Be careful with escrow accounts

Although it is not yet a feature of large numbers of transactions, the practice of S&P brokers being asked to hold deposits on behalf of buyers and sellers is now sufficiently established to be considered part of the normal course of business. Andrew Jamieson, Legal Adviser and Claims Director at International Intermediaries Club (ITIC), explains what to look for.

The reluctance of banks to open closing accounts for S&P transactions lies behind the push to get S&P brokers to hold money in escrow. And the need to comply with costly money-laundering regulations is one of the main reasons for the banks' reluctance in this regard. Shipbrokers must ensure that they are aware of local money-laundering regulations and how they apply to their business, because failure to comply is a criminal offence, likely also to carry uninsured financial penalties.

By accepting instructions to hold money on behalf of buyers and sellers, brokers accept on obligation to treat both parties equally.  This may create a difficult commercial situation if a dispute subsequently arises.

The duties of the shipbroker should be clearly set out in an escrow agreement signed by both buyers and sellers. The agreement should cover how the money is to be held and the grounds upon which it is to be released. The Baltic Rules provide 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, this should be made clear in the agreement. The question of who will receive interest paid on the account should be set out, and a common provision will be that the unspecified 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 liability for negligence. A good guiding principle is that the broker should avoid being placed in a position where it has to make a decision as to whether to pay out the funds or not.
The normal wording is, "The buyers and 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."

It should be noted, however, that there is a problem when releasing against a "final and unappealable decision", because the broker is not in a position to assess whether such an award is "final and unappealable". So it is recommended that that part of the wording be replaced with "a decision of an arbitration tribunal or court which appears on its face to be final". Although this provision has caused some principals concern, it 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 is added to the effect that the broker has the option at any time to pay the funds into court. And a recent agreement provided that the principals would reimburse any legal fees incurred by the broker in performing its duties.

Brokers frequently ask about obtaining indemnities from principals. And although this will not prevent them from being liable irrespective of what happens, it is prudent to add something along the following lines:

"The buyers and sellers jointly and severally agree:

(1)   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 with his escrow agreement; and
(2)   that the broker's only obligation is to hold the funds upon the terms set out in this escrow agreement. The broker will have no liability for any act or omission taken or not taken by him in good faith. For the avoidance of doubt it is the burden of the party alleging that the broker 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 Memorandum of Agreement. But the escrow agreement is a separate contract and there are obvious advantages in having it subject to the law and jurisdiction where the broker is based.

8th January 2007.
The Baltic December 2006 (Article).