Escrow Holder Liability to Third Parties – A Simple Framework

What is Escrow? What is an Escrow Account?

Escrow disputes may arise in a real estate or business context. One typical area where escrow is used and may be the source of litigation is in the course of a purchase and sale. Escrow disputes are one of many potential issues which may arise in the purchase of real property, generally, or in the bankruptcy context. Thus, it is important to understand what escrow is in order to properly describe the potential liability of an escrow holder to third parties.

The definition of escrow or an escrow account is provided in the California Civil Code.

A grant may be deposited by the grantor with a third person to be delivered on performance of a condition, and, on delivery by the depositary, it will take effect. While in the possession of the third person, and subject to condition, it is called an escrow.

Cal. Civ. Code § 1057.

Escrow has also been defined in California case law.

An escrow involves the deposit of documents and/or money with a third party to be delivered on the occurrense of some condition.

Summit Financial Holdings, Ltd. v. Continental Lawyers Title Co. (2002) 27 Cal.4th 705, 711.

As if these two sources did not clear up the issue enough, the term escrow is also defined in California’s Financial Code.

‘Escrow’ means any transaction in which one person, for the purpose of effecting the sale, transfer, encumbering, or leasing of real or personal property to another person, delivers any written instrument, money, evidence of title to real or personal property, or other thing of value to a third person to be held by that third person until the happening of a specified event or the performance of a prescribed condition, when it is then to be delivered by that third person to a grantee, grantor, promisee, promisor, obligee, obligor, bailee, bailor, or any agent or employee of any of the latter.

Cal. Fin. Code § 17003(a).

Escrow Holder Liability

Given the obligations created by the creation of an escrow account, the escrow holder’s liability is typically limited to the parties to the agreement under which the escrow holder is granted possession of the material in the account.

An escrow holder is an agent and fiduciary of the parties to the escrow. The agency created by the escrow is limited – limited to the obligation of the escrow holder to carry out the instructions of each of the parties to the escrow.

Markowitz v. Fidelity Nat. Title Co. (2006) 142 Cal.App.4th 508, 526.

In limited cases, however, an escrow holder may be liable for damages suffered by a person who is not a party to the escrow.

Escrow Holder Liability to Third Parties Based on Direct Contract

An escrow holder may be liable to third parties arising from a direct contract with that third party.

There are situations where escrow instructions directing the escrow holder to comply with instructions provided by a third party not in privity with the escrow agreement. Thus, when an escrow holder agrees to abide by a third party’s instructions, the escrow holder has entered into a separate contract binding it to comply with the third party instructions, or face being held liable to the third party. The two most common instances of this third party liability arise when an escrow holder enters into a contract with a lender or enters into a contract with a creditor of one of the parties to the escrow.

Escrow Holder Liability to Third Party Lenders

It is not uncommon for third party lenders to provide closing instructions to an escrow holder that provide the conditions upon which the lender will fund the escrowed transaction. See Plaza Home Mortgage, Inc. v. N. Am. Title Co. (2010) 184 Cal.App.4th 130, 136.

Recently, a lender sued an escrow holder for failing to comply with the lender’s closing instructions when disbursing the loan proceeds in connection with the sale of a business. Money Store Investment Corp. v. Southern Cal.  Bank (2002) 98 Cal.App.4th 722. The court held that when the escrow holder and lender exhibited mutual consent to the lender’s closing conditions, a contract was created between the escrow holder and lender allowing the court to impose liability on the escrow holder for damages suffered by the lender arising from the escrow holder’s breach of that contract. Id. at 728.

Escrow Holder Liability to Third Party Creditors of a Party to the Escrow

An escrow holder may also agree with a party to the escrow and a creditor of that party to the third party creditor with the proceeds held in the escrow. When the escrow holder enters into an agreement such as this one, the escrow holder is obligated to disburse the funds in accordance with the agreement. By agreeing with the party to the escrow and its third party creditor, the escrow holder becomes a party to a new contract with the party’s creditor, subjecting the escrow holder to typical contractual duties owed to the third party creditor. Thus, an escrow holder may be liable to breach of contract to this third party creditorSee Warrington Lumber Co. V. Fullerton Mortgage & Escrow Co. (1963) 222 Cal.App.2d 706, 710-11.

Escrow Holder Liability to Third Parties Based on Equitable Estoppel

An escrow holder’s conduct may compel a court to use principles of fairness and equity to order a holder liable to third parties.

An escrow holder may also face liability to third parties unassociated with the escrow agreement when the formal elements of contract are not met. If the third party relies on the escrow agreement to its detriment, the escrow holder may be held liable to the third party who detrimentally relies on the escrow agreement.

For example, a recent California case gave rise to a third  party’s recovery from an escrow holder based on equitable estoppel. Feinberg v. Intrastate Escrow Corp. (1963) 216 Cal.App.2d 80, 82-84. In that case, the escrow holder knew of the creditor’s reliance on an original escrow agreement by refraining from attaching property in reliance on the escrow agreement’s instructions to pay the creditor with the proceeds of a sale. Id. The party to the escrow agreement then entered into a new agreement with the escrow holder whereby the escrow holder would provide all proceeds to the party, and leave the creditor with no assets to collect a debt from. Id. 

Because the escrow holder knew of the creditor’s detrimental reliance on the original agreement, the escrow holder was able to be held liable for the damages suffered by the third party creditor arising from the party to the escrow’s fraudulent conduct in which the escrow holder was compliant. Id.

Escrow Holder Liability to Third Parties Based on Implied Contractual Indemnity

A third party may recover from an escrow holder may arise from an escrow holder’s breach of an obligation to a party to the escrow which would indemnify that party from liability for the escrow holder’s failure to comply with its obligations. This recovery would be based on a theory of implied contractual indemnity.

A recent California case provides an example of an escrow holder’s liability to a third party based on implied contractual indemnity. Bear Creek Planning Com. v. Title Ins. & Trust Co. (1985) 164 Cal.App.3d 1227, 1236-39 (disapproved of on other grounds by Bay Dev. Ltd. v. Sup. Ct (1990) 50 Cal.3d 1012).

In Bear Creek, the escrow holder failed to comply with instructions in the escrow agreement obligating the escrow holder to properly record covenants, conditions, and restriction on all four units in a certain subdivision. Id. The homeowners association of the recent development disallowed construction for a buyer who proposed a development which would have been in violation of the covenants if they had been recorded by the escrow holder. Id. The homeowners association was sued for slander of title (as an aside, when filing a quiet title action, it is necessary to file a lis pendens (notice of pendency of action) concurrently with the complaint for quiet title) due to its recordation of a notice of violations against the buyer. Id. 

The escrow holder was held to be liable for the foreseeable damages suffered by the homeowners association incurred in an attempt to enforce the covenants which would have been recorded if the escrow holder had complied with the escrow agreement. Id. Thus the association was awarded a judgment for fees and costs associated with defending the suit brought after the escrow holder’s failure to comply with the escrow agreement. Id.

Escrow Holder’s Liability to Third Party Broker

An escrow agreement may provde instructions to the escrow holder to disburse some proceeds derived from the sale of property to pay a broker’s commission. Generally, because a broker is not a party to the escrow agreement, the seller of a property may always amend the instructions to cut the broker out of the proceeds held in escrow. If the seller does so, the  escrow holder does not have liability to the broker for following the seller’s instructions and failing to disburse the commission to the broker. See Contemporary Investments, Inc. v. Safeco Title Ins. Co. (1983) 145 Cal.App.3d 999, 1003,04 (holding that becayse broker was not party to an escrow, an escrow holder has to follow instructions of the parties to the escrow which were amended by the seller to revoke the order to pay the commission of the broker from the proceeds of the sale).

Escrow Holder’s Liability to Third Parties Based on General Negligence Law

Generally, as with all other tort law, an escrow holder must owe some sort of duty of care to the third party trying to hold the escrow holder liable under general negligance law. See Paz v. State of Cal. (2000) 22 Cal.4th 550, 559. An escrow holder generally does not owe a duty of care to third parties not privy to the escrow agreement. See Summit Financial Holdings, Ltd., supra, (2002) 27 Cal.4th at 716.

The determination whether in a specific case the defendant will be held liable to a third person not in privity it a matter of policy and involves the balancing of various factors, among which are the extent to which the transaction was intended to affect the plaintiff, the foreseeability of harm to him, the degree of certainty that the plaintiff suffered injury, the closeness of the connection between the defendants’s conduct and the injury suffered, the moral blame attached to the defendant’s conduct, and the policy of preventing future harm.

Biankanja v. Irving (1958) 49 Cal.2d 647, 650.

Thus, if on balance, the brunt of these factors weigh in favor of holding the escrow holder liable to a third party under the general principles of negligent tort law, a court may hold the escrow holder liable.

Contact an Experienced Business and Real Estate Attorney in Los Angeles, Orange County, San Francisco, Riverside, San Diego, San Jose, Sacramento, and Surrounding Areas in California

Given the ability of third parties to hold an escrow holder liable, it would serve an escrow holder or third party well to contact an experienced business and real estate attorney to talk through the specifics of their dispute and their likelihood of recovery or liability.

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