The California Financial Code, Section 17003, defines escrow as follows:
Escrow means any transaction wherein one person for the purpose of affecting 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 any 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, promissor, obligee, obligor, bailee, bailor, or any agent or employee of any of the latter.
ESSENTIALS OF A VALID ESCROW
To have a valid escrow, there must be a binding contract between buyer and seller, and the conditional delivery of transfer instruments to a third party. The binding contract may appear in any legal form; the most common are a deposit receipt, agreement of sale, exchange agreement, option, or mutual instructions of buyer and seller.
Escrow instructions supplement the original binding contract, above, and both the escrow instructions and the contract are interpreted together, if possible. If the supplemental escrow instructions should contain any terms in conflict with the original contract, the instructions constituting the later contract usually control. It is thus important that all conditions, whether in the original contract or in subsequent instructions, be clear and concise and that they be fully understood by all parties to the agreement.
In addition to a binding contract, there must be a conditional delivery of transfer instruments to a third party (usually called the escrow agent or escrow officer), together with instructions to deliver the instruments on fulfillment or performance of certain conditions.
The actual procedures followed by an escrow officer may vary, depending on the particular locale within the state. The licensee should understand that the procedures we shall discuss are general in nature, and he should, in addition, familiarize himself with certain special practices that may exist in his particular area.
A complete escrow contains all the necessary instructions that reflect an understanding by the parties in all the essential requirements of the transaction. If properly drawn and executed, it becomes an enforceable contract binding on all the parties. An escrow is termed a complete escrow when all the terms of the instructions have been met. Generally, to have a correct escrow, a valid and binding contract must be entered into between the grantor and the grantee, and an irrevocable deposit must be made with the escrow holder. If a contract did not exist, the grantor could recover his deed from the escrow holder at any time before the conditions were performed. Where the contract does exist, the escrow officer exceeds his authority if he attempts to deliver any instruments to the grantee before the performance of any conditions specified, and in actual practice, the escrow officer will refuse such delivery prior to satisfactory performance of conditions.
THE ESCROW AGENT
All escrow agencies must be licensed by the California Corporation Commissioner. The regulations under which these escrow agents must operate will be found in Sections 17000 to 17614 of the California Financial Code.
Section 17004 of the Financial Code defines an escrow agent as “Any person engaged in the business of receiving escrows for deposit or delivery, for a compensation.” Any corporation, partnership, firm, or individual who wants to engage in business as an escrow agent in California must be licensed.
Certain exceptions are made with regard to banks, savings and loan companies, insurance companies, title insurance companies, real estate brokers, and attorneys. An attorney may escrow a transaction only if it is incidental to the duty he is performing for his client or a client’s estate as an attorney at law. A real estate broker may escrow only a transaction in which he acts as the broker.
Duties and responsibilities of the escrow holder:
For a detailed description of the duties and responsibilities of the escrow holder, the licensee is referred to the sections mentioned above in the Financial Code. A few of the more important are as follows:
- An escrow is confidential, and no information concerning the escrow may be given to any persons not a party to the escrow.
- If disputes arise between the parties in an escrow, it is not the duty of the escrow agent to act as mediator. The escrow agent accepts and follows instructions from the parties and must be very careful not to give either party any advice that is not within the generally accepted scope of his duties as the escrow holder. For instance, one of the parties to the escrow may ask the escrow agent for some legal advice about alternative methods of taking title to real property. The escrow officer must give the party the same answer the real estate broker is so often cautioned to give; he must suggest that the party consult with his attorney.
- An escrow holder may not deliver documents or funds unless there has been a strict compliance with the conditions of the escrow. If an instrument is delivered by the escrow holder before all the conditions of the escrow have been met, the delivery is not valid and title does not pass.
- An escrow agent is prohibited by law from paying referral fees to anyone except a regular employee of the escrow company. Usually, this also prohibits payment of commissions to real estate licensees and to outsiders for sending business to a particular escrow company. Such fees include gifts of merchandise or other items of value.
- An escrow agent may not permit any person to make an addition to, deletion from, or alteration of an escrow instruction or amended or supplemental escrow instruction unless it is signed or initialed by all persons who had signed or initialed the instructions or amendments thereto. An escrow holder must at the time of execution deliver any escrow instruction or amended or supplemental instruction to all persons executing it.
Termite reports:The question of ordering a termite report should never be raised by the escrow holder. This is strictly a matter for the parties to the escrow to decide on, and unless the subject of a termite report is made a condition to the escrow by one of the parties involved, the escrow holder should refrain from making any statement regarding the subject. Actually, the practice in California is for the parties to the contract to reach some agreement about a termite report before going into escrow. The agreement is usually stated on the deposit receipt.
TERMINATION OF ESCROW
An escrow is usually terminated when any one of the following occurs:
- Full performance of the conditions of the escrow by the parties involved is the most common method by which an escrow is completed.
- Cancellation by mutual consent of the parties involved usually occurs when the buyer and seller mutually agree to end negotiations and so instruct the escrow holder.
- Revocation by one of the parties to the escrow occurs when one of the parties to the escrow decides not to meet conditions previously agreed on. The result may be the termination of the escrow; however, such action by some of the parties will usually result in litigation, and the escrow holder will do nothing pending a decision by the court.
- An intervening condition or event may make it impossible for one of the parties to perform, a result if one of the escrow parties expires or becomes incapacitated prior to close of escrow.
DIFFERING ESCROW PRACTICES
Every real estate transaction involving the transfer of an equitable or legal title will involve a final closing statement or settlement sheet. Both the buyer and seller must be shown, in writing, the cash requirement, the proceeds, the expense or charge allotments, and the prorations in the transaction.
Customs in closing vary in different parts of California, particularly between the northern and southern parts of the state. In southern California, most transactions are closed in escrows performed by the escrow departments of banks, specialized escrow companies, or title insurance companies. The escrow function is an independent transaction, as is the issuance of a policy of title insurance. A separate fee is charged for each separate function. Although the title insurance company always issues the policy of title insurance, it may or may not perform the escrow function. Escrow instructions are generally more formalized, especially when a bank or specialized escrow company performs the escrow function.
In northern California, the prevailing practice is for the title insurance company to issue the policy of title insurance and also perform the escrow function. The title company charges one fee for the policy of title insurance, and this takes care of the escrow function also; one fee covers both.
Practices also vary among firms. Many large real estate firms throughout the state perform the escrow function within their own offices and use the title company only to obtain the title insurance policy and see that the necessary instruments are publicly recorded.
In northern California, the form showing the financial aspects of the transaction is called the Buyer’s Statement and the Seller’s Statement. In southern California, this same type of form is referred to as the Settlement Sheet.
DIVISION OF ESCROW CHARGES
Division of the various charges in escrow also differs, depending on the particular locale involved. The customary divisions of charges is shown below, but the licensee should remember that this is customary and not mandatory. Occasionally, the parties to the escrow may decide to divide certain charges in other than the customary way, and there is nothing to prevent them from doing so.
The seller is generally responsible for:
- Drawing instruments in favor of the purchaser.
- Real estate transfer tax.
- Any notaries fee on instruments in favor of purchaser.
- Broker’s commission.
The purchaser is generally responsible for:
- Drawing instruments in favor of the seller or lender.
- Recording fee for deed.
- Recording fee for trust deed in favor of the lender.
- Notaries fee on instruments in favor of seller or lender.
The title insurance policy fee is an important part of the closing costs. In the majority of counties, the buyer pays for the title insurance policy, while in some, the seller pays; in still others, the cost is divided equally between the buyer and the seller.
Such items as taxes, insurance, and rents are prorated between the buyer and seller as of the date of close of escrow. In southern California where the escrow fee may be separate from the title insurance fee, the escrow fee is generally split 50-50 between the buyer and seller, or two thirds to the seller and one third to the buyer.
Any variation from what is customary in the division of fees should be agreed on by the parties in advance of close of escrow. Often, through sheer bargaining power, one party can be relieved of all or some of the customary charges that might otherwise be assigned against him.
CHECKLIST FOR REAL ESTATE TRANSACTIONS
The Reference Book, published by the California Division of Real Estate, contains an extensive checklist of items that may be part of a real estate transaction. Often, only certain of these items will apply in any one particular transaction. After looking over the list, the reader will appreciate the reason most brokers prefer to let an expert handle the escrow function in a transaction. For instance, when a title company performs the escrow function in connection with the issuance of a title insurance policy, many of the items shown on the checklist below become the responsibility of the title company rather than of the broker. An example is the preparation and examination of most of the documents and forms necessary to the transaction.
Factors to be considered and preparations to be made prior to and during the preparation of the purchase contract are:
- The date of the contract.
- The name and address of the seller.
- Is the seller a citizen of full age and competence?
- The legal status of the seller.
- The full name of the seller’s spouse.
- The name and legal status of the purchaser.
- The full name of the purchaser’s spouse.
- The address and telephone number of the purchasers.
- The purchase price and the terms of the contract.
- The kind of deed to be delivered.
- What special agreement will have to be made regarding any personal property?
- Is the mortgage to be assumed, or is the buyer purchasing subject to the mortgage?
- What type of note will be involved?
- Will a deed of trust be involved, and will there be any special conditions or provisions?
- Do mortgages or trust deeds contain acceleration or restrictive conditions?
- Are there to be any special reservations or exceptions in the deed?
- Special conditions or provisions to be inserted into the contract.
- Rights of tenants or lessees.
- Items to be adjusted at close of escrow.
- Division of charges in escrow.
- Any special arrangements concerning liens, easements, assessments, taxes, covenants, or restrictions?
- Place and date on which escrow is to be closed.
- How will the buyer take title to the property?
- Name and address of escrow holder and of broker making the sale.
- How will the problems of termite inspection and possession be taken care of?
After acceptance of an offer and during escrow, the seller may need to furnish the following:
- Copy of contract.
- Latest tax, water, and receipted assessment bills.
- Latest water meter readings.
- Latest gas meter readings.
- Information regarding last payment of interest on mortgages or trust deeds.
- Insurance policies on the property.
- Certificate or offset statement from any holder of a mortgage or deed of trust.
- Any subordination agreements that may be called for in the contract.
- Certificate showing satisfaction of mechanic’s liens, chattel mortgages, judgments, or mortgages to be paid at or prior to close of escrow.
- Rental statement listing tenants, amount of rents paid or due, and moneys being held as advance rents or deposits.
- Assignment of leases affecting the property.
- Notification to tenants regarding subsequent rent payments.
- Bill of sale for any personal property involved in the sale.
- Seller’s last deed and deed he is to prepare for buyer.
- Any instruments the seller is to prepare or deliver at close of escrow.
- Any unrecorded instruments that may affect the title.
The purchaser should have and/or check on the following:
- Purchaser’s copy of the contract and certificate of title or policy of insurance showing title vested in the grantor.
- Examination of the deed to see that it conforms to the contract.
- Examination of property description on deed to see that it is correct.
- Examination of the deed to see that it is properly executed.
- Disposition of all liens that must be removed.
- Sufficient cash to make necessary payment required at close of escrow.
- Names and information concerning tenants, leases, and rent (estoppels).
- Bill of sale of any personal property involved.
- Examination of preliminary title search or survey.
- Any matters that may affect title or use of the property.
- Bills for any unpaid taxes, water, or assessments.
- Any unrecorded instruments that may affect title.
- Copies of any loan papers signed in connection with the sale.
- Examination of purchase money mortgages.
- Examination of note and deed of trust.
- Adjustments completed if called for in the contract.
CHRONOLOGICAL STEPS IN THE ESCROW
Although the sequence of steps in any type of escrow may vary slightly, there is a general order in which they occur. The basic escrow procedures in a southern California differ from northern California. In southern California the escrow function and issuance of a title insurance policy are performed separately. In northern California escrow where the title insurance company performs the escrow function and issues the policy of title insurance.
Northern California escrow steps
In many respects, the outline of steps below resembles the one for southern California. The main difference here is that the title company does both jobs; that is, it issues the policy of title insurance and takes care of recordation, and also performs the escrow function. The general sequence of steps is as follows:
- After obtaining a completed deposit receipt signed by all parties to the transaction, the broker will open an escrow at the title company. If the broker does not maintain a trust account at a bank, he will at this point deposit with the title officer (who is also the escrow officer) any money received from the purchaser as deposit.
- A preliminary title search is prepared, and sufficient copies are sent to the broker so that he may give one to the purchaser and one to the seller.
- Matters disclosed by the preliminary title search are considered and are taken care of with the approval, if necessary, of buyer and/or seller. The title officer will receive any instructions that may be necessary in addition to those agreed on in the deposit receipt.
- The title officer requests, from any beneficiary under an existing deed of trust, a statement of the condition of indebtedness and balance of the loan.
- When the title officer receives all the documents necessary in order to close the escrow, he will make the necessary prorations in financial adjustments and prepare a seller’s statement and a buyer’s statement. These forms are also called buyer’s and seller’s instructions.
- The instructions are presented to the respective parties to the transaction, and the parties sign their respective instructions and any other documents, such as a grant deed, note, and deed of trust, that may be necessary.
- The title officer requests and obtains all funds necessary to close. The title search is run to date as of the close of business on the date set for close of escrow; and if no change of title is found, the deed and other pertinent instruments are recorded on the following morning at 8 A.M.
- Following recordation, the title policy is issued and funds are disbursed to the parties entitled to them. Necessary insurance endorsements are obtained or may have been obtained just before recordation, and the policy and copies are sent to those entitled to them. When the title officer receives the recorded documents from the recorder’s office,. he will forward them to the necessary parties.
- Certain information is reported to the IRS by the title company.
Southern California escrow steps:
1. After obtaining a completed deposit receipt signed by all parties to the transaction, the broker will open an escrow and prepare escrow instructions. He will generally use a standard printed form prepared by the escrow holder for drafting instructions.
- The escrow instructions are signed by all parties to the contract, and the escrow holder orders a title search from a title company. A report is subsequently made to the escrow officer by the title company.
- The escrow officer requests a Beneficiary’s Statement from the beneficiary shown on the recorded deed of trust. The statement will show the condition of the indebtedness and the unpaid balance of the loan.
- Matters disclosed by the preliminary title report that are not approved by the escrow instructions are reported to the seller for clearance or to the buyer for approval.
- When the escrow officer receives all the documents and funds necessary to close the escrow, he makes the necessary adjustments and prorations between the parties on what is called a settlement sheet.
- The necessary instruments are then forwarded to the title insurance company with instructions to record them.
- The title search is run to date as of the close of business on the date set for close of escrow, and if no change of title is found, the deed and other instruments are recorded on the following morning at 8 A.M. By filing the moment the recorder’s office opens at 8 A.M., the title company can issue a title policy with the assurance that there are no intervening matters of record against the property.
- On the day that recordation has taken place, the escrow officer will disburse funds to the parties entitled to them, cause any fire insurance policies to be transferred or amended, and present closing statements to the parties entitled to them. The title insurance company generally tries to issue the policy of title insurance to the purchaser on the same day or as soon after recordation as possible. Within a few weeks, the recorder’s office will return the recorded deed to the escrow officer, who will forward it to the purchaser.
- Certain information is reported to the IRS by the title company.
Change of ownership report:
State law requires certain information to be given the county assessor regarding transfers of real property. The law requires the county recorder to make available a preliminary change-of-ownership form to be completed and which may be filed concurrently with the recordation of documents evidencing a change of ownership.