INTRODUCTION

INTRODUCTION

An escrow is essentially a small and short-lived trust arrangement. It has become an indispensable mechanism
in this state for the consummation of real property transfers and other transactions such as exchanges, leases,
sales of personal property, sales of securities, loans, and mobilehome sales. This chapter discusses the real
estate sale escrow.

Definition of an Escrow

California Civil Code Section 1057 provides this description of an escrow:

“A grant may be deposited by the grantor with a third person, to be delivered on the
performance of a condition, and, on delivery by the depositary, it will take effect. While in the
possession of the third person, and subject to condition, it is called an escrow.”

And, in Section 17003 of the Financial Code:

“Escrow means any transaction wherein one person, for the purpose of effecting the sale,
transfer, encumbering or leasing of real or personal property to another person, delivers any
written instrument, money, evidence of title to real or personal property, or other thing of
value to a third person to be held by such third person until the happening of a specified event
or the performance of a prescribed condition, when it is then to be delivered by such third
person to a grantee, grantor, promisee, promisor, obligee, obligor, bailee, bailor, or any agent
or employee of any of the latter.”

Essential Elements of an Escrow

The two essential elements for a valid sale escrow are a binding contract/agreement between buyer and seller
and the conditional delivery to a neutral third party of something of value, as defined, which typically includes
written instruments of conveyance (grant deed) or encumbrance (deed of trust) and related documents. The
binding contract/agreement can appear in any legal form, including a deposit receipt (a residential purchase
agreement), other forms of agreements of sale, exchange agreements, option agreements, or jointly executed
bilateral or individually executed unilateral escrow instructions evidencing a mutual agreement of the buyer and
the seller.

Escrow Holder

The escrow holder is the agent and depositary (as an impartial/neutral third party) having and holding
possession of money, written instruments, documents, personal property, or other things of value to be held
until the happening of specified events or the performance of described conditions. Once these events occur or
the conditions are met and performed (satisfied or waived) in strict compliance with the escrow instructions, the
escrow holder (performing as the “escrow agent”) has accomplished its primary duty of faithfully executing the
instructions given to it by the principals to the escrow (e.g., the buyer and the seller in a real estate sale escrow).

The escrow holder is the agent and fiduciary of the principals to the escrow, and is defined to be a person who
is lawfully engaged in the business of receiving escrows for deposit in behalf of or for delivery to the
designated principal(s). As a fiduciary in performing its duties, the escrow holder must at all times exercise
reasonable care, loyalty, and good faith towards the principals of the escrow. An escrow holder’s fiduciary duty
is generally limited to the faithful performance/execution of the instructions given by the principals to the
escrow. See Summit Financial Holdings, Ltd. v. Continental Lawyers Title Co. (2002) 27 Cal. 4th 705, 711,
Civil Code Section 2297and Financial Code Section 17004.

The escrow holder acts to ensure that all principals to the transaction comply with the terms and conditions of
the contract/agreement as set forth in the escrow instructions. The escrow holder may (within the course and
scope of the escrow instructions) coordinate the activities of the professional service providers involved in the
transaction, such as the activities of the lender(s), the title company (if distinguishable from the escrow holder),
the title insurance company, as well as those among the buyer, seller and real estate broker.

Definition of Principals to the Escrow

In a real estate sale escrow, the principals include the buyer and the seller and, if applicable, the lender(s)
making the “purchase money” loan. While principals are parties to the escrow, not all parties involved are
principals. The principals are persons who are executing and performing the escrow instructions and who are

making the conditional deliveries in connection therewith. The lender(s) are included in this category, since
they execute and provide to the escrow holder their written instructions together with instruments of
encumbrance and related loan documents that are conditionally delivered in anticipation of the issuance of title
insurance coverage. These instructions, instruments, funds, and loan documents are essential to the real estate
sale escrow when financing by a lender(s) is required.

As discussed above, the escrow holder is (within the course and scope of the escrow instructions) the agent and
fiduciary of the principals of the escrow. As a result, the escrow holder is a dual agent, i.e., agent and fiduciary
of the buyer and seller and of the lender(s), if applicable. Upon the completion and close of the sale escrow, the
escrow holder is the agent for each of the principals to deliver the statements, instruments, funds, documents,
and title insurance coverage to which each are entitled in accordance with the escrow instructions.

Escrows include parties who are not principals to the escrow and, therefore, to whom fiduciary duties are not
owed by the escrow holder. These parties may include, among others, claimants within the chain of title,
persons placing demands for payment into the escrow, persons submitting reports/inspections to be delivered
through the escrow. To these parties the escrow holder functions as a custodian with the duty to act in good
faith and consistent with the standard of care applicable to escrow holders/agents. See Summit Financial
Holdings, Ltd. v. Continental Lawyers Title Co. (2002) 27 Cal. 4th 705, 711.

Escrow Instructions

The conditional delivery of an instrument of conveyance or encumbrance, money/funds, or other things of
value is accompanied by instructions to the escrow holder authorizing the delivery of the instruments, funds,
and related documents upon the happening of specified events or the performance of stipulated conditions. In
California, there are two forms of escrow instructions generally employed: bilateral (i.e., executed by and
binding on both buyer and seller) and unilateral (i.e., separate instructions executed by the buyer and seller,
binding on each). Since the escrow instructions implement and may supplement the original
contract/agreement (e.g., residential purchase agreement or agreement of sale), each are interpreted together.

However if the escrow instructions contain terms in conflict with the original contract/agreement, the
instructions constituting the later contract/agreement will usually control, subject to separate consideration
regarding the escrow instructions (as may be required). When joint/bilateral instructions have been signed by
the principals to the escrow, neither principal may unilaterally change the escrow instructions. The principals
may change, by mutual agreement, the instructions at any time and one principal may waive the performance
of certain conditions, provided the waiver is not detrimental to the other principal to the transaction.

While an independent/neutral escrow holder can be held liable for violating written instructions (including
breaches of fiduciary duty within the course and scope of the escrow instructions), the escrow holder is only a
neutral stakeholder who is not to be concerned with controversies among the principals. As such, an escrow
holder is entitled to file an action of interpleader and for declaratory relief to ask a court of competent
jurisdiction to resolve the controversies and to direct the escrow holder on how to proceed.

Completed Escrow

Properly drawn and executed escrow instructions become an enforceable contract/agreement. An escrow is
termed “completed” or “perfected” when each of the terms of the instructions have been met or performed
(satisfied or waived).

Escrow Principles

The following are major escrow principles:

1. Escrow instructions must contain mutuality, including the understandings and the intentions of the
principals to the escrow. Properly drawn instructions should be clear and certain as to the understandings
and the intentions of the principals, the duties of the escrow holder, and the fact that it is the principals
themselves who must perform the escrow contract/agreement. The escrow holder does not have, and must
not exercise, discretionary authority. The escrow holder/agent acts in behalf of and not in the place and
stead of principals.

2. The escrow holder does not act as a mediator. However, the escrow holder/agent may offer advice to the
principals as an agent and fiduciary within the course and scope of the escrow instructions. As previously
discussed, the escrow holder/agent does not participate in controversies among the principals or among the
parties to the escrow, or arbitrate disputes. Instructions are drawn so that the principals to the escrow make

the promises, perform their obligations, and put the escrow holder in a position to complete and close the
escrow. If the claim of the non-principal parties to the escrow is within the chain of title, such claims must
be satisfied by the escrow holder to obtain the title insurance coverage required by the principals (including
the lender(s)).

3. The escrow holder is prohibited from offering legal advice and must suggest that disagreeing parties
consult an attorney (or a real estate broker when the transactional matter may be negotiated within the
course and scope of the real estate license).

4. Escrow is a limited/special agency relationship governed by the content of the escrow instructions. As
agent for both principals (often including an additional principal, the lender(s) extending credit in the form
of “purchase money” financing), the escrow holder acts only upon specific written instructions of the
principals. As previously noted, when the escrow is completed/perfected and closed, the escrow holder
becomes the agent for each principal with respect to those things in escrow to which the principals have
respectively become entitled.

5. When all principals to the escrow have signed mutual (conforming) instructions, the escrow becomes
perfected. If only one principal has signed, that principal may terminate the proposed escrow at any time
prior to the other principal’s signing of conforming escrow instructions. As an additional principal, the
lender(s) typically reserve the right to withdraw their instructions, instruments, funds, and related
documents if the escrow instructions of the buyer and seller do not conform to the instructions of the
lender(s).

6. The escrow holder must avoid vague or ambiguous terms and provisions in the escrow instructions and
related documents.

7. The escrow holder must forward immediately to the title insurance company (or its underwritten title
company agent, if other than the escrow holder) any instrument that is to be recorded. Copies are to be
furnished to appropriate and concerned principal(s) or third parties, so that the instrument’s sufficiency can
be determined. This will help avoid a delay in completing and closing the sale escrow.

8. The escrow holder without authorization of the principals may only accept claims, demands, instruments,
funds, as well as related documents contemplated by the escrow instructions. Other claims, demands,
instruments, funds, and documents are not to be accepted by the escrow holder.

9. The escrow trust account must be maintained with extreme care. Overdrawn accounts (debit balances) are
strictly forbidden.

10. Escrows are privileged and confidential in nature. The escrow holder must not give out any information to
third parties (persons who are not principals of the escrow) concerning an escrow without approval of the
principals.

11. The escrow holder is the agent of the principals to the escrow. Any facts known by the escrow agent are
imputed to the principals. Therefore, the escrow holder owes a duty to communicate to its principals
knowledge acquired within the course and scope of the agency relationship established by the escrow
instructions with respect to material facts that might affect a principal’s decision as to the pending
transaction. Any detrimental or new material information, previously undisclosed, made known to the
escrow holder and affecting the principals should be disclosed to them for their instructions in the matter.

12. The escrow holder must maintain a high degree of trust, efficient service, and good public relations,
particularly concerning the principals to the escrow.

13. The escrow holder must remain strictly neutral, not favoring either principal, including the lender(s)
extending credit in the form of “purchase money’ financing. Notwithstanding the required neutrality, the
escrow holder must advise the principals to the escrow in the context described in item 11. To the extent
possible, the escrow holder must be careful to avoid preceding in a manner that results in a gain to one
principal to the detriment of the other principal(s).

14. The escrow holder must constantly maintain records and files to be sure that a procedure is not overlooked.
Neat and orderly files, complete with check sheets, will help ensure smooth progression towards
completing and closing the escrow.

15. Before closing an escrow, the escrow holder must audit the file, accounting for all items to be handled,
recorded and delivered, including cleared funds.

16. The escrow holder must not disburse any funds from an escrow account until all items such as checks,
drafts, etc. have cleared, and thus have become available for withdrawal as an automatic right. This
“holding period” may range from 1 to 10 days, depending on the type and location of the financial
institution upon which the checks, drafts, etc. have been drawn.

17. Completing and closing the escrow must be prompt, using forms and disclosures which are simple and
clear.