In the course of any transaction, each side has a simple wish: for the counterparty to fulfil all their obligations in full. But people and situations can vary, and life is full of surprises… An instrument of financial interaction like an escrow account, aka “transaction account”, can come to the rescue. Today, Bilderlings Pay discusses this universal mechanism, which can be applied to transactions of all kinds, including in the field of e-commerce.
Indeed, the globalization of trade, finance and labor relations has led, in particular, to the fact that a seller and a buyer, an employer and a remote employee can live in different countries, on different continents and never meet in person. Of course, whatever mutual settlement tools you are using, you still need a customary bank guarantee. Usage of an escrow account and relevant contract is convenient, first of all because this mechanism is universal.
In many situations it is indispensable. In these cases it’s not important whether the financial relationship is of an online or offline nature. Of course, this is especially crucial for the purchase or sale of high-value assets – for example, the acquisition of materials and components necessary for the manufacturing process, electronics or wholesale quantities of grain. Buying a ready-made business, real estate, antiques, jewelry, cars, etc. are likewise situations where an escrow account can be necessary. This method of mutual settlement is most reliable in cases of sale of copyright, websites, domain names and other intellectual property rights, as well as payment for traffic and mobile operators.
This may be a series of relatively small, one-time supply of goods to the contractor, but which are performed on a regular basis. This may be a work contract that requires a relatively long period for full completion, or is of a narrow and specialized nature. For example, a construction project, writing a book to order or software development. The product of this work can be rightfully attributed to high-value assets.
In all these and many other situations, the natural desire will be to get guarantees of the fulfillment of obligations by both parties of the contract. And here – and this is the unique thing about the escrow account usage – the guarantor-intermediary, or the “third party”, comes to the rescue.
When three is NOT a crowd
Therefore, the escrow account (also: target deposit account, conditional deposit account) or “transaction account” is one of the forms of a trilateral agreement. The escrow contract itself is an addendum to the main contract – for example, a purchase-sale contract or execution of work contract. As has been mentioned, the escrow contract is a trilateral agreement in which the participants are:
- The buyer (commissioner of works). The buyer transfers money to the transaction account opened by an escrow intermediary. After that, his active participation ends for some time, unless otherwise stated in the escrow contract. It is worth noting that the deposited funds cannot be returned by the depositor himself. This can be done only in the event of the contract’s termination with the counterparty, which is acknowledged and documented and unequivocally expressed by both parties. It can also be done if the term for fulfilling contractual obligations has passed, but no fulfillment has occured.
- The seller (executor of works). The seller undertakes to fulfil certain obligations to the buyer. For example, to deliver a batch of goods of a certain quality, and within a certain timeframe, to write a program, to transfer ownership of an apartment or business, etc. He receives the money deposited in the escrow account only after fulfillment of these obligations has been confirmed with the appropriate documentation.
- Escrow intermediary. This is the “third party” that guarantees the security of the transaction. The escrow intermediary opens the escrow account and is, nominally, its administrator. However, it is worth noting that the escrow intermediary can manage the account’s assets only within the framework of a relevant tripartite agreement. In fact, they just receive these funds from one of the parties and transfer to the other one as soon as the fact of fulfillment of the second party’s obligations is confirmed.
In their turn, the two other parties of the agreement do not have the right to access these funds. The depositor, as already stated, cannot arbitrarily, at his own discretion, cancel the transaction and collect the money. The seller will receive the money only if certain conditions, fixed in the contract, are fulfilled.
EU law does not stipulate who can act in this role. The only necessary, “extra-legislative” condition is the trust of both parties in their intermediary. This service is provided by banks, FinTech platforms and specialized escrow companies. Bilderlings also offers its customers an opportunity to apply the model of escrow account in various commercial transactions.
This tool, as our experience shows, is effective in particular for M&A transactions and the creation of joint ventures, offline trading operations, and especially for online commerce.
“It’s as easy as a pie to build castles in the sky”
Due to the variety of situations in which transactions can be affected through escrow accounts, the relevant contracts may also include additional terms. For example, the main contract is meant for the long-term supply of a large batch of food products. But, due to the specifics of the product, delivery will be carried out periodically, in small batches. In this case, the escrow contract may stipulate partial payments to the supplier, as the products are received.
Or, for example, a construction contractor concludes a contract for the construction of a store building in a full cycle, from zero to the turnkey stage. It is reasonable to provide a partial payment for the execution of each cycle of work, although the total sum of the contract is transferred to the customer on the escrow account immediately, for example, when the firm-contractor begins work. For the sale of a ready-made business, all its assets at the time of the transaction’s conclusion should be documented as per checklist. The escrow contract, in its turn, should provide that the former owner will receive the money deposited by the buyer only after showing the act of property transfer as per checklist, signed by the parties.
In these and other situations, the use of an escrow account for a transaction guarantees not only fulfillment of the terms of the agreement by the parties, but, above all, its complete fulfillment. It also guarantees the absence of mutual claims at that moment, which is also important, since it eliminates the danger of further judicial proceedings. You can also conclude a contract of mutual escrow. It is simple: nobody gets anything until both parties fulfil their obligations.
Let’s return to the area of online commerce and remote work. The use of escrow accounts is rather relevant here for all the reasons that were discussed at the beginning of the article. This opportunity enables the online merchant to receive payment, and to the buyer – the goods or services specified in the contract specifications – in various force majeure circumstances, including the disappearance of the buyer. It will, for example, shield the target software developer from the risk of not being paid for his work.
Of course, this mechanism is not a certificate of insurance; but using it, the parties of the transaction can worry less about the successful outcome of the transaction. It’s no coincidence that this type of model is used by large marketplaces, such as, in Aliexpress/Alibaba with PayPal payments, and something similar is also being developed by Amazon Pay. Owing to the conditional deposit of money in the account of a financial intermediary, the parties of the transaction receive guarantees against the most common difficulties. For example, the buyer is better protected against a misleadingly-described product, which is vital for virtual purchases. In turn, the e-tailer minimizes returns, and both parties make themselves more secure against fraud.
In comparison with traditional banking mechanisms which function in a similar way, using an escrow account is more flexible. This goes a long way toward explaining the growing demand for escrow accounts among online merchants. Parties are relieved of the need to perform a number of actions, like verifying obligations on documentation. This kind of transaction makes it possible to optimize its participants’ expenses, since it does not involve unnecessary intermediaries. Naturally, the transaction itself becomes more secure.
Our practice has shown that the vast majority of transactions carried out under this model are concluded favorably for both parties. The very specificity of this type of transaction forces contractors to be more accountable. In turn, independent arbitration guarantees them equal conditions. If the seller (supplier, contractor, developer) does not fulfil his obligations, the financial arbitrator does not unblock funds on the escrow account. If the buyer (the customer) does not pay according to the contract, he will not receive his order. However, it is worth noting that, using this model, the two main parties of the deal should formulate and set out their obligations as clearly as possible.
In summary, the above written, the escrow contract, as well as the use of an escrow account for transactions, minimizes the risks for both of its counterparties. This is a guarantee, all the more valuable in the virtual “world without borders”, that you will get what you expect from a transaction.