This article discusses the purpose of an escrow to ensure that the expectations of the parties and terms of the transaction are met. This article is part of our Fundamentals of Real Estate Practice series.
The execution of a purchase agreement
Escrow is a process employed to facilitate the closing of a transfer of real estate between two parties, typically under a primary agreement, e.g., a purchase agreement. [Calif. Financial Code §17003(a)]
In mortgage transactions, escrow references the duty of the lender to receive funds from the property owner for the payment of the property taxes and insurance premiums (TI) of the property securing the mortgage. Typically, these funds are collected monthly with the regular principal and interest (PI) payment. The funds accumulate and are disbursed by the lender. Collectively, the mortgage principal, interest, property taxes and insurance premiums are referred to as PITI
Escrow activity consists of:
- one person, such as a seller or buyer of real estate, who delivers written documents or money, called instruments, to an escrow company for the purpose of fully performing his obligations owed another person under an agreement entered into prior to opening the escrow for a sale, encumbrancing or leasing of real estate; and
- the escrow company, who delivers the documents and money to another person, such as the buyer, seller or third parties, on the occurrence of an identified event or the performance of prescribed conditions, such as the receipt of reports or the issuance of a title insurance policy. [Fin C §17003(a); Calif. Civil Code §1624]
An individual engaged in the business of acting as an escrow agent, called an escrow officer, must be licensed and employed by a corporation, called the escrow company. The escrow company must also be licensed by the California Department of Corporations, unless exempt. [Fin C §17200]
Individuals exempt from the escrow licensing requirements include:
- a licensed real estate broker, either individual or corporate, who represents a person in a real estate transaction (sale, mortgage or lease) in which the broker will perform escrow services;
- a licensed attorney who is not actively engaged in conducting (holding himself out as) an escrow agent;
- a bank, trust company, savings and loan association (thrift) or insurance company; and
- a title insurance company whose principal business is preparing abstracts or making searches of title used for issuing title insurance policies. [Fin C §17006]
The services rendered by escrow agents typically include:
- receiving funds and collecting necessary documents, such as appraisal reports, disclosure statements and title reports called for in the escrow instructions;
- preparing documents necessary for conveyancing, encumbrancing and evidencing the creation of debts required for escrow to close;
- calculating prorations and adjustments; and
- disbursing funds and transferring documents when all conditions for their release have been met. [Fin C §17003(a)]
However, the specific duties of the escrow officer, outlined in the escrow instructions, vary according to local real estate custom.
Consider a buyer and seller who enter into a purchase agreement for the sale of the seller’s one-to-four unit residence. As provided in the purchase agreement, escrow needs to be opened to handle the closing of the transaction, called performance by the buyer and seller.
In modern real estate practice, opening escrow simply means establishing a depository – the escrow – for the instruments (deed, money and other items) with accompanying escrow instructions. Escrow instructions are signed by all necessary persons (the buyer and seller in the case of a sale) to authorize escrow to transfer or hand those instruments to the other person or others on closing. [Montgomery v. Bank of America National Trust & Savings Association (1948) 85 CA2d 550]
Before accepting any instruments as an escrow holder for a transaction, the escrow officer will need to receive dictated instructions by an agent of the buyer or seller regarding precisely when and under what circumstances the documents and monies deposited with escrow are to change hands. The escrow officer notes all the tasks to be undertaken to manage and close escrow by preparing a “take sheet” before drafting escrow instructions.
Increasingly, agents simply email a copy of the purchase agreement to the named escrow company. The escrow officer then drafts escrow instructions from the purchase agreement provisions and sends the instructions to the real estate agent to verify they conform to the intent of the persons in the transaction.
Any number of details (preparation, receipt and transfer of monies and documents) must be attended to by the escrow officer before the transaction can be completed, called a closing or settlement. [Shreeves v. Pearson (1924) 149 C 699]
As a checklist for “going to escrow,” a worksheet helps the seller’s agent to organize the collection of facts and supporting papers the escrow officer will need to immediately draw instructions, clear conditions and close escrow. [See first tuesday Form 403]
The escrow officer will perform only as instructed. Escrow instructions are prepared by the escrow officer based on the information received from the seller’s agent about the transaction. [Moss v. Minor Properties, Inc. (1968) 262 CA2d 847; see first tuesday Form 401]
In practice, the escrow officer prepares the instructions on forms they have adopted for this use, forwarding them to the agents of the persons in the transaction for their signatures and return to escrow. When returned, escrow is then open for the person who signed and returned the instructions.
Two types of escrow instructions are used in California: bilateral and unilateral instructions.
In Southern California, escrow instructions prepared by escrow officers are usually bilateral and prepared when escrow is opened. Bilateral escrow instructions are given to escrow by the buyer and seller jointly, each signing a copy of the same instructions. [See first tuesday Form 401]
Separate unilateral escrow instructions provide separate instructions to the buyer and seller. Each set of instructions contain only the activities to be performed by or on behalf of one person, the buyer’s instructions or the seller’s instructions. In Northern California, escrow instructions are occasionally unilateral and prepared at the time of closing, after escrow determines it has all documents necessary to call for funding and closing.
The documents work together
Most modern real estate sales transactions depend on both the purchase agreement and the escrow instructions working in tandem to close a transaction.
Both the purchase agreement and the escrow instructions are contracts regarding interests in real estate. To be enforceable under the Statute of Frauds, both documents must be in writing. [CC §1624; Calif. Code of Civil Procedure §1971]
A purchase agreement sets forth the sales price and terms of payment, together with conditions to be met before closing.
Escrow instructions constitute an additional agreement between the buyer and seller which is entered into with an escrow company, but do not replace the purchase agreement. Escrow instructions are merely directives which an escrow officer undertakes to coordinate a closing under the terms of the purchase agreement on behalf of the buyer and the seller. [Claussen v. First American Title Guaranty Co. (1986) 186 CA3d 429]
However, escrow instructions occasionally add exactness and completeness, providing the enforceability sometimes lacking in purchase agreements prepared by brokers or their agents.
Generally, the purchase agreement is the primary underlying document in a real estate sales transaction and is considered the original contract. All further agreements, including the escrow instructions, must comply with the primary document, unless intended to modify the terms of that original agreement.
The agents negotiating a transaction, and their brokers, are responsible for ensuring the escrow instructions, whether prepared or dictated by them or others, conform to the purchase agreement. They do this by reviewing the instructions prepared by the escrow officer to ensure the intentions of the buyer and seller are clear. The escrow instructions should be reviewed by the agents prior to submitting them to their clients for additional review and signatures.
In some instances, the buyer and seller orally negotiate the sale and go directly to escrow, without first reducing their agreement to writing. Thus, they do not enter into an underlying written purchase agreement prior to opening escrow. Here, the buyer and seller intend the escrow instructions to function as the binding contract documenting the sale, in addition to simply providing closing instructions. In this situation, the escrow instructions constitute a binding contract between the buyer and seller which satisfy the Statute of Frauds should either need to enforce the agreement. [Amen v. Merced County Title Co. (1962) 58 C2d 528]
Escrow checklist ensures a timely closing
To provide for a smooth, timely closing, the agent dictating instructions needs to collect and hand to the escrow officer all of the information necessary to prepare the instructions and documents. Some agents leave the job of tracking down documents and information to the escrow officer, limiting the agent’s involvement to simply forwarding a copy of the purchase agreement to the named escrow company. To enhance the likelihood of a successful and timely closing, the agent should have a checklist of items and information to gather for the escrow officer. [See first tuesday Form 403]
Leaving it up to the escrow officer to glean from the purchase agreement the needs for closing without the supplemental information known to the agent imprudently stresses the escrow officer and threatens a timely closing.
Of note, an escrow officer does not have an obligation to notify the buyer or seller of any suspicious fact or circumstance detected by the officer before the close of escrow, unless the fact affects closing. However, an agent best serves his client by selecting escrow officers who properly alert the agent to potential problems outside the escrow instructions which are known to the escrow officer. [Lee v. Title Insurance and Trust Company (1968) 264 CA2d 160]
To avoid confusion when dictating instructions, the broker must consider the type of transaction (sale, loan, exchange or lease) being escrowed, timelines for the elimination of any contingencies and the final date scheduled for the close of escrow.
If the escrow instructions are vague or incomplete on any point, the underlying purchase agreement must be analyzed by the agents and their clients before dictating amended instructions.