Transactions and the advantages of an escrow mechanism    

Businesses have long been searching for the most optimal way to carry out transactions smoothly. In this context, escrow services have been enjoying a growing popularity over the last decade. Their function is to ensure that companies receive what they have agreed on with each other, while minimising the cost of this type of guarantee. As long as participants perform a careful risk assessment, escrow services could be beneficial to both the seller and the buyer. They reflect the need for a payment system that brings security at low cost.

Main aspects of escrow services

A third party is involved in the escrow mechanism - an escrow agent, who facilitates the transaction by keeping the assets and cash in an account until the agreed transaction is completed. The escrow agent releases the considerations of the parties upon receipt of pre-agreed written evidence for the fulfillment of the parties' transaction obligations.

In Bulgarian law, the closest concept to escrow services are banking services, and in particular - the various types of money storage accounts that are serviced under contractual conditions. This is why it is assumed that an escrow service is a banking service.

The escrow account agreement is not explicitly regulated in Bulgarian law. It is a type of framework agreement, according to which a trust account is opened and a certain amount is blocked, the release of which requires the fulfillment of pre-approved conditions.

Nevertheless, the escrow mechanism is a type of agent service and, in particular, a type of guardianship. The most common practice is for escrow services to be provided by financial institutions in view of the high regulatory requirements towards them. In different jurisdictions, lawyers also act as escrow agents, and this trend is currently developing in Bulgaria as well.

In the case of transactions involving the purchase and sale of movable property, the escrow agent may observe the sent goods, further ensuring that both parties receive what they agreed upon. Upon receipt of the goods, the assets or sale price are released by the Escrow agent and transferred to the seller.

Creditors are the driving force in the structuring of the escrow mechanism. They define the requirements in terms of how their assets will be stored (held) and their expectations on how to document the transaction. In addition, escrow services may include instructing other related parties on behalf of the participants and ensuring that everyone has received what they have previously agreed to - for example in real estate transactions: the property mortgage has been canceled, brokers have received their commission , all taxes and fees are duly paid, etc.

Risks and benefits of Escrow services

The escrow mechanism may provide for an effective modification of the prepayment or for other payment methods, provided that the risks are carefully assessed by the participants.

No sector is immune to fraud. In this regard, the parties should conduct a thorough review of the selected escrow service and the reputation of the agent to ensure that the latter will be able to handle the relevant business transaction. In addition, the exact and complete performance of the escrow agent's obligations may be subject to an additional guarantee through risk insurance.

Commonly, the assets in the escrow account are released only when both parties have obtained the fulfillment of the pre-agreed conditions. In addition, the escrow mechanism may provide for no consideration to the seller before the buyer has inspected the goods and approved their quality, quantity, etc.

Escrow mechanism and letter of credit

The aforementioned indicates the difference between the escrow mechanism and the letter of credit, where the seller usually receives almost immediate payment after sending the goods.

When you rely on escrow services, the payment process depends on the fulfillment of specific conditions, which may depend on the other party and, accordingly, payment may be delayed or even refused. However, the benefits of the escrow mechanism compared to the letter of credit are significant.

    1. Firstly, escrow services are usually cheaper than bank services (such as the letter of credit).

    2. Under the escrow mechanism, the buyer receives additional protection, as he is not obliged to pay before verifying the characteristics of the goods, and can cancel the transaction if the receipt is not what he expected.

    3.Last but not least, escrow services can be more expeditious and, if properly structured in advance, can save effort and time for the parties.

      The terms of the agreed escrow mechanism must be precise and unambiguous in order to avoid misunderstandings. Provided that the parties have consulted a competent person and have fully understood the risks and benefits of escrow services, the latter can be entirely in favour of business turnover and of preserving the interests of the participants.

      Subscribe to our newsletter and follow our LinkedIn page so you never miss important updates and expert analyses.