Securing project financing, lengthy consultations with advisers, endless negotiations and successive revisions to the investment agreement. Finally, completion. When a transaction closes after several weeks of intensive discussions and work, everyone feels relieved. It seems that an agreement running to several dozen or even several hundred pages including appendices contains every necessary warranty and safeguard, with sanctions that will provide adequate incentives for proper performance…
The parties begin performing their obligations and cooperation starts or the target is acquired. Everything follows the agreed plan, and the future looks positively rosy. New opportunities arise, the business grows and both parties are satisfied. If events unfold this way, even the warranties and safeguards would be unnecessary, let alone detailed sanctions. The agreement could, in fact, be reduced to a dozen or so pages.
An escrow account: protection against potential problems
Although such a picture of the counterparty's performance is every entrepreneur's dream, any businessperson with their feet on the ground knows that a contract's role is to provide protection if problems arise. However utopian a newcomer's view of the transaction market may be, they soon realise that trusting others is not enough to run a profitable business, and that a good contract provides for every eventuality.
As already mentioned, in sale agreements, the seller is normally expected to give the buyer specific assurances about the subject matter of the sale, whether its legal status, for example the title to shares, or the financial position of the target company. If the agreement is breached or false statements are made, the other party will have claims for damages on the terms set out in the agreement or under the general rules.
This may seem to protect the buyer adequately, but it should be remembered that even written provisions are worth little without appropriate enforcement mechanisms. Debt recovery proceedings may last for years and, in the worst case, prove ineffective, for example if the seller subsequently becomes insolvent.
How does this work in practice?
Part of the transaction price may be secured in an escrow account and released once the conditions agreed with the bank are met. The bank verifies the payment conditions specified in the agreement; this should not be taken to mean that it automatically resolves every dispute over a breach of the sale agreement. An escrow account must also be distinguished from a trust account meeting the requirements of Article 59 of the Banking Law.
Settlement takes place on the terms agreed between the parties to the transaction and the bank in the escrow account agreement. Its provisions may, among other things, limit payments to the buyer by amount, to part of the sale price, and by time, for example to two or three years from signing. The seller usually deposits, or freezes, an amount corresponding to an agreed part of the sale price, such as 10%, in the account.
The bank administers the escrow agreement, controls withdrawals and, once the specified conditions are met, pays the claim amount directly to the buyer in accordance with the agreement.
Ensure your claims can be enforced effectively
In conclusion, this mechanism makes dealings between the parties to a transaction more secure by enabling claims under their agreements to be enforced quickly and effectively through automatic transfers of funds. In addition, certain forms of escrow account offer the buyer further protection: if the seller subsequently becomes insolvent, is subject to enforcement attachment or even dies, the funds in the trust account remain protected for the period specified in the agreement and cannot be used for other purposes (Article 59(4)–(6) of the Banking Law).
At present, the vast majority of banks offer this service. The agreement can be tailored to the parties’ individual needs. Facilitating the enforcement of claims through an escrow account should, it seems, now be standard practice in transaction agreements.
