In The High-Stakes World of Mergers and Acquisitions, a Way of Trust and Risk Management: Escrow Agreements

One of the closing conditions that the buyer must fulfill in a merger and acquisition project is to prove to the satisfaction of the seller that the purchase price to be paid on the closing date is already in its accounts or that the said price will be ready on the closing date. In cases where the purchase price is not in the buyer’s accounts, this condition is satisfied with a letter from a bank stating that the buyer has sufficient credit line and that the purchase price will be covered upon the request of the buyer from that credit line.

In cases where the purchase price is already in the buyer’s accounts or an acquisition financing will not be obtained, the purchase price is deposited into an escrow account and transferred from that account to the seller’s account on the closing date as of a guarantee that the purchase price will be paid to the seller on the closing date.

What is an Escrow Account?

An escrow account is a segregated bank account opened by the escrow agent which is the bank where the account will be opened, in order to keep the amount determined on behalf of one or more persons, and to transfer the amount to the account of the designated person if the conditions are met¹.

In a merger and acquisition project, an escrow account is opened based on an escrow agreement to which the buyer, seller and the bank are parties.

What Issues are Regulated in an Escrow Agrreement?

In an escrow agreement; in general, issues such as the purpose for which an escrow account is opened, when and under what conditions the amount therein will be transferred to another account, and the deposit interest rate that will be applied until the account is closed are regulated.

Since a significant part of the issues in an escrow agreement are related to the issues regulated in the share transfer agreement, it is important that escrow agreement is drawn up after the share transfer agreement is agreed or at least the provisions regarding the escrow account in the share transfer agreement are agreed.

How is the Amount Transferred from the Escrow Account to the Seller’s and/or Buyer’s Account?

The issue of when the amount kept in the escrow account will be transferred to the seller’s account or under what conditions it will be returned to the buyer’s account should be regulated in both the share transfer agreement and the escrow agreement.

[1] https://uk.practicallaw.thomsonreuters.com/0-107-6230?transitionType=Default&contextData=(sc. Default)&firstPage=true#:~:text=A%20segregated%20account%20opened%20by,the%20account%20have%20been%20met (Access Date: April 29^th, 2025).

Since the payment of the purchase price to the seller in the share transfer agreement is subject to the satisfaction of the conditions precedent, the buyer must pay the amount in the escrow account to the seller upon the full satisfaction of these conditions. The escrow agreement stipulates when the bank will transfer the amount to the seller’s account, and this usually happens when both the buyer and the seller notify the bank separately or jointly. In the escrow agreement, it may also be regulated that the notification in question can only be made only by the seller or by the buyer, but in practice, this notification is made jointly in terms of transaction security. If the parties make the notification obligation before the conditions precedent are satisfied or do not do so on the closing date, it will constitute a breach of its obligation under the share transfer agreement.

Apart from the notification, in the escrow agreement, it may also be stipulated that the amount in question will be automatically transferred to the seller’s account by the bank on a specified date, but this is not a common practice.

In a merger and acquisition project where the locked box mechanism is determined; the amount in the escrow account will be transferred to the seller’s account upon the satisfaction of the conditions precedent since the agreed purchase price will not be affected by the target company’s accounts on the closing date.

In merger and acquisition projects where the closing account or closing adjustment mechanism is determined; in order to calculate the equity value, the calculation will be made on the target company’s accounts on the closing date over the enterprise value, so if the amount in the escrow account is below the equity value, the buyer must pay the difference to the seller on the closing date or within a period following the closing date. If the equity value is above the amount in the escrow account, the amount that equals to the equity value is transferred to the seller’s account and the excess amount will be transferred to the buyer’s account.

It is stipulated in the escrow agreement that which party will have the deposit interest that will accrue until the closing date. Since the most important function of the escrow account is to assure the seller that the purchase price is ready to be paid, in practice, the deposit interest that accrues until the closing date generally belongs to the buyer.

What are the Advantages and Disadvantages of an Escrow Account?

The biggest advantage of the escrow account for the seller is the assurance that the purchase price is in the account held by a third party. So, the concern that the buyer will not have sufficient financing on the closing date disappears.

The advantage for both parties is that, since the purchase price is ready in the escrow account before closing, the procedures to be carried out by the banks regarding the payment of the purchase price on the closing date are reduced and there is an easier closing process for the parties.

The biggest disadvantage of the escrow account on the buyer’s side is that the purchase price to be paid on the closing date is prepared before the closing date and kept in the escrow account, and the buyer cannot benefit from the amount until the closing date. If the deposit interest that will be accrued in the escrow account until the closing date belongs to the buyer, this disadvantage will be eliminated a little more.

Another disadvantage of the escrow account is the cost of opening the escrow account. The party to which the said cost will belong is regulated in the share transfer agreement and escrow agreement. Since the escrow account is usually opened at the request of the seller, the cost of opening an escrow account is also born by the seller in practice.

Summary

Although it is not a requirement to open an escrow account in a merger and acquisition project, we see that it is used in transactions where the seller has more bargaining power. Although there are advantages and disadvantages for both parties, the biggest advantage is that the seller’s concerns about the payment of the purchase price are eliminated as the purchase price is kept in the escrow account before closing. However, it should not be forgotten that the cost may be born by the seller for escrow accounts opened at the request of the seller.