In the complex and high-stakes realms of real estate and mergers and acquisitions (M&A), ensuring the security of obligations and the overall safety of transactions is paramount. One of the most effective and widely used approaches to achieve this is by leveraging escrow services.
Using an escrow service for real estate and M&A transactions offers several key benefits, including risk mitigation by holding funds securely until all conditions are met and protecting funds from unauthorized access or fraud. Furthermore, escrow services contribute to efficient fund handling by offering a structured process for holding and releasing funds based on predefined conditions. This efficiency not only accelerates transaction timelines but also ensures compliance with agreement terms, leading to smoother deal closures.
This article analyses potential aspects for consideration when using escrow services in real estate and M&A transactions and potential risks for the parties to underlying transactions and for escrow agent that may arise during the lifetime of escrow agreement.
What are the key aspects to be considered when using escrow services in Real Estate and M&A transactions?
Before entering an escrow transaction, the seller or buyer must submit the underlying sale-purchase agreement to the escrow agent for feasibility analysis. In addition to this analysis, the escrow agent conducts due diligence checks on the parties involved and the source of funds for financing real estate or M&A transactions. If an escrow agent is satisfied with all checks, the buyer, the seller and the escrow agent enter into the three parties Escrow Agreement.
Real Estate Transactions
In accordance with the Escrow Agreement with the underlying real estate transaction, the buyer is obliged to transfer funds in the amount of agreed purchase price of real estate to the escrow account and the seller is obliged to fulfil the conditions in respect to the real estate object (e.g. provide technical documentation, access to the object for examination, etc.).
Among others, a very important condition to be fulfilled is the transfer of the title to the real estate. Depending on the jurisdiction in which the property is located, different rules apply to the transfer of title. In Switzerland, for example, the sale and purchase agreement must be notarized and registered in the land register. The parties must consult legal counsel in the relevant jurisdiction to clearly understand the country-specific requirements in order to have clarity when describing the release mechanism in the Escrow Agreement.
M&A Transactions
In case the underlying transaction is M&A transaction, the seller is required to deposit shares with the escrow agent, and the buyer must deposit the agreed purchase price or a part of it into the escrow account. Nowadays the shares are held rather in electronic form than as physical certificates. The buyer and seller might agree to deposit only part of the purchase price into the escrow account as a guarantee for fulfilling set conditions or for satisfying claims in case of warranty breaches or false representations.
If the buyer sets up a special purpose vehicle for the acquisition, the parent company must provide information and documentation regarding the source of funds used in the transaction.
In the case of anticipation of post-closing adjustments to the purchase price, certain portion of purchase price should be allocated for this purpose when paying funds to the escrow account. The types of adjustments must be defined and the methodology for calculating these adjustments specified. The escrow agent shall release escrow funds concerned in accordance with the joint instructions of the seller and buyer or court decision reflecting the agreed or arbitrated adjustments.
What are the potential risks or drawbacks that may occur during the lifetime of an Escrow Agreement?
✗ Delayed Fund Release
In real estate and M&A transactions delayed release of escrow funds can occur if not all transaction conditions are met or if disputes arise between the involved parties. For instance, if the buyer and seller disagree on the fulfillment of contract terms, the funds may remain in escrow until the dispute is resolved, causing potential financial strain and uncertainty for both parties.
✗ Dispute Resolution Challenges
When conflicts arise regarding the distribution of funds, it can add layers of complexity to the transaction. Effective resolution mechanisms envisaged in the Escrow Agreement are essential to address these disputes promptly and amicably. Without a clear and efficient dispute resolution process, prolonged conflicts can result in increased legal fees, wasted time, and strained relationships between the parties involved.
✗ Lack of clarity in instructions
The seller and buyer jointly instruct the escrow agent on the timing and conditions for the release of funds. This can be specified through special clauses in the Escrow Agreement that clearly outline the release procedure or through separate joint written instructions provided by the seller and buyer. It is crucial to have clearly stipulated release mechanism clauses in the Escrow Agreement to avoid misunderstandings among the buyer, the seller and the escrow agent during the life of the Escrow Agreement.
The ambiguity can slow down the transaction process significantly, as the escrow agent might have to seek further clarification, leading to delays. Moreover, unclear instructions can result in actions that may not align with the intentions of the parties, causing further complications and potential financial losses.
✗ Market fluctuations
Changes in market conditions can affect the value of the assets or funds held in escrow. For example, a sudden drop in real estate market values could impact the agreed-upon price of a real estate object, potentially leading to renegotiation or even cancellation of the deal. Similarly, fluctuations in the stock market or currency exchange rates can affect M&A transactions, as the value of the assets being acquired may change, necessitating adjustments to the terms of the deal.
In such a case all parties to the Escrow Agreement must agree to the changes. The changes should be formalized through written and signed amendments to the original Escrow Agreement.
Are there any special considerations when using escrow services for international Real Estate transactions or M&A?
When engaging in international real estate transactions or M&A, utilizing escrow services can add a layer of security and trust. However, there are several special considerations to keep in mind to ensure a smooth and successful deal:
✓ Currency Exchange and Fluctuations
One of the primary considerations in international transactions is dealing with multiple currencies. Currency exchange rates can fluctuate significantly, impacting on the total value of the transaction. It is essential to agree on which currency will be used for the transaction and to consider hedging strategies to mitigate the risk of unfavorable exchange rate movements. Additionally, ensure that the escrow agent can handle the required currency exchanges efficiently and transparently.
✓ Regulatory Compliance
Different countries have varying regulatory requirements for real estate and M&A transactions. Ensuring compliance with all relevant regulations is essential to avoid legal complications. This includes understanding any restrictions on foreign ownership, mandatory disclosures, and anti-money laundering (AML) requirements. Partnering with a reputable escrow agent that has experience in international transactions can provide valuable assistance in managing regulatory compliance.
✓ Governing Law and Jurisdiction
The Escrow Agreement should always specify the governing law and jurisdiction. As a rule, an escrow agent’s location determines governing law and jurisdiction in the Escrow Agreement.
LINDEMANNLAW has deep legal experience and a solid escrow practice in real estate and M&A transactions, where agreements are tailored to the individual needs and conditions of the parties or their advisors. Please contact us for further information, we will be happy to help.
These services are generally provided by our separate sister company LINDEMANN FINANCE, unless they qualify as typical escrow lawyer activities.
Would you like to learn more about escrow deals? Join our free WebWorkshop on Escrow Services on September 5, 2024, hosted by LINDEMANNLAW. Discover how to protect your transactions and get your questions answered in a live Q&A session. Register now to secure your spot, and we look forward to the upcoming conversation.
