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In a commercial real estate transaction, the parties often utilize the concept of escrow and a third-party escrow agent to facilitate the closing of the transaction. The job of the escrow agent is to ensure that all parties have performed their obligations (delivery of title, delivery of funds, etc.) before the parties sign all closing documents, and prior to the parties transferring title to the property and funds.
A wise practitioner will begin planning for a smooth and expeditious closing while drafting the contract itself. Clarity on issues related to purchase price, financing, title insurance, prorated rents and expenses, and other issues will set a clear roadmap for the parties and the escrow agent to follow as they plan for closing. Parties and the escrow agent should also negotiate, plan for and draft clear and concise escrow instructions that clarifies what each party must provide at closing, what certifications will need to be made, what documents will need to be signed, and when funds are to be released.
Escrow instructions are written instructions to the escrow agent regarding the specific steps to be taken to close a particular real estate transaction. Most often, the escrow agent is also the title company.
The escrow instructions serve as a roadmap to closing. Good instructions should make clear which documents and how many of each document are required, what each party is required to deposit into escrow, what the prescribed forms of the documents are and advise the escrow holder of how much money will be deposited, and by whom (e.g., the buyer, the lender, an exchange company).
Escrow instructions should also list all of the conditions that the escrow holder must be certain are satisfied before the escrow holder is permitted to “close” the deal. Typically, the conditions include such things as: (a) verifying that all of the required documents and funds have been deposited into escrow, and that the documents are fully executed and notarized (if notarization is required); (b) confirming that the title company is irrevocably committed to issue the owner’s (and, if applicable, the lender’s) title policy at closing, in the forms required by the instructions; and (c) preparing and having the parties approve a preliminary closing statement. The preliminary closing statement should include all of the prorations, adjustments and payments to be made as part of the closing. The closing statement should also allocate closing costs between the parties.
Once all conditions to closing have been satisfied, the escrow instructions should provide the escrow holder with step-by-step instructions regarding closing the transaction. The closing instructions should include the order in which the recorded documents are to be recorded, who (in addition to the seller) gets paid out of escrow, and whether the funds are to be disbursed to the seller before or after the deed is recorded (most commonly, the deed is recorded before funds are released to the seller, but there may be circumstances in which it makes sense for recordation and disbursement to happen in the reverse order). The instructions should also detail how the original documents held by the escrow holder are to be distributed to the parties.
Escrow instructions may be amended at any time prior to the time the escrow agent begins the closing process (i.e., recording documents, disbursing funds). If the escrow instructions are joint instructions from the buyer and the seller, or if they are fully contained in the purchase agreement, they can be amended only by a writing signed by both parties (or, if included in the purchase agreement, by an amendment to that agreement). However, particularly in larger transactions, the parties often prepare their own separate instructions to the escrow agent that are consistent with the terms of the purchase agreement. In that case, the parties can each amend its own instructions by a separate amendment to the initial escrow instructions.
The escrow is terminated when (1) all of the conditions stated in the escrow instructions have been performed, (2) it is abandoned or canceled by mutual agreement of the parties, or (3) it is canceled by one party, prior to the time the escrow agent has begun the closing process (e.g., one party would likely terminate the escrow if the other party breached its obligations under the purchase agreement). Termination shifts the right to possession and control of deposited instruments and funds to the parties respectively entitled to the delivery or return of the items.
In the event the parties wish to mutually cancel escrow, the parties should execute joint instructions to the escrow agent indicating that the parties wish to mutually terminate the escrow and detailing exactly how and to whom the deposit money should be refunded. If one party wishes to cancel escrow due to the other party’s breach, then counsel for the non-breaching party should notify the escrow agent in writing, specifically describing the other party’s breach. Counsel should also reach out to the breaching party (or counsel for such party, if represented) in an attempt to agree upon mutual cancellation instructions. However, the parties may disagree regarding who should receive the deposit. In the event the parties do not agree on refund of the deposit, the escrow holder will not release any escrowed funds until the parties reach an agreement, or until litigation has resolved how funds are to be distributed.
For access to comprehensive coverage regarding the concept of escrow within a commercial real estate transaction, as well as a host of other forms and commentary related to this subject, please click Here to visit Lexis Practice Advisor.