What is an Escrow Account?
An escrow account is a special kind of account that holds money or assets until certain conditions are met by the parties involved in the transaction.
In India, escrow accounts are used for real estate, digital lending, e-commerce, digital marketplaces, online gaming and more. Escrow accounts significantly reduce the risk of non-payment or counterparty risks.
Understanding the Escrow Process
Escrow accounts are used in transactions where there is a risk that one or both parties may not fulfil their obligations. In other words, an escrow account is used when there is a chance that something might go wrong.
Escrow solutions bring together tech, trustee and banking, making escrow payments as seamless as possible. They also help with compliance, automations and making sure the entire transaction is as seamless as possible.
Escrow in India is used across industries and businesses in a range of transactions. The fundamental mechanism of an escrow account is as follows:
- An escrow account is a special kind of account that holds money or assets until certain conditions are met.
- Escrow accounts in India are used for real estate, digital lending, e-commerce, digital marketplaces, online gaming, and more.
- Using escrow accounts significantly reduces counterparty risk or risk of fraud.
Read more: Escrow vs Nodal vs Current Account
An escrow agreement is a contract between 3 agents: a buyer, a seller and an independent third party – an escrow agent. The agreement lists the terms and conditions of the escrow payment.
In an escrow agreement, a depositor deposits funds or assets with the escrow agent. Once the terms in the escrow agreement are met, the escrow agent releases the money or assets to the beneficiary.
Format of Escrow Agreement
An escrow agreement generally contains the following details:
- Names and addresses of the buyer, seller, and escrow agent
- Description of the property or assets being held in escrow
- Amount of money or value of the assets being held in escrow
- Conditions that must be met before the money or assets are released
- Fees that will be charged by the escrow agent
- Procedures for resolving disputes
- Time period for completing the escrow payment
- Method for notifying the escrow agent of any problems
- Procedures for releasing the money or assets if the transaction is not completed
- Procedures for resolving disputes if there is a disagreement about whether the conditions of the agreement have been met
If these terms are not met by one or both parties, the agreement may be terminated.
Types of Escrow
Escrow accounts are used in a variety of transactions across industries. Listed below are the major uses of escrow.
Escrow in Real Estate
Real estate transactions involve huge amounts of money and are high risk for both buyer and seller, since there is the possibility that either party might not meet their obligations.
Escrow accounts help mitigate this risk. The escrow agent takes possession of the property and holds the buyer’s money till all terms and conditions are met.
Once met, the escrow agent releases the property to the buyer and the money to the seller.
Escrow in Online Sales
Customer trust in e-commerce and digital marketplaces is very important. Most customers are wary of trusting online sellers because there is the risk of receiving defective products, or even not receiving the product at all.
To address these risks, most e-commerce sellers choose to receive money through an escrow account, which will only release money to the seller upon delivery and verification of the product.
Most online marketplaces also deal with a lot of vendors. Amazon, for example, does not manufacture most of the products it sells on its marketplace. It is only a middle man between the vendors who do and the people who buy.
So, money earned from sale of these products does not actually belong to Amazon – most of it has to be given to the vendor and only a part of the sales will go towards Amazon’s revenue.
To foster vendor relationship and trust, most online marketplaces choose to receive money from sales in an escrow account from where the money is distributed back to the vendor and the commission retained by the marketplace.
Escrow in Online Gaming
Online gaming platforms like Dream11 and MPL allow players to play games online and win real money. To enter a game, players must pay an entry fee, out of which the prize money is paid to the winner. Till the winner is determined, the pool money is held in an escrow account to eliminate the risk of fraud.
Escrow in Stock Market
Sometimes, shares are issued in escrow – meaning that issued shares are not transferred to the owner until certain terms are met. In India, when a company issues shares to the public, the issuance is only valid if more than 90% of the shares are subscribed to.
If less than 90% of the shares issued are subscribed to, the money is returned back to the investors. To ensure this happens, the company issuing shares is required to open an escrow account and receive subscription money to that account.
Another common use of escrow payments when issuing stock is for employee compensation or bonus plans.
Escrow in Lending
In lending transactions, escrow payments are used to protect both the borrower and the lender. The borrower’s funds are held in escrow until they have met the terms of the loan, such as making all of the required payments.
The lender’s funds are also held in escrow until the borrower has met the terms of the loan. This helps ensure that both parties are protected in case of default.
Escrow in Acquisitions and Business Deals
Escrow accounts are also used by companies in mergers & acquisitions and other business deals like credit sales.
In case of mergers, the deal amount is first deposited into an escrow account. Once the terms are met by both parties, the amount is released to the selling party.
In case of credit sales, the business might open an escrow account for the funds to be held till the vendor fulfils their side of the transaction.
For example, a business buys goods from a supplier on credit. The supplier agrees to deliver the goods in 30 days, and the business agrees to make the payment immediately – but the money will be transferred to an escrow account.
Once the supplier delivers the goods, the business verifies condition and quality; following which the escrow agent releases the funds to the supplier.
Advantages and Disadvantages of Escrow Payments
|Convenient for complex transactions involving multiple parties and complicated terms||Escrow agreement and escrow transaction can be complex and confusing|
|Reduces the risk of dispute||Can delay the transaction as verifications and third-party transfers can take time|
|Helps ensure compliance with regulations and the law|
Despite the drawbacks, there is huge benefit from using an escrow account to facilitate complex, multi-party transactions.
Regulations around Escrow in India
In India, the law mandates the use of escrow accounts for certain kinds of transactions. It is important to know what the law says about escrow accounts and whether your business needs one or not.
- The Securities and Exchange Board of India (SEBI) mandates the use of an escrow account when issuing shares. This is to ensure that the money collected from investors is used for the intended purpose of issuing shares and is not misappropriated.
- The Reserve Bank of India (RBI) requires banks and non-banking financial companies (NBFCs) to use escrow accounts to hold property taxes and homeowners insurance payments for home loans. This is to ensure that these payments are made on time and that the home loan borrowers are not defaulting on their payments.
- The Real Estate (Regulation and Development) Act, 2016 (RERA) requires real estate developers to open an escrow account to hold the money collected from homebuyers. This is to ensure that the money is used for the construction of the project and is not misappropriated.
- The Information Technology (Intermediary Guidelines) Rules, 2011 (IT Rules) require online platforms that facilitate escrow services to comply with certain regulations. These regulations include registering with the Ministry of Electronics and Information Technology (MeitY), maintaining records of all transactions, and resolving disputes in a timely manner.
In addition to these regulations, there are also a number of laws that apply to escrow accounts in India. These laws include the Indian Contract Act, 1872, the Negotiable Instruments Act, 1881, and the Punjab National Bank (Amendment) Act, 2014.
The regulations and laws around escrow in India are designed to protect the interests of all parties involved in an escrow transaction. By complying with these regulations and laws, escrow agents can help to ensure that escrow accounts are used safely and securely.
Choosing the Right Escrow Account for Your Business
There are many different escrow solutions on the market – the wisdom lies in knowing which one is the right one for your needs and your business.
RazorpayX Escrow+ is the only escrow solution on the market with automated, 10-second disbursals, all-in-one escrow, trustee and banking services and more:
- Effortless auto-reconciliations
- Multi-bank routing
- Robust APIs
- Pre-approved money flows
- Plug & play industry modules
What is escrow account India?
An escrow account in India is a bank account where money or assets are held by a third party, called an escrow agent, until certain conditions are met. The escrow agent is typically a bank or financial institution.
What is escrow bank account?
Escrow bank account is a special kind of account provided by an escrow agent. It holds money or assets until certain conditions are met by the buyer and seller parties.
Why is escrow account used?
Escrow accounts are used by businesses and merchants involved in complex, risky transactions. They reduce counterparty risk and increase trust on both sides of the transaction.
Do banks have escrow accounts?
Yes, banks do have escrow accounts. Escrow accounts are a type of bank account where money or assets are held by a third party, called an escrow agent, until certain conditions are met. In the case of banks, the escrow agent is typically the bank itself.
Can I open an escrow account?
If you have the requirement for an escrow account, you can open an escrow account with an escrow agent or an escrow provider like RazorpayX Escrow+.
What is escrow as a service?
Escrow as a service (EaaS) is a type of escrow service that is provided by a third-party company. EaaS can be a convenient and cost-effective way to manage escrow accounts. It can also help to reduce the risk of fraud and errors.
What is an example of escrow services?
Escrow accounts can be used in online gaming to hold pool money that will be used to pay winnings. Online gaming companies like MPL or Dream11 use escrow extensively for this purpose.