What is an escrow agreement in an M&A transaction? Definition, mechanism, and advantages

In this article, we analyse the key aspects of escrow agreements. In any company acquisition process, one of the main concerns for both buyers and sellers is ensuring that the terms agreed in the sale and purchase agreement (SPA) are properly fulfilled. To this end, mechanisms that safeguard those obligations and minimise risk for both parties are essential.

A legal tool that has gained significant relevance in Spain in recent years—particularly in cross-border deals and family business sales—is the escrow agreement. Originating from Anglo-Saxon legal systems, this mechanism has proven to be a practical and effective way of protecting the interests of the parties involved in such transactions.

What is an escrow agreement?

An escrow agreement is a three-party contract involving the buyer, the seller, and an independent third party, known as the escrow agent. The buyer deposits a sum of money (normally deducted from the purchase price) or certain assets into an account managed by the escrow agent, who acts as a neutral guarantor.

This agent—typically a financial institution, law firm, notary public, or trust services provider—holds the funds until certain conditions in the SPA are met. These conditions might include:

• Regulatory approvals

• Discharge of specific debts or encumbrances

• Achievement of commercial or financial milestones

• Absence of third-party claims during a post-closing period (commonly known as a clean exit period)

  
  

Once the conditions are fulfilled, the agent releases the funds to the designated party—usually the seller. In this way, the escrow agreement acts as a secure guarantee to enforce contractual obligations and enables the resolution of disputes without resorting to litigation.

How is an escrow agreement structured under Spanish law?

Although escrow agreements are not specifically regulated under Spanish law, their validity is supported by the principle of freedom of contract (Article 1255 of the Spanish Civil Code). These contracts typically combine elements of deposit, mandate, and conditional obligations (suspensive or resolutory).

To ensure the effectiveness of an escrow agreement, it is essential to clearly define the following aspects:

• The amount held in escrow and its intended purpose
• The conditions that trigger the release of funds
• The escrow term or duration
• The treatment of any interest accrued on the funds
• Procedures to follow in case of dispute
• The duties and liabilities of the escrow agent

Advantages of escrow agreements in M&A transactions

Using an escrow agreement offers multiple benefits for both buyers and sellers:

For the buyer:

• Legal certainty: Ensures the seller complies with its obligations before receiving full payment, reducing the risk of post-closing breaches.
• Contingency protection: Allows the buyer to retain funds to cover potential claims or undisclosed liabilities identified during due diligence—providing a financial buffer.
• Efficient dispute resolution: Offers a quick, out-of-court mechanism to resolve disagreements, avoiding lengthy legal proceedings.

For the seller:

• Financial assurances: Confirms the buyer has the financial capacity to honour the payment obligations from the outset.
• Faster deal closing: Reduces the likelihood of last-minute renegotiations, allowing the transaction to progress smoothly while pending risks are managed.
• Post-closing risk mitigation: Minimises the chance of claims or disputes after closing, thanks to funds retained for contingencies.

The escrow agreement has become a valuable tool for both buyers and sellers in M&A transactions. It offers a mechanism that balances interests, mitigates risks, and facilitates smoother, more secure closings. However, to serve its purpose effectively, the agreement must be well-drafted, the escrow agent must be fully trustworthy, and the structure should be carefully planned, both from a legal and tax perspective. As with any complex transaction, it is crucial to have the support of professionals with proven experience in this area.