Five Crucial Steps to a Successful Escrow Agreement

In today’s complex business deals, escrow agreements are often the last item to be negotiated. Yet, their place on the checklist should not negate their importance as a critical risk mitigation tool — one that can give all parties in a deal an added level of comfort.

The security procedures outlined in an escrow agreement, while often not considered during negotiations of the underlying transaction, can help attorneys protect their clients. Whether you are working on a joint venture, a merger, an acquisition or an IPO, a comprehensive escrow agreement can give you and your clients the crucial support needed to make your commercial transaction a reality.

Wanted: Full Disclosure from Bankers
Today, many dealmakers are concerned with more than just the basic terms of an escrow agreement.  They now also want full disclosure from their banks on the standard security procedures for the distribution or transfer of assets held in escrow accounts. Have these security procedures been thoughtfully developed? How are they monitored? Will they effectively mitigate the risk of potential fraud or clerical errors?

According to Rocky Motwani, global head of Escrow Services at J.P. Morgan Treasury Services, when setting up an escrow agreement, there are steps to take to help ensure that your bank’s procedures meet your needs. “The primary goal of an escrow account is safeguarding a client’s funds and making sure that, when it’s time to make disbursements, the intended beneficiaries receive their funds,” says Motwani. “That requires that a comprehensive set of policies and procedures always be in place.”

The starting point in evaluating a bank’s security procedures should be the incorporation and review of the bank’s standard language in the draft escrow agreement.  At J.P. Morgan, standard escrow agreements are offered for all types of transactions, and stringent security procedures are included within these standard documents. “When we are dealing with a client who has a proposed agreement that has been drafted elsewhere, we also insist that J.P. Morgan’s security procedures be added to that document,” explains Motwani. “It’s an added step we take to help protect our clients.”

Setting Up Your Escrow Agreements
How can you ensure that your bank’s security procedures meet your needs? There are several basic steps that are necessary components to all escrow agreements, including:

1. Always get it in writing. First and foremost, when drafting an escrow agreement, make sure that it specifies that all instructions to the escrow agent must be in writing — and that they must be signed by authorized representatives for all applicable parties.
   
   
2. Clearly identify all authorized representatives. An escrow agreement should limit the number of people who can provide instructions to the bank on behalf of each party. And the bank should make sure they take instructions only from those persons that each party to the agreement designated in writing as an authorized representative. Each person executing the final agreement should be included in the list of authorized representatives, but in the event a signer is not available, Motwani recommends that additional people be identified. “It’s important to take into account what will work for a particular deal.” He advises. “You don’t want too few people on the list, or too many. You should look to strike the right balance that works for each deal.”
   
   
3. Develop a schedule of authorized representatives. “It’s good business practice,” advises Motwani, “to add a schedule of all authorized representatives to an escrow agreement.” For agreements with J.P. Morgan, the schedule should contain authorized signers names, specimen signatures, telephone numbers and other contact information. It is then incumbent upon the escrow agent to refer to this schedule of authorized representatives when examining all requests for disbursing funds from the escrow account and to verify the validity of each request by calling another authorized signer to confirm the request.
   
   
4. Have a detailed process in place for changing authorized representatives. “People change jobs all the time,” explains Motwani, “so you need to be able to easily update the procedures and requirements for changing authorized representatives and their contact information.”  But Motwani cautions that the process needs to be stringent enough to prevent a fraudster from easily changing the authorized representatives list.
   
   
5. Remember the callbacks! There are several situations that demand that callbacks always be performed. For example, specific instructions by all parties for wire transfers should be included in each escrow agreement; if that is not possible, then it is important to require that a callback be performed after disbursements are requested in writing by any authorized representative. A callback requires that a bank employee call an authorized representative to confirm all the details around any request for the movement of funds. 

Some requests should always trigger a callback, such as distributions or transfers to beneficiaries other than the parties signing the agreement, according to Motwani, (unless security procedures for establishing “Standing Settlement Instructions” for that beneficiary are established by an Authorized Representative). Similarly, if either party to an agreement wants to change its own wire transfer or standing instructions for a beneficiary, a callback should always be performed before any funds are released according to the new instructions.

“These steps may result in an escrow agreement that undergoes significant changes and multiple reviews,” Motwani says. “But we ask our clients to look beyond the “red” inserts we add to a proposed escrow agreement, and see the added value and protection J.P. Morgan’s standard security procedures provide.”

For More Information
Contact Nick Scarabino, Managing Director & Global Head of Escrow Sales at Nicholas.A.Scarabino@jpmorgan.com