In the rapid-developing economy and the expansion of trade, contract has become an essential part of business activities. Currently, escrow deposit is one of the most important and widely used tools in civil and commercial transactions to ensure contract performance. Through this article, TNTP will analyze the nature, role, and effectiveness of escrow deposit in contract execution while clarifying the benefits they bring to the parties involved in transactions.
1. Concept and characteristics of escrow deposit
• According to Article 330 of the Civil Code 2015, escrow deposit is one of the measures to secure the performance of obligations. Under this measure, the obligor (escrow depositor) is required to deposit a sum of money, precious metals, gemstones, or valuable papers into a blocked account at a credit institution to ensure that contractual commitments are properly and fully performed. In cases where the obligor fails to perform or improperly performs their contractual obligations, the escrow deposit may be used to settle the obligation and compensate for any damages caused by the obligor.
• According to Article 39 of Decree 21/2021/ND-CP, parties involved in a contract must carry out the escrow deposit and payment in accordance with specific principles, as follows:
– Escrow deposit: The escrow must be deposited into a blocked account at a credit institution as agreed upon by the parties or as designated by the obligee to ensure the performance of contractual obligations.
– Forms of escrow deposit: The parties may agree to make the escrow deposit in a single transaction or in multiple installments, depending on contractual requirements or legal provisions.
– Use of escrow funds: If a contractual obligation is breached, the escrow deposit will be used to settle the obligation and compensate for damages, after deducting service fees.
2. Rights and obligations of parties in escrow
An escrow agreement is considered a civil transaction, so for it to take effect, the parties must comply with the provisions of Article 117 of the Civil Code on the validity of civil transactions. Accordingly, the contracting parties must have legal capacity and civil act capacity to conclude the contract; voluntarily participate in the agreement; and ensure that the purpose and content of the contract do not violate prohibitions of the law or contravene social ethics.
During the escrow deposit process, the involved parties include: the credit institution holding the escrow, the escrow depositor, and the beneficiary. Each party has specific rights and obligations, as stipulated in Article 40 of Decree 21/2021/ND-CP, as follows:
• Rights and obligations of the credit institution acting as an intermediary in managing the escrow funds are defined as follows:
– Entitled to service fees from escrow activities.
– Request the beneficiary to comply with the escrow agreement to ensure payment obligations.
– Make payments upon the beneficiary’s request within the escrowed amount.
– Refund the remaining escrow funds to the escrow depositor after fulfilling obligations and terminating the escrow.
– Other rights and obligations as agreed upon by the parties or as prescribed by law.
• Rights and obligations of the escrowing party (the party obligated to deposit escrow funds or assets into a credit institution to ensure contract performance) are stipulated as follows:
– Make an agreement with the credit institution on the conditions for escrow payment in accordance with the commitment to the entitled party.
– Request the credit institution to return the remaining escrow amount and receive interest (if agreed).
– Withdraw, supplement, or use the escrow funds for other transactions with the consent of the entitled party.
– Fully deposit the escrow amount as agreed with the credit institution.
– Oher rights and fulfill obligations as stipulated in the contract or by law.
• The entitled party has the following rights and obligations:
– Request the credit institution to fully and timely fulfill obligations within the scope of the escrow amount.
– Comply with the procedures required by the credit institution to exercise the right to receive payment from the escrow.
– Other rights and fulfill obligations as agreed or as prescribed by law.
3. Advantages and limitations of escrow deposit in contract performance
Escrow is a widely used and essential measure in contractual transactions, ensuring the fulfillment of obligations by the parties and promoting fairness in contract execution. However, like any security measure, escrow has its own advantages and limitations.
a. Advantages
• Protection of rights: Escrow safeguards the interests of the parties, especially in cases where the a parties breaches obligations or fails to fulfill commitments. In such instances, a party only needs to provide evidence proving full compliance with obligations and fulfillment of agreed conditions to receive payment.
• Ensuring contractual obligations: Escrow serves as an effective tool to secure the timely and complete fulfillment of contractual obligations. The involved parties are more accountable for performing their duties.
• Risk mitigation: The escrow minimizes risks, particularly for sellers or lessors. If the counterparty fails to fulfill contractual obligations, the escrow funds can be used to cover the obligations or compensate for damages caused by the defaulting party in a timely manner.
• Enhancing trust: Holding an escrow that is only released upon full contract performance fosters trust between the parties.
b. Limitations
However, escrow deposit also has certain limitations and may present some challenges in its application.
• Escrow costs: Requiring an escrow deposit can be a financial burden for the parties, especially the escrow depositor. The service fees charged by the credit institution add to the overall cost of the contract.
• Clear Regulations on escrow conditions: While escrow protects the parties’ rights, in cases where the conditions for escrow release are not clearly agreed upon or specified, determining the exact requirements for receiving escrow funds can be challenging, leading to delays or potential legal disputes.
• Restrictions on the use of escrowed assets: Escrow funds must be held in a restricted account, limiting their availability for other uses. This may create difficulties for the escrow depositor if they face urgent financial needs during the contract period.
4. Common forms of escrow deposit in contracts
Currently, there are various types of escrow arrangements, but the two most commonly used in contract formation and execution are guarantee escrow deposit and L/C escrow deposit (Letter of Credit).
• Guarantee Escrow: This form of escrow requires the depositor to place a sum of money into a restricted account to secure the fulfillment of contractual obligations. If the obligor fails to meet their commitments, the beneficiary can request the credit institution to release funds from the escrow account to compensate for the losses.
• L/C Escrow: A Letter of Credit (L/C) is an escrow mechanism in which a bank commits to making a payment to the seller once the buyer fulfills all agreed-upon contractual conditions. L/C escrow deposit safeguards both the buyer’s and seller’s interests, particularly in international transactions, ensuring timely and full payment execution.
Escrow deposit is an effective method to secure contract performance, protect the interests of all parties involved, and mitigate the risk of contractual breaches. However, its implementation must be handled with awareness to ensure transparency and compliance with applicable legal regulations, thereby preventing disputes. As commercial transactions continue to evolve, escrow deposit will remain a crucial tool in fostering trust and facilitating lawful and fair transactions.
This article by TNTP discusses “Escrow deposit and their role in contract performance” We hope it provides valuable insights for readers in their business activities.
Best regards,
