It seems that whenever things settle into a regular routine, changes suddenly occur when you least expect them. One issue that is always at the forefront of real estate investing is who should have an escrow for a purchase or sale. While escrows are only given by buyers in a real estate transaction, the seller and buyer must agree who and when will keep the deposit and whether it will be released if the buyer doesn’t close.
If you are the seller in a transaction, your options for retaining the escrow your buyer will give you are:
1. Hold the deposit yourself with the check made out to you or your entity (company or LLC). This is the best way to control the deposit in case the buyer backs out and doesn’t close. You must “segregate” these funds in your checking account, as some states require an escrow accounting at any time. I was involved in a transaction where the seller asked me to make the escrow payable to a company called the National Escrow Company or similar name. In reality, this was his company that he had formed just to hold the escrows, but the title gave the buyer a bit of a sense of security rather than making it payable to John Smith.
2. Ask your lawyer to hold the escrow, which gives you some degree of control, but in the event of a dispute later, you’ll have little chance of getting the funds unless the buyer signs a release or you go to the court. It should be simple because your contract says that if the buyer doesn’t close, he’ll get the deposit, but the buyer can still sue for breach of contract and hold the deposit from being disbursed. This is easily resolved by having language in your contract that provides and authorizes the release of the deposit if the buyer does not close on or before the prescribed closing date. Have your closing agent approve this language before you give the buyer your contract to sign.
3. Allow the buyer’s attorney to retain the security deposit. This is the worst case scenario because you have an adversarial relationship on your hands to begin with and the buyer’s attorney will not release the deposit unless authorized by his client, his buyer. If you allow the security deposit to be withheld in this manner, make sure your attorney agrees to the language specifying release and disbursement in your contract before signing. This can be a deal breaker, so be prepared to make a decision about how important this buyer is.
4. Independent escrow agent who is “neutral” to both parties. This is no better than #3 above, except that the buyer may more easily agree than give the deposit to their lawyer. Again, the critical aspect is the clause in the contract that allows you to control the escrow by giving the escrow agent written authorization to disburse the funds automatically if the buyer does not close for any reason. Likewise, the rider has to say that you agree to release the escrow if you can’t close for any reason.
The key to making an escrow work is to make sure that your Purchase and Sale Agreement (contract) has verbiage that clearly states that the escrow agent is authorized to disburse the escrow in the event that any of the parts do not arrive at the closing table on time. If the contract has contingent clauses, such as financing, and the buyer is ineligible for a loan, the deposit must be returned. This is one reason not to sign buyers who need financing unless you absolutely know they can get financing, which is almost impossible to know these days. Escrow release is less affected in cash transactions and this is why investors try to deal with cash buyers, especially in wholesale properties.
If your closing agent (or lawyer) doesn’t write the legal language to release the escrow “automatically”, find another closing agent who does because at some point you will have the problem of not being able to get the escrow to which they have right.