Escrow accounts

23 December, 2014
by: Cripps Pemberton Greenish

Contractors and employers are equally nervous souls. Employers at the outset of a project are terrified that their chosen contractor goes bust half way through. In turn, the contractor frets about whether it will get paid, particularly if the employer is a special purpose vehicle or dependent on a lender for finance.

Various options are available. To protect the employer, a parent company guarantee may be on offer, if the contractor has a parent with a strong balance sheet. A performance bond may be required. Routinely, retentions will be held to provide some security against defective work.

To protect the contractor, a parent company guarantee may again be appropriate. Security over an asset, such as the site of the works, may be possible. The cash flow may be adjusted to provide what are effectively advance payments; or an escrow account may be set up so that there access to real cash in the event of a payment default.

These escrow arrangements have a negative impact on the employer’s cash flow in that the employer has to put aside some cash, typically equivalent to an average month’s valuation, in a designated bank account. However, the security that it affords the contractor may mean that the contractor is prepared to do a better overall deal. The cash will sit there through the project. It will earn interest for the employer and be paid out at a pre-agreed point, possibly on practical completion, more likely on settlement of the final account. The contractor can only access the cash in the event of the employer’s failure to pay a certificated sum due to the contractor or a sum awarded by a court or adjudicator. If there is a payment out to the contractor, the employer is obliged to top up the account again. Failure to do so would give the contractor the right to suspend performance or to determine the contract.

If there is a dispute, the contractor may not be able to get at the cash immediately – but at least it knows that the money will still be there when the dispute has been settled or litigated.