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mitchborkowsky

The Never-Ending Escrow


Reprinted with permission by the Nassau County Bar Association.


Whenever I speak at continuing legal education programs, particularly on the subjects of real estate or escrow, I am approached by attorneys seeking guidance on one of the more vexing nuisances afflicting the profession. What to do with funds sitting in an escrow account when the client or party entitled to the funds cannot be located or a dispute exists over the money and no resolution is in sight. Criminal defense practitioners deal with the same problem when restitution checks issued on behalf of their clients are not negotiated and the victims are nowhere to be found. Indeed, just about every practitioner with an escrow account can relate to this problem.


Although the amounts at issue are often de minimis and the attorneys are generally not civilly or professionally at risk (provided they’ve acted in good faith and the funds have been preserved), the obligation gnaws on their psyche like a distant siren. Their anxiety is reasonable, however, because while the funds may not be large in amount, the consequences if the funds are mishandled are enormous. And, let’s face it, nobody likes to be stuck in the middle with no upside or benefit to themselves.


The Lawyer’s Fund as Repository

Fortunately, the Rules of Professional Conduct (“RPC”)[1] provide a relatively simple solution for instances in which a client or other party entitled to funds cannot be located.

Pursuant to RPC, rule 1.15(f), if a lawyer cannot locate a client who is owed funds from a trust account, the lawyer is required to seek a judicial order fixing the lawyer's fees and disbursements, and to deposit the missing client's share with the Lawyers' Fund for Client Protection (“Lawyer’s Fund”). While rule 1.15(f) only refers to a missing “client,” when read together with rule 1.15(g), which provides a mechanism for depositing funds held in a deceased lawyer’s escrow account with the Lawyer’s Fund, it is not unreasonable to envision Rule 1.15(f) as being elastic enough to cover missing payees who are not clients.


The Lawyer’s Fund website[2] provides samples of pleadings under a variety circumstances, including where the party in interest is not a “client,” and affirmatively states that it will accept funds of less than $1,000 without a court order based on a 2004 Erie County Bar Association Ethics Opinion.[3]


Caught in the Middle

The more difficult situation arises where there is a dispute over entitlement to escrow funds and the escrow agent is caught in the middle. Acting as escrow agent is essentially a service provided by attorneys and others to help facilitate agreements between other parties. The permutations and scenarios under which attorneys obligate themselves to hold funds in escrow are endless. In all cases, however, the attorney is saddled with contractual and fiduciary duties to all parties to the escrow agreement and may dispose of the escrow funds only in strict accordance with the terms of the agreement.[4] Despite best intentions, escrow agents are frequently dragged into court as stakeholders or accused of bad faith and professional misconduct. This happens in the most routine and sophisticated circumstances.


Post-Closing Escrows

One of the most simplistic but frequent scenarios involves real estate practitioners who at the closing table agree to continue acting as escrow agent, “post-closing,” to ensure their client or the other party satisfy a condition. Many of us have been at closing tables where one attorney quickly drafts an agreement, stating, in form and substance, as follows:


“The undersigned shall hold $2,000 in escrow to ensure that a CO is issued for the deck within 60 days from the date hereof. In the event said certificate is not issued within said 60 days the escrow shall be released to the purchaser to cover the cost of obtaining the CO.”


The problem with such an agreement is that it’s often so hastily and inartfully drafted that no one could possibly know what his or her obligations are, least of all the attorney who obligated herself to hold the money.


If no CO is issued within the timeframe provided and the attorney remits a check to the purchaser’s attorney, it would seem as if the conditions of the agreement have been complied with and the attorney’s obligation satisfied. However, if the purchaser’s attorney returns the check because his client feels it’s insufficient and instructs the escrow agent to retain the funds until the dispute is resolved, the escrow agent has no choice but to preserve the funds indefinitely, pending his or her own commencement of an interpleader action or commencement of an action by one of the parties.[5]


Ironically, the attorney in our example strictly complied with the terms of the agreement but is still stuck because she cannot force the purchaser to negotiate the check. Moreover, no matter how much time passes or how little is done by either party to resolve the situation, the attorney cannot release the funds to her client, as Rule 1.15(c)(4) states that funds may only be released to a client or third party when “the client or third party is entitled to receive” them.


Potential Grievance Inquiry

Adding insult to injury, these cases frequently result in grievances being filed by one side or the other, usually the purchaser. In case you’re wondering how a legal dispute between clients could result in a grievance investigation against an attorney, well… it really shouldn’t. However, such complaints often include other assertions, such as that the escrow agent has failed to respond to repeated calls and letters from the purchaser’s attorney, or there’s a good faith belief that the escrow agent improperly released the funds. In those instances, the grievance committees are more likely to inquire and ask for records establishing that the funds have been preserved throughout the entire escrow period.


Fiduciary Duties and Contract Law

Sometimes, entitlement to the funds is not as clear as in the above example. Perhaps the purpose of the escrow is to ensure funds are available to satisfy an existing or anticipated tax lien or assessment against the property attributable to the seller. If funds are withheld from the seller at closing but the lien is not enforced or doesn’t materialize after a few years, it would seem reasonable that the seller should be entitled to receive the balance of the sales proceeds at some point. However, if the purchaser instructs the escrow agent to continue to hold the funds, then… well, again… what does the agreement say? Clearly, these are legal issues that require not just an examination of fiduciary duties but also contract law.


The case of Schoolman v. U.S. Bank Nat'l Ass'n[6] can be instructive. Schoolman involved an asset purchase agreement in which some of the assets sold by Schoolman were subject to a tax lien. The defendant bank, acting as escrow agent pursuant to a comprehensive escrow agreement, agreed to hold in escrow an amount significantly greater than the tax lien and to disburse the funds to Schoolman in two equal installments at delineated times, subject to the buyer’s right to make claims against the funds by submitting Claims Notices and “Disbursement Letters” to the bank.


The buyer in Schoolman did not timely submit such documents to the bank; instead, days after the second installment was due, the buyer unilaterally notified the bank there was a dispute over the escrow and directed the bank to continue to hold an amount equal to the tax lien. On that basis, the bank failed to release the entire balance of the escrow to Schoolman. Schoolman sued.


The Court found that because the escrow agreement clearly and unambiguously delineated the procedures, manner, and timing of the release of the escrow amount, and explicitly stated that the funds "shall . . .[be] released from escrow by the Escrow Agent only in accordance with the terms and conditions of this Agreement,” the bank had inappropriately withheld the funds from Schoolman.


Avoiding the Never-ending Escrow

Unlike the typical post-closing residential real estate escrow, the Schoolman case involved sophisticated clients, a non-attorney escrow agent, and significant amounts of money. Nevertheless, the lessons from that case are manifest.

To avoid the “never-ending escrow,” the most important step is to tighten up your escrow agreements. Among other things:


  • include specific dates, notice requirements, and triggering events establishing parameters for the release of the escrow;

  • clearly define yourself as a stakeholder and provide yourself with indemnification by the parties for actions taken in good faith and pursuant to the escrow agreement;

  • include conditions and mechanisms regarding dispute resolution tailored to the specific purpose of the escrow;

  • require an objecting party to commence an action within a specified and reasonable time-frame;

  • reserve to yourself the options of continuing to hold the funds, releasing the funds pursuant to the terms of the agreement, or seeking a court order directing their deposit with the court and the payment of reasonable attorney’s fees.

Always remember, however, that because you may be dealing with less sophisticated clients, you might still be better served by, and I would recommend, continuing to hold the funds in escrow. But, by having a solid agreement and strictly complying with its terms, you will at least force the other side's hand, spur some action, and have some legal basis if you do choose to release the funds pursuant to the terms of the agreement.


1. 22 NYCRR 1200

3. Erie County Ethics Opinion 04-01 (2004)

4. Farago v. Burke, 262 NY 229 (1933)

5. Brooklyn Bar Ethics Opinion No. 1993-1

6. 2012 NY Slip Op 32394(U) (N.Y. Sup. Ct., 2012)


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