120 Week 3 A /For WIZARD KIM

Chapter 30: Escrow, the way to perform 211

After reading this chapter, you will be able to:

• understand the steps escrow takes to facilitate the closing of a real estate sale;

• distinguish the various services rendered by escrow and the duties of an escrow officer;

• appreciate how the purchase agreement and the escrow instructions work in tandem to create and close a transaction;

• recognize how agents ensure the escrow instructions conform to the purchase agreement and the intent of the buyer and seller;

• calculate prorations and adjustments for the buyer and the seller in a transaction; and

• advise on who has the right to receive the buyer’s funds held in escrow when escrow fails to close.

Learning Objectives

Escrow, the way to perform

Chapter

30

Escrow is a process employing an independent agent to manage and coordinate the closing of a real estate transaction through the exchange of documents and money between two parties such as a buyer and seller. Escrow activities are typically based on a primary agreement, such as a purchase agreement.1

In mortgage situations, escrow references the accounting by the lender for its management of the receipt and disbursement of funds received from the property owner for the annual payment of property taxes and insurance

1 Calif. Financial Code §17003(a)

The execution of a purchase agreement

escrow

escrow instructions

escrow officer

good faith deposit

proration

Statute of Frauds

Key Terms

212 Real Estate Principles, Second Edition

premiums (TI) owed by the owner of the secured property. Typically, these funds are collected monthly with the regular principal and interest (PI) payment. Collectively, the mortgage principal, interest, property taxes and insurance premiums are referred to as PITI.

Escrow activity employed to close a real estate transaction consists of:

• one person, such as a seller or buyer of real estate, who delivers written documents or money, called instruments, to an escrow company for the purpose of fully performing their obligations owed another person under an agreement entered into before the escrow is opened for a sale, a mortgage origination or leasing of real estate; and

• the escrow company, who receives and delivers the documents and money to another person, such as the buyer, seller or third parties, on the occurrence of an specified event or the performance of prescribed conditions, such as the receipt of reports or the issuance of a title insurance policy.2

An individual engaged in the business of acting as an escrow agent is called an escrow officer. The officer is employed by an escrow company and needs to be licensed. Likewise, the escrow company is licensed by the California Department of Corporations (DOC), unless exempt.3

Individuals exempt from the escrow licensing requirements include:

• a licensed real estate broker, either individual or corporate, who represents a person in the real estate transaction in which the broker will be performing escrow services;

• a licensed attorney who does not hold themselves out as an escrow agent;

• a bank, trust company, or insurance company; and

• a title insurance company whose principal business is preparing abstracts or making searches of title used for issuing title insurance policies.4

The services rendered by escrow officer typically include:

• receiving funds and collecting necessary documents, such as property reports, disclosure statements and title reports called for in the escrow instructions [See RPI Form 401];

• preparing documents necessary for conveyancing and mortgaging a property required for escrow to close;

• calculating prorations and adjustments; and

• disbursing funds and transferring documents when all conditions for their release have been met.5

2 Fin C §17003(a)

3 Fin C §17200

4 Fin C §17006

5 Fin C §17003(a)

escrow The depository process employed to facilitate the gathering of instruments and funds for use to transfer real estate interests between two persons.

Escrow companies and escrow

officers

escrow officer An individual licensed and employed as an agent of an escrow company or other escrow service provider to perform escrow services.

escrow instructions Directives an escrow officer undertakes, as given by buyer and seller, or lender and borrower to coordinate the closing on a purchase agreement or mortgage origination. [See RPI Form 401]

Chapter 30: Escrow, the way to perform 213

The specific duties of the escrow officer, outlined in the escrow instructions, vary according to local real estate custom. [See RPI Form 401]

Consider a buyer and seller who enter into a purchase agreement for the sale of the seller’s one-to-four unit residence. As provided in the purchase agreement, escrow is opened to handle the closing of the transaction.

In modern real estate practice, opening escrow simply means establishing a depository for the instruments (deeds, money and other items) with accompanying instructions for their use. Escrow instructions are signed by all necessary persons (the buyer and seller in the case of a sale), each authorizing escrow to transfer or hand their instruments to the other person or third parties on closing.6

Before accepting any instruments as an escrow holder for a transaction, an agent of the buyer or seller dictates instructions to the escrow officer. The purpose for this communication is to establish precisely when and under what circumstances the documents and monies deposited with escrow are to change hands.

When receiving instructions from an agent, the escrow officer prepares a “take sheet” noting all the tasks they are to undertake to handle and close escrow. When drafting escrow instructions, the officer relies on the take sheet as a checklist to determine the contents of the instructions.

Increasingly, agents simply email a copy of the purchase agreement to the named escrow company. The escrow officer then drafts escrow instructions as needed for the buyer and seller to comply with their obligations under the purchase agreement. When prepared, the officer sends the written instructions to the agent to verify they conform to the intent of the persons in the transaction.

As a checklist for “going to escrow,” a worksheet helps the seller’s and buyer’s agents to organize the collection of facts and supporting papers the escrow officer needs to draw instructions, clear title conditions and close escrow. [See RPI Form 403]

An escrow officer will perform only as instructed. Escrow instructions are prepared by the escrow officer based on the information received from the seller’s agent about the transaction.7 [See RPI Form 401]

In practice, the escrow officer prepares the instructions on forms adopted for this use. Once completed, the instructions are forwarded to the agents of the persons in the transaction for their signatures and return to escrow. When returned, escrow is then open for the person who signed and returned the instructions.

6 Montgomery v. Bank of America National Trust & Savings Association (1948) 85 CA2d 550

7 Moss v. Minor Properties, Inc. (1968) 262 CA2d 847

Escrow basics

Escrow instructions

214 Real Estate Principles, Second Edition

Two types of escrow instructions are used in California:

• bilateral; and

• unilateral instructions.

Throughout most of California, escrow instructions used in real estate sales transactions are bilateral in nature. As bilateral escrow instructions, they are entered into by both the buyer and seller. Each signs a copy of the same instructions and hands them to escrow. [See RPI Form 401]

In some areas of Northern California, separate sets of unilateral escrow instructions are prepared, usually waiting until the transaction is ready to close. Each set of instructions contain only the activities to be performed by or on behalf of one person; one set being the buyer’s instructions, the other set the seller’s instructions. When escrow determines it has all documents necessary to call for funding and closing the transaction, the officer prepares the separate instructions for signatures of the respective buyers and sellers.

Most modern real estate sales transactions depend on both the purchase agreement and the escrow instructions working in tandem to close a transaction.

Both the purchase agreement and the escrow instructions are contracts regarding interests in real estate. Both documents are required to be in writing to be enforceable under the Statute of Frauds.8

A purchase agreement sets forth the:

• sales price;

• terms of payment; and

• conditions to be met before closing. [See RPI Form 150]

Escrow instructions constitute an additional agreement entered into by the buyer and seller with an escrow company. Under the instructions, escrow facilitates the completion of the performance required of the buyer and seller in the underlying purchase agreement.

Escrow instructions do not replace the purchase agreement. Instead, the instructions function as directives an escrow officer undertakes to coordinate a closing intended by the terms of the purchase agreement.9

Escrow instructions occasionally add exactness and completeness, providing the enforceability sometimes lacking in purchase agreements prepared by brokers or their agents.

A written and signed purchase agreement typically is the primary underlying document in a real estate sales transaction. All further agreements, including the escrow instructions, need to comply with the primary document, unless the parties intend to modify the terms of that original agreement.

8 Calif. Civil Code §1624

9 Claussen v. First American Title Guaranty Co. (1986) 186 CA3d 429

The documents

work together

Statute of Frauds California state law requiring specific types of contracts to be in writing and signed by the person to be charged with performance before they will be enforceable by a court, e.g., purchase agreements and lease agreements for a term of more than one year.

Chapter 30: Escrow, the way to perform 215

The agents negotiating a transaction are responsible for ensuring the escrow instructions conform to the purchase agreement. This is done by reviewing the instructions prepared by the escrow officer to ensure the intentions of the buyer and seller are clear. Thus, the escrow instructions are reviewed by the both agents prior to submitting them to their clients for their review and signatures.

In some instances, the buyer and seller orally negotiate the sale and go directly to escrow, without first memorializing their understandings in a written purchase agreement. In this instance, there is no underlying written purchase agreement generated prior to opening escrow.

Here, the buyer and seller intend the escrow instructions to function as the binding contract documenting the sale. In this situation, in addition to providing closing instructions, the escrow instructions constitute a binding contract between the buyer and seller, satisfying the Statute of Frauds.10

To provide for a timely closing, the agent dictating instructions collects and hands to the escrow officer all of the information necessary to prepare the instructions and documents.

If a dispute between the buyer and seller arises over a point not addressed in the underlying purchase agreement or escrow instructions, the agents need to mediate an agreeable solution.

The negotiated resolution then needs to be added to the escrow instructions by amendment and signed by the buyer and the seller. Signed amended instructions bind the buyer and seller to the terms agreed to in the amended instructions as part of their contractual obligations in the transaction.11

Escrow instructions which modify the intentions stated or implied in the purchase agreement need to be written, signed and returned to escrow by both the buyer and seller. Proposed modifications signed by some but not all parties are not binding on a party who has not agreed to the modifications.12

All written escrow instructions signed by a buyer or seller are to include:

• the escrow agent’s name; and

• the name of the California state agency issuing the license or granting the authority under which the escrow agent is operating.13 [See RPI Form 401]

In addition, all escrow transactions for the purchase of real estate where a policy of title insurance will not be issued are to include an advisory notice prepared in a separate document and signed by the buyer.

10 Amen v. Merced County Title Co. (1962) 58 C2d 528

11 U.S. Hertz, Inc. v. Niobrara Farms (1974) 41 CA3d 68

12 Louisan v. Vohanan (1981) 117 CA3d 258

13 CC §1057.7

Modifying escrow instructions

Required escrow disclosures

216 Real Estate Principles, Second Edition

Finally, escrow has a duty to advise the buyer in writing of the Franchise Tax Board (FTB) requirements for withholding 3 1/3% of the price paid the seller, unless the seller certifies they are exempt from state income tax withholding.14

On the close of escrow, buyers and sellers receive a credit or a charge for their proportionate share of income or expenses involved in the ownership or operations of the property being conveyed, called prorations.

Prorations are usually calculated based on the date escrow closes. However, they may be set based on any date agreed to by the buyer and seller. For calculating prorations based on the date of closing, the entire day of closing is the first day of the buyer’s ownership, unless the escrow instructions specify otherwise.

Items which the buyer takes over and are prorated include:

• property taxes;

• interest on mortgages/bonds assumed;

• rent; and

• service contracts assumed by the buyer.

Prorations are initially agreed to in the purchase agreement. Proration provisions entitle the seller to a credit for the portion of prepaid sums which have not fully accrued by the day of closing on items the buyer takes over or receives on the sale. Prorations are based on a 30-day month or a 360-day year.

Conversely, the buyer receives a credit for unpaid amounts assumed by the buyer which accrued through the day prior to the close of escrow. [See RPI Form 150 §12.6]

Property taxes are levied for the fiscal year which begins July 1st and ends June 30th of the following calendar year. To prorate property taxes, the beginning of the fiscal year – July 1st – is the starting point for accrual.

Property taxes are paid in one or two installments. The first installment is payable no later than December 10th for the first half of the fiscal year. The second payment is due no later than April 10th for the second half of the fiscal year.

For interest on mortgages, improvement bonds or other debts assumed by the buyer, the seller is charged and the buyer receives a credit for the interest accrued and unpaid during the seller’s ownership of the property through the day before the close of escrow.

14 Calif. Revenue and Taxation Code §18662(e)(3)(B)

Prorations

proration Provisions entitling the seller to a credit for the portion of prepaid sums which have not accrued on obligations a buyer assumes on the day escrow closes, or entitling the buyer to a credit for amounts assumed which accrued unpaid through the day prior to the close of escrow. [See RPI Form 401 §10]

Chapter 30: Escrow, the way to perform 217

On the purchase of income property, the buyer is entitled to a credit for the prepaid rents collected by the seller which have not accrued for the remaining days of the month beginning with the day of the close of escrow.

All security deposits held by the seller are credited to the buyer as a lump sum adjustment, not a proration. After closing, the buyer is responsible to account to the tenants for the deposits on termination of their tenancies. [See RPI Form 585]

The seller is credited for any delinquent unpaid rents which have accrued prior to closing and are to be collected by the buyer, unless otherwise agreed in the purchase agreement and escrow is so instructed.

When escrow fails to close, a buyer’s good faith deposit toward the payment of the purchase price of a one-to-four unit residential property is returned within 30 days after the person entitled to the funds demands them. If disputed by the other party, the issue becomes who has the right to receive the funds deposited in escrow.15

A seller or buyer who wrongfully refuses to release the buyer’s good faith escrow deposit is liable for a money penalty of three times the amount wrongfully withheld, called treble damages. Treble damages need to be greater than $100 but less than $1,000, plus attorney’s fees.16

Usually the dispute arises on the seller’s claim they are entitled to the deposit under a forfeiture-of-deposit provision in the purchase agreement. However, the seller is not entitled to any of the buyer’s funds unless the seller has suffered out-of-pocket money losses due to a breach by the buyer.

Unless escrow receives mutual instructions to disburse the funds held in escrow when escrow fails to close, the escrow company deposits the funds with the court. This relieves escrow of any further responsibility to account for the funds, called an interpleader. Thus, escrow can close out its trust account on this escrow file.17

Release of deposited funds is not required if a legitimate good faith dispute exists between the buyer and the seller over entitlement to the funds.18

Neither the buyer nor seller will be entitled to any penalty or statutory attorney’s fees on resolution of a good faith dispute.

The good faith standard for an individual’s refusal to release escrowed funds requires a reasonable belief by the individual of their right to the funds.19

15 CC §1057.3

16 CC §1057.3

17 Calif. Code of Civil Procedure §386; Security Trust & Savings Bank v. Carlsen (1928) 205 C 309

18 CC §1057.3(f)(2)

19 CC §1057.3(c)

Prorations on the purchase of income property

Funds held in escrow on cancellation

good faith deposit A money deposit made by a buyer to evidence their good faith intent to buy when making an offer to acquire property. Also known as earnest money. [See RPI Form 401 §1.1]

Good faith dispute over deposits

218 Real Estate Principles, Second Edition

Escrow is a process employed to facilitate the closing of a transfer of real estate interests by two parties. Escrow activity consists of:

• one person, such as a seller or buyer of real estate, who delivers written documents or money to an escrow company for the purpose of fully performing their obligations owed another person under an agreement; and

• the escrow company, who delivers the documents and money to the other person, such as the buyer or seller, on the occurrence of an specified event or the performance of prescribed conditions.

The services rendered by escrow agents typically include:

• receiving funds and gathering necessary documents, called instruments;

• preparing documents necessary for conveyancing and mortgaging a property required for escrow to close;

• calculating prorations and adjustments; and

• disbursing funds and transferring documents when all conditions for their release have been met.

Most modern real estate sales transactions depend on both the purchase agreement and the escrow instructions working in tandem to close a transaction. Both the purchase agreement and the escrow instructions must be in writing to be enforceable under the Statute of Frauds.

Agents negotiating a transaction are responsible for ensuring the escrow instructions conform to the purchase agreement and the intent of the parties.

On the close of escrow, buyers and sellers receive a credit or a charge for their proportionate share of income or expenses, called prorations.

When escrow fails to close, a seller or buyer who wrongfully refuses to release the buyer’s good faith escrow deposit is liable for a money penalty of three times the amount wrongfully withheld. Release of deposited funds is not required if a legitimate good faith dispute exists between the buyer and the seller over entitlement to the funds.

escrow ............................................................................................ pg. 212 escrow instructions .................................................................... pg. 212 escrow officer ............................................................................... pg. 212 good faith deposit ....................................................................... pg. 217 proration ....................................................................................... pg. 216 Statute of Frauds ......................................................................... pg. 214

Chapter 30 Summary

Chapter 30 Key Terms

Quiz 6 Covering Chapters 24-30 is located on page 611.