Escrow Accounts

ITIC has seen an increasing number of sale and purchase brokers being asked to hold deposits on behalf of the buyers and sellers. While not yet a feature of a large number of transactions, the practice is now sufficiently established that it may be considered part of the usual course of business of a sale and purchase broker. A member insured as a sale and purchase broker would therefore be covered by their entry with ITIC in respect of deals where they have acted as brokers. The cover would apply to negligence in operating the account.

This task is falling on shipbrokers due to a reluctance by banks to open closing accounts for S&P transactions. A major reason for their reluctance is the cost of complying with money laundering regulations. Shipbrokers may not face all the detailed regulations applying to banks, but they must ensure that they are aware of the local money laundering regulations and how they would apply to their businesses. A failure to comply with such regulations is a criminal offence and any penalties are likely to fall outside cover.

By accepting instructions to hold money on behalf of the buyers and sellers the broker accepts an obligation to both parties and cannot treat one more favorably than the other. This may create a difficult commercial situation if a dispute arises and one party believes that “their broker” should be doing more to support their position.

It is very important that the duties of the shipbroker are clearly set out in an escrow agreement signed by both buyers and sellers. The agreement should cover both how the money is to be held and the grounds upon which it is to be released.

The Baltic Code provides that members of the Baltic Exchange acting as brokers are required to operate a separate bank account for clients. The agreement will often specify that the money will be held separately from the funds of the broker. The parties will accordingly be protected if the broker becomes insolvent. There is a difference between a client account and one specially opened for a transaction. If, as is usual, the broker is using a general client account that should be made clear in the agreement.

The question of who will receive interest paid on the account should be set out. The broker should not, of course, specify what the rate of interest will be. A common provision is that the rate of interest is to be determined by the bank and shall be the rate for immediately available deposits. The interest on the money while held as a deposit is usually stated to belong to the buyer.

The most obvious concern is that the broker could release the funds wrongly and therefore face a liability for negligence. A good guiding principle is that the broker should avoid being placed in a position where he has to make a decision as to whether to pay out the funds or not.

The normal wording is:-

“The buyers and the sellers instruct the broker to release the funds in accordance with:-

1) a written instruction signed (jointly or in counterpart) on behalf of both the sellers and buyers;or

2) a final and unappealable decision of an arbitration tribunal or court(*);or

3) an order of a court of competent jurisdiction.”

* There is a problem when releasing against a "final and unappealable" decision. This is because the broker is not in a position to assess whether such an award is "final and unappealable". ITIC recommends it is replaced with "a decision of an arbitration tribunal or court which appears on its face to be final". This provision has caused some principals concern but has been widely accepted.

The broker should seek advice if a dispute arises. Most court systems have a process where a person holding funds as a stakeholder can either pay disputed funds into court or ask the court to determine the issue. Sometimes a provision that the broker has the option at anytime to pay the funds into court is added. An agreement ITIC reviewed recently provided that the principals would reimburse any legal fees incurred by the broker in performing his duties.

Brokers frequently ask about obtaining an indemnity from the principals. This will not prevent the broker being liable “come what may” but it is prudent to add something along the following lines:-

“The buyers and sellers jointly and severally agree:-

i) to indemnify the broker upon first demand against all losses, liabilities, costs and claims and demands arising out of and in connection with our holding of the funds in accordance with his Escrow agreement; and

ii) that the broker’s only obligation is to hold the funds upon the terms set out in this Escrow agreement. We will have no liability for any act or omission taken or not taken by us in good faith. For the avoidance of doubt it is the burden of the party alleging that we have acted in bad faith to produce evidence thereof.”

The agreement should contain a choice of law and jurisdiction clause. The parties will often choose the same law and jurisdiction as governs the MOA. The escrow agreement is however a separate contract and there are obvious advantages in having it subject to the law and jurisdiction where the broker is based.

The managers are always available to advise on the wording of individual escrow agreements and assist members who are caught up in disputes regarding money they are holding.