be guided in his/her duty by what the contract says. S/he is not authorized to ignore one part of the contract on the basis that another part of the escrow omits such features as to time and date. Federal Deposit Ins. Corp. v. First Nat’l Bank & Trust Co., 496 F. Supp. 294, 296-297 (W.D. Okla. 1980).
A depositary has a fiduciary relationship of trust and confidence to the parties to the escrow. A depositary must perform the responsibilities with scrupulous honesty, skill, and diligence. Berry v. McLeod, 124 Ariz. 346 (Ariz. 1979).
The duty of a depositary to act with scrupulous honesty, skill, and diligence includes the duty of taking reasonable efforts to ascertain the identity of the named parties to the transaction. Maxfield v. Martin, 217 Ariz. 312, 315 (Ariz. Ct. App. 2007).
The escrow relationship gives rise to two specific fiduciary duties:
- to comply strictly with the terms of the escrow agreement; and
- to disclose facts that a reasonable depositary would perceive as evidence of fraud committed on a party to the escrow. Burkons v. Ticor Title Ins. Co., 168 Ariz. 345 (Ariz. 1991).
In the case of deposit of funds, the depositary is a trustee of funds deposited in escrow and must be guided in his/her duty by what the escrow agreement says and must act strictly in accordance with the escrow instructions. Webster v. Uslife Title Co., 123 Ariz. 130, 133 (Ariz. Ct. App. 1979).
Terms of Escrow:
As the duties of a depositary are governed by the terms of the escrow, care is to be taken in drafting depositary instructions. An escrow agreement must include the names of the parties submitting the instructions and the name and address of the depositary. Agreement shall include the date of the instructions. A list of the items or documents deposited or to be deposited with the depositary must be included in the agreement. Conditions for the delivery of the escrow property are to be included in the agreement. Additionally, default provisions can also be included in an escrow agreement. A good idea is to include an arbitration clause plus an attorneys fees clause. See our articles on The Acid Test Clause. An escrow cannot be invoked without the consent of all the principals to the agreement. Moreover, indemnity provisions can also be included in the agreement. Certain agreements include the acceptance by a depositary.
Primary duties of a depositary found in most states are:
- A depositary shall disclose to the parties all information which is necessary to prevent a loss to the party. Lane v. Oustalet, 873 So. 2d 92, 96 (Miss. 2004).
- A depositary can keep escrowed property until conditions are performed. S/he must then deliver the property to the grantee. Jackson v. Jackson, 67 Ore. 44, 52 (Or. 1913).
- When the prescribed condition is performed the depositary is obliged to deliver the property to the grantee. However, s/he must redeliver the property to the grantor, when the condition is not performed. Howlin v. Castro, 136 Cal. 605 (Cal. 1902).
The general rule is that a depositary is to act according to the terms of the agreement. In the case of a breach of an instruction that is contracted to perform or of an implied promise arising out of the agreement, the injured party acquires a cause of action for breach of contract. Moreover, when a depositary acts negligently, s/he will ordinarily be liable for the loss occasioned by breach of duty.
However, an escrow holder has no general duty to police the affairs of its depositors. A depositary’s duty is limited to faithful compliance with instructions. Schaefer v. Manufacturers Bank, 104 Cal. App. 3d 70, 77 (Cal. App. 2d Dist. 1 980).
Although an escrow agent is liable for negligence in failing to perform his/her duties in accordance with the escrow agreement, s/he has no duties or liabilities to the parties until a deposit is made with him or her.
Although exculpatory provisions relieving the escrow officer of liability do not enjoy special favor in the law, such provisions can be included in an escrow. However, they are not effective as to breaches of trust committed in bad faith or intentionally or with reckless indifference to the interest of the beneficiary. Axelrod v. Giambalvo, 129 Ill. App. 3d 512, 517 (Ill. App. Ct. 1st Dist. 1984).
Breach of Escrow:
Escrows are most commonly used in the context of real estate. Escrow companies are also used in the transfer of high value personal and business property, like websites and businesses, and in the completion of person-to-person remote auctions. Generally once an escrow agreement is made, an escrow account is established by a broker under the provisions of license law for the purpose of holding funds on behalf of the broker’s principal or some other person until the consummation or termination of transaction. In real estate, the account is often held primarily to pay obligations such as property taxes and insurance premiums.
When the conditions of the escrow agreement are fulfilled and the depositary fails or refuses to deliver the escrowed item, the remedy, either in law or equity, lies against the depositary and not against the depositor. However, the other party to the escrow may be joined as a defendant with the depositary when that party’s failure to comply with the required escrow conditions caused the depositary to refuse to act, or that party asserts rights in the escrowed property which adversely affect the plaintiff’s rights in it. See our article on American Litigation.
However, all the parties and the depositary may be joined in an action when that is necessary to obtain complete relief. For example, the purchasers under a land sale contract are indispensable parties in an action by a seller and a real estate broker to recover the earnest money from the escrow agent, when the seller and broker would not be entitled to a division of the earnest money until it was established that the purchasers were in default.
When the depositary wrongfully delivers the subject of the escrow to a third person, the person entitled to the property may maintain an action against the third person without joining the escrow holder or the depositor. Law v. Title Guarantee & Trust Co., 91 Cal. App. 621 (Cal. App. 1928).
When the depositor wrongfully deals with the property after it is deposited in the escrow, the other party to the agreement, not the depositary, is the proper party to bring an action. For instance in Gunby v. Hayden, 181 Mo. App. 449 (Mo. Ct. App. 1914), the owner entered into a written contract with an individual whereby both parties agreed to exchange lands. Both gave a check to the escrow holder in consideration of the contract. The money represented by checks was only to be turned over to the owner when deeds passed. The owner and the individual then entered into a new contract in lieu of the old contract. The owner told the escrow holder that the deeds passed and to release the money. Before the escrow holder released the money, the owner and the individual placed stop payments on the checks. The escrow holder filed a three count petition against the owner to recover the value of the owner’s check and protest fees. The trial court entered judgment for the owner and the escrow holder appealed. The court affirmed the decision of the trial court. The court held that the escrow holder did nothing to cause liability to attach to him, but the owner’s wrongful act in stopping payment on the check may have rendered the owner liable to the individual. The escrow holder’s petition failed to state a cause of action. He neither received nor lost any money. There was no right of recovery shown that he held.
Conclusion:
The underlying purpose of an escrow is to establish a repository for monies or assets that will hold them in safe keeping until events occur as agreed upon by the parties contracting for the escrow. It often involves real estate but is not restricted to that type of transaction nor is it restricted to licensed escrow holders minus state or federal law being involved. Indeed, the simplest escrow is simply asking a friend to hold the stake when two people are betting on the outcome of an event.
Only when real estate or securities are involved do the far more complex rules imposed by government become active. The role of the escrow holder, however, invariably involved a contractual set of instructions and a fiduciary duty, something to keep in mind should you ever be asked to act as escrow.