Treasury Today Country Profiles in association with Citi

Escrow: more than a go-between

Tangram puzzle waiting to be fulfilled and completed

There is more to escrow used in corporate transactions than just a third-party looking after funds until the conditions are met by both sides.

In the corporate world, when a complex, large and lengthy deal is about to take place, security is paramount on both sides. This is the unique role for which escrow was created. And unlike escrows used in smaller ‘everyday’ transactions such as private mortgage funding, the corporate world should make many more demands on its service providers.

Whilst escrow is a fundamentally simple process, acting as the agent where the individual parties define the requirements, it is the transactions themselves that tend to be the source of complexity, notes Susan Dean, Managing Director, Treasury Services, J.P. Morgan.

Getting started

To establish the basic ground rules, an agent will usually offer a standard escrow agreement. Within that agreement, the detail is very much open to dialogue between the legal teams representing each party; the agent is not the mediator, explains Dean. “There might be some negotiation around the standard contract to the extent it affects the agent but we are otherwise receivers of an agreed approach which we then facilitate.”

In escrow, there can be sizeable sums involved. The role of the agent is to execute with no discretion the instructions of the parties on the terms documented in the escrow agreement. Any agent of repute will carry out in-depth validation of the instructions, through multi-level verification of signatories and call-back processes, says Dean.

It is also vital for the agent and its specialist law team partners to understand the precise nature of each type of transaction. The agent must have the expertise to assimilate key points of the transaction, bring absolute clarity to each party’s requirements, and be able to place all in the context of escrow. Essentially, the agent must know what could go wrong, so that what is being drawn up can be made entirely fit for purpose.

A good agent must also have the ability to work at speed, because often there is a short timeframe, sometimes just a matter of days, especially in M&A deals. That agent also needs to have a global outlook and capacity, providing consistency amidst frequent cross-jurisdictional corporate activity.

Risk management plus

With contracts that provide for a guarantee, escrow brings security to each party. It is a risk management tool that is used in a multitude of scenarios for just this purpose. In M&A, the escrow may be to cover risk around price adjustments or indemnities, to bridge the time gap between announcement and the achievement of conditions precedent or regulatory approvals, or to demonstrate funding is available as a ‘good faith’ deposit. In a financing context, it could mitigate counterparty risk in a major real-estate purchase, be used as assurance on infrastructure or project finance or be used to ensure proceeds from a bond issuance are used only for the purpose stated to investors.

Escrow can also be used in litigation cases, for example pending the outcome of a court judgement. In a regulatory context, holding assets in escrow might be a compliance requirement when engaging in areas such as real-estate development or environmental protection.

It is often considered at the end of a transactional dialogue but the exact circumstances of its use will determine when escrow is called into play, explains Dean. It may be that the broader transactional documentation requires escrow to be used in the period of final closure of an M&A, for example. In other cases, it may be that the parties reach a point early in their discussions where it is apparent that escrow is appropriate.

Not every transaction needs escrow but, says Dean, the uncertainty of when and if it might be needed is precisely why the agent needs to be able to move quickly.

Adding value

As a risk mitigation solution that is typically taken care of at the very last hour, quality and level of client service are key factors. A dedicated team to ensure quick onboarding and document turnaround, an understanding of the underlying transaction dynamics, and a focus on client needs and priorities are all important considerations when selecting an agent, advises Dean.

But, warns Dean, “like any deposit, corporates should be mindful of where they are putting their deposit, and what the counterparty risk is of placing it with a particular entity”.