There are a multitude of situations that might trigger the need for a post-closing escrow agreement. A few examples I’ve encountered lately include the following:
- Escrowing for repairs that could not be completed prior to closing.
- Escrowing to allow a Seller to remedy a survey defect post-closing.
- Escrowing to confirm whether a condominium special assessment was approved a few days after closing.
In light of the aftermath of Hurricane Ian, the Risk of Loss provision in both the Standard and AS-IS FAR/BAR Contracts has been frequently utilized, requiring a Seller to restore or repair the Property for up to 1.5% of the Purchase Price prior to Closing. If restoration or repair cannot be completed prior to Closing, the contract calls for a post-closing escrow of 125% of the cost to repair or restore. In a recent transaction, I was asked by the Seller, “Why do we need an escrow agreement? Can’t you release funds when I say so?”
What is an escrow agreement, and why is an escrow agreement so important?
An “escrow agreement” is an agreement between two (or more) parties (typically the Buyer, the Seller, and the Escrow Agent) that details the terms and conditions of the escrowed funds and the rights and responsibilities of the parties involved. The Escrow Agent is a neutral third party who holds onto the escrowed funds post-closing. It is important to note that the terms and provisions of an escrow agreement survive closing.
What terms does an escrow agreement include?
An escrow agreement provides clear direction for all parties involved. The agreement may include, but is not necessarily limited to, the following:
- The parties to the escrow agreement
- The amount of funds to be held in escrow
- The reason for the escrow – e., corrective action for a survey remedy, post-closing repairs, and so on.
- When the funds are to be released
- Who provides notice that the corrective action or repairs have been completed?
- Does the Buyer have the unilateral right to notify the Escrow Agent to release the funds?
- The time period within which the corrective action or repair needs to be completed
- Resolutions to the “what-ifs” (see below)
What could go wrong? Why do we need an escrow agreement?
A few of the common “what-if” situations that an escrow agreement can protect against:
- What if the corrective action or repair does not happen during the timeframe permitted in the Escrow Agreement?
- What does the Escrow Agent do with the remaining balance of any unused funds?
- What if the established escrow amount does not cover the invoice for the work to be done?
- What if, during the repairs, more damage occurred – who is responsible?
- What if the Buyer and the Seller disagree on releasing the funds?
Having a formal escrow agreement is crucial to protect both the Buyer and the Seller. Since an escrow agreement is legally binding, it is imperative to have an attorney draft it. A poorly drafted escrow agreement could expose the Buyer or the Seller to additional liability, fees, and even litigation. As always, if you have questions regarding a post-closing escrow agreement, we encourage you to consult your trusted real estate attorney.