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Post-Closing Escrows (Part Two): What Happens if There is a Disagreement?
We recently wrote about post-closing escrows for mergers and acquisitions and other complex transactions. See here. In this follow-up article, we discuss legal issues with respect to what happens if there is a dispute about the money or tangible items placed into the escrow account. In general, it can be said that what happens partly depends on what is in the escrow agreement and, if the escrow agreement is silent, then the court proceedings are invoked.
San Diego Corporate Law: How the Escrow Agreement Determines Dispute Resolution
As described in our earlier article, an “escrow” is created by contract among three (or more) parties whereby an “escrow agent” holds certain property — like money or the deed to real property — on behalf of the other parties. The escrow agreement controls the conditions and procedures for holding the property — legally called the corpus of the escrow — and also what happens in the event of a dispute. In this respect, escrow agreements are like all other contracts in California and, unless the agreement is ambiguous, California courts will enforce the escrow agreement as written.
As with any contract, the parties are free to specify the details. That being said, in general, escrow agreements tend to be one of two kinds: self-executing or two-signature. Escrows are intended to be temporary. It is expected that the corpus of the escrow will be released reasonably soon after the transaction has closed depending on the conditions set in the escrow agreement. As an example, often a “tax clearance certificate/statement/letter” is needed for the sale of a business. The taxes might be sales taxes, withholding taxes, income taxes or something similar. In our example, assume there has been a delay, or everyone is in a hurry. The buyer and seller want to close and might agree to consummate the sale without the clearance letter. To do so, they agree to escrow certain portions of the purchase price until receipt of the tax clearance letter.
The escrow agreement can be set up as self-executing. Something like this: “Upon receipt of the tax clearance letter, ESCROW AGENT shall pay any amounts due and then shall remit to the SELLER any funds remaining in the escrow and close the escrow account.”
Conversely, the escrow agreement can require the consent of the buyer and seller. The language might read something like this: “Upon receipt of the tax clearance letter, ESCROW AGENT shall pay any amounts due. Then, upon notice to and written approval from the BUYER, ESCROW AGENT shall remit to the SELLER any funds remaining in the escrow and close the escrow account.”
Most business owners prefer self-executing escrow agreements because there is no room for disagreement that will prevent the full and final completion of the transaction. As can be imagined, the problem with a two-signature escrow agreement is the possibility that the buyer will not want to sign off on disbursing the remainder of the escrow to the seller. The escrow agent is at risk legally if the escrow agent disburses without the approval of the buyer. Thus, the three parties are in a standoff.
If the parties can agree, a well-drafted escrow agreement will provide a mechanism for resolving a standoff like this. Mechanisms might include use of mandatory mediation, arbitration or some other form of neutral resolution. Otherwise, the escrow agent must resort to the court system.
San Diego Corporate Law: Resolving a Dispute Through Interpleader
Under the California civil procedure rules, if the parties cannot or will not agree to resolve a dispute over disbursement of an escrow corpus, the escrow agent can force the buyer and seller to resolve their dispute in court. This is called an “interpleader” action. See Cal. Civ. Proc. Code, § 386 and following. In simple terms, the escrow agent deposits with the court whatever is in the escrow, minus allowable fees and costs. Thereafter, the escrow agent is generally free and clear of any legal liability. The buyer and seller are now in court and must resolve their disagreement via litigation.
Contact San Diego Corporate Law Today
If you would like more information about mergers, acquisitions and post-closing escrows, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard can be reached at (858) 483-9200 or via email. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters, and he proudly provides legal services to business owners in San Diego and the surrounding communities.
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