Turkey: Escrow Agreement: Definition And Situation In Turkish Law

1. In General

Escrow is a legal concept describing a financial instrument whereby an asset or escrow money is held by a third party on behalf of two other parties that are in the process of completing a transaction¹. Escrow agreement is an agreement that provides opportunity to the parties of an initial agreement to make transactions in a more secure way by keeping the payment hold in a trusted third party (escrow agent) or a secure account (escrow account).

Escrow Agreement is a very useful security mechanism in asset deals or business transactions if and when a large amount of money is involved and a certain number of obligations need to be fulfilled simultaneously. Since a variety of agreements can be subject to an escrow agreement, securities, funds and other assets can all also be held in escrow agents or accounts as well as money.

2. Escrow Agreement in Comparative Law

Escrow structure has been used in United States of America ("USA") since 1850's, and it has become a critical practice since Great Depression of the 1930's, as a vehicle to protect the interest of homeowners. In 1934, escrow accounts regulated as mandatory for loans, and as a consequence, it become the standard procedure for real estate transactions. Ever since, most of the mortgage companies states requirement of an escrow account separate than mortgage account in mortgage agreements to secure property taxes and insurance payments to be made by mortgagor.

Also, becoming an escrow agent is regulated in certain USA states, i.e. anyone wishing to become an escrow agent in the state of California is required to have five years of escrow experience. In addition, they must undergo investigation, have assets that comply with state escrow laws and have insurance to fulfil the role of trusted third party and have a license to practice escrow or obtain an escrow agent certification.

In United Kingdom, solicitors act as escrow agent during private property transactions, and hold the deposit until the transaction is complete.

While traditional escrow services are mostly facilitated through lawyers and banks as third parties, as a consequence of the age of technology and tenancy to become more online every other day, a lot of websites provide online escrow services as well, especially since the beginning of internet auctions and e-commerce.

In USA, online escrow companies have been started to classified as licensed companies by government on July 1^st, 2001 while European Union has regulated licencing online escrow services with Payment Services Directive² on November 1^st 2009.

3. Escrow Agreement Structure

The purpose of the escrow agreement is to secure the performance of the obligations arising from an initial agreement, which forms a base for the escrow structure ("Initial Agreement").

Chronologically, following the execution of the Initial Agreement, if parties decide that there is a necessity to build a trust structure and perform the agreement with a security, they may include terms of an escrow agent in the Initial Agreement and then execute an escrow agreement with an agent or directly execute a agreement called escrow agreement following the Initial Agreement without any prior decision.

Parties of the Initial Agreement unites as one party of the escrow agreement, and the other party is a trusted third party(person, institution or and account called as escrow agent or escrow account.) Escrow agent/account would not be a party to the Initial Agreement. Depending on the nature of the escrow structure, a bank, a lawyer or an independent third party may be determined as the escrow agent.

Escrow agent is responsible for maintaining and safeguarding the securities put into its possession subject to the escrow agreement until fulfilment of the Initial Agreement's obligations and to release or return them in accordance with the structure to be defined in the escrow agreement.

It's not possible to categorize escrow agreement either a side agreement or an independent agreement, the categorization must be determined for every case separately evaluating the terms of both agreements, whether the escrow agreement includes attribution to the Initial Agreement or escrow agreement have terms related for termination independent from the Initial Agreement.

4. Turkish Contract Law

Escrow agreement is an agreement which originally has its source in Common Law system (Anglo Saxon Law). Moreover, it has not been regulated under the Turkish Code of Obligations³ ("TCO") or any other Turkish laws. As a consequence, escrow agreement is qualified as an atypical or sui generis agreement and escrow agreement creates only a contractual liability under the TCO.

Although lack of legislation, as per freedom of contract principle TCO adopts as a core principle in Article 26; Freedom of Contract entitles; (i) a party to decide to execute an agreement with their own free will (also, any party may not be forced to sign an agreement); (ii) a party to determine the other party of an agreement and, (iii) parties to decide content, type and form of an agreement to be executed. These provisions may be determined in the contract as a consequence of the parties' consensus.

The only restriction of the freedom of contract is regulated under Article 27 of TCO. If an agreement is against a person's rights, obligatory provisions of Turkish law, moral values or if the subject of the contract is impossible/unachievable; such contract is considered definitely null and void.

5. Terms of an Escrow Agreement

A solid and well-prepared escrow agreement should include terms and conditions considered as crucial to have, such as;

1. Information on the Initial Agreement,
2. Detailed information on the asset assigned to the escrow agent,
3. Relevant obligations of the escrow agent, detailed information under which conditions the assigned asset shall be returned to the parties of the Initial Agreement,
4. The procedure to be followed in case of fulfilment of the terms and conditions of the Initial Agreement by parties,
5. Consequences of the rights and obligations related to the assigned money or asset during the escrow agreement's period,
6. Terms and conditions of returning the assigned asset in case of any failure of the parties to fulfil the conditions of the Initial Agreement,
7. Parties of the Initial Agreement may determine a fee to pay to the escrow agent,
8. Information on the applicable law and jurisdiction to be applied to the escrow agreement, if any conflicts arises (especially recommended for escrow agreements which have an international character.)

6. Conclusion

Escrow agreement is a sui generis agreement which is not regulated under TCO or any other Turkish law. Nevertheless, it's being preferred by parties who makes transactions in large amounts and became an irreplaceable structure for various types of agreements regarding business and financial transactions.

As a result of relevant clauses of TCO, parties may draft an escrow agreement as they may see fit, within the scope of freedom of contract. Parties should carefully draft and negotiate the escrow agreement, particularly the release mechanics, to avoid causing any unwanted delays or disputes among the parties at the end of the transaction. The liabilities of the escrow agent towards the parties and vice versa should also be determined in the escrow agreement precisely.

Footnotes