Trying to understand what an escrow account In India means?
Yes, we understand, this is a tricky one.
After all, the rules and procedures surrounding an escrow account can vary across regions. What’s more, it is often confused with a nodal account.
So, in this blog, we will cover:
- Meaning of an escrow account in India
- How to open an escrow account in India
- Escrow account agreement format in India
- Escrow account charges in India
However, before we move ahead, care to take a quick quiz?
What is Escrow Account in India?
An escrow account in India is a bank account with conditions on ownership of funds.
In simple terms, it is a safe house for assets while the transaction process is still ongoing.
An escrow agent is a mediator who holds this escrow account. Consider them an intermediary between the buyer and the seller.
Interestingly, an escrow account is not just limited to funds. It can be used for different types of assets like money, stocks, funds etc.
In this blog, we will cover all aspects of an escrow account in India.
So, without further ado, let’s jump right in.
Why Do You Need An Escrow Account In India?
You may need an escrow account in case of:
- A large transaction (between two or more parties)
- that have some legal obligations attached to them
- which need to be fulfilled before the release of the payment or an asset.
Here’s an example:
Let’s say you are a construction builder and aim to sell apartments. Now, let’s assume that you aim to get these apartments booked by customers before they are ready to move in.
Naturally, there are transaction risks-
- The customer may not want to pay the full amount before possession
- There is a risk of scams (money being redirected to other avenues)
- Customers may be wary if pre-determined conditions are not fulfilled
(Here’s an example of a predetermined condition. As a construction builder, you might have promised free home appliances at the time of house possession.)
Here’s where an escrow account in India steps in.
It reduces the risk of fraud as it acts as the third party between the two parties. Moreover, it helps control the cash flow between the two parties.
Additionally, since September 2022, escrow accounts have become indispensable for co-lending use cases.
According to the digital lending guidelines by RBI, all loan repayment and disbursement must be done directly between the bank account of the lender and borrower. This means that no third party pass-through account can be used by banks, NBFCs or lending service providers (LSPs).
However, co-lending use cases are an exception to this rule.
In other terms, co-lending players (like banks and NBFCs) can use escrow accounts to pool funds before disbursing to borrowers.
How To Open An Escrow Account In India?
Here’s the escrow account opening procedure in India:
- The buyer and the seller agree before opening the account, which involves the terms and conditions of the buying and selling assets. This agreement is the “Escrow Agreement”
- After reviewing and signing the agreement, the buyer deposits the amount to the escrow account
- The escrow agent verifies and validates the receipt to both parties
- The escrow agent regularly monitors the buyer’s account to confirm whether or not the buyer is paying the seller as per the agreed process
- Subject to the positive response from both parties, the assets under the escrow agent’s control are released at the agreed event or time
- If there is any disagreement between the two parties, the escrow account in India will move to dispute resolution. The outcome process of the dispute resolution decides what to do with the escrow funds
However, if you are a co-lending player (NBFC or fintech), you can directly integrate with full-stack digital lending service providers, like Cashfree Payments.
This will allow you to integrate and go live within 3 weeks.
Moreover, Cashfree Payments’ low code APIs & dashboard access can help you with easy loan disbursement & collections as well.
Examples Of Escrow Accounts In India
Let’s have a look at some of the examples of an escrow account in India.
Escrow Accounts For Real Estate
This is an industry most associated with the term “escrow account”.
After all, buying or leasing a property is a massive transaction that requires trust. The seller needs to assure the buyer that they will get possession without hassle. On the other hand, the buyer needs to assure of timely payment.
In recent times, many developers have defaulted on their promises.
To ensure regulation of the real estate industry, the Government of India made escrow accounts mandatory for real estate transactions. In fact, the Real Estate (Regulation and Development) Act, of 2016 require real estate builders to keep 70% of the customer funds in an escrow account.
Therefore, this is quite a “win-win” situation for both parties.
- The buyer can assure the seller that they have the necessary funds.
- The seller can assure the buyer that they are using the fund only for the desired purpose: the construction of said real estate.
Co-Lending NBFC and Fintech Players
NBFCs, fintechs and other LSPs can use escrow accounts to pool their funds before disbursement to customers.
Let’s take the example of two NBFCs titled A and B that have a co-lending partnership. Here, the borrower ‘Jane Doe’ applies for a loan of Rs. 10 Lakhs.
NBFC “A” might lend 80% of the funds and NBFC “B” lends the remaining 20%.
This is where they require a pass-through account (aka an escrow account) wherein they can pool the funds before disbursing to Jane Doe.
Mergers And Acquisitions
Let’s say that Company A acquires Company B.
Now, there are a lot of aspects in takeover proceedings. Company B might have to transfer:
- All the assets
- Company resources (even employees)
- Paperwork and required documents
Evidently, the takeover will not be complete if Company B does not finalize the handover. Moreover, the company may facilitate the asset transfer in batches over time.
In such a situation, an escrow account in India helps reassure both parties. It maintains trust between the players and ensures that both parties hold up their part of the deal.
Once the stakeholders (or the governments) approve the merger, the exchange of the cash and documents occurs with escrow accounts.
Escrow Account For Rental Deposit
Rental deposits are another use case for escrow accounts in India. More often than not, landlords require a security deposit. Once the tenant vacates the rental property, the landlord has to return the deposit.
An escrow account assures the buyer of the safety of their security deposit. Moreover, it assures the landlord that they are dealing with verified parties.
Here is how the process goes:
- The landlord and tenant agree on terms for the escrow account
- The tenant transfers the security deposit
- The agreement might permit partial withdrawal of the security deposit as per the conditions
- The landlord transfers the deposit back to the buyer once they stop the property possession
Escrow Accounts For Auctions
Some people participate in online auctions to buy assets through banks. These banks serve as escrow accounts between the auction and the buyer.
Escrow Accounts For Software
Using an escrow account for your software keeps the source code confidential.
When someone buys your software through an escrow account, it gives you the right price and keeps your source code secure.
On the other side, the buyer gets exclusive user rights, and it assures to provide the required source code even if the developer stops working.
Escrow Accounts For Freelancers
Many major websites act as escrow accounts between the freelancer and the employer.
The websites help freelancers work with an employer without losing money. If the freelancer’s work is satisfactory, the website transfers the money to the freelancer.
Escrow Account For Cryptocurrencies
Bitcoins or cryptocurrencies are the latest market trends.
Many people hesitate to invest in this as it is still not legal in many countries. In such cases, the transactors provide an escrow account to the buyer due to the trust issues revolving around the same.
Every transaction which involves buying and selling can make use of escrow services.
Given below are some additional examples that require an escrow account in India.
- Conservation of assets
- Capital Fundraising
- Fundraising for charities
- Gambling/betting
- Legal agreements
- Stock market trading
- Asset transactions
- Valuable private trades
- Government-backed loans
- Insurance payments
Escrow Account In India Vs Nodal Account
Now that we have covered the examples of an escrow account in India, it’s time to move on to something equally important.
What is the difference between an escrow account and a nodal account?
Before we move on to concrete differences between the two, let’s have a look at the definition of a nodal account.
A nodal account is a very specific type of bank account mandated by RBI. Businesses that act as an intermediary between buyers and sellers use nodal accounts in India.
They aid in building trust between buyers, sellers and the payment system.
Essentially, a business or payment aggregator may use a nodal account to:
- Collect money on behalf of vendors
- Source products without manufacturing them
Essentially, the business has no role in creating or maintaining inventory.
Now, let’s move on to the differences between an escrow account in India and a nodal account.
Who Uses It?
Virtually anyone can use an escrow account in India. As we saw in the preceding examples, banks, corporations, or real estate owners can use it for their purposes. Essentially, buyers and sellers transferring a sizeable asset have to use an escrow account.
On the other hand, only intermediaries use nodal accounts in India. Basically, these are businesses that connect the buyer and seller. For example, a payment system helps a merchant accept payments.
Online marketplaces (like Amazon), PPI (pre-paid instrument) and payment aggregators (PAs) use a nodal account for their respective use cases.
Some features of a nodal account are:
- Strict adherence to RBI norms for marketplaces
- Protecting customer and merchant interest
- Safe collection of payment for merchants by customers
- Settlements within the defined timeline
Do Buyer And Seller Know Each Other?
More often than not, the two parties may not know each other in an escrow account deal. Instead, the escrow agent facilitates the transaction.
However, in the case of a nodal account, payments are transferred to the account maintained by the payment aggregator.
Thereafter, it disburses the payment to the correct recipient on settlement.
What Is The Purpose Of The Account?
In an escrow account in India, the buyer makes the payment. However, the buyer keeps the payment on hold until all the conditions of the pre-decided agreement are fulfilled. Thereafter, they transfer the funds to the seller.
In the case of a nodal account, the payment aggregator collects the payment on behalf of the merchant. Then, they keep the funds on hold until the time of the settlement. This ensures that this intermediary does not have access to the funds.
Hence, this ensures the safety of payment.
Advantages Of Having An Escrow Account
Security
The buyer and seller will have protection for both their funds and the goods as the funds are neutral with the third party agent.
Automation
An escrow account is fully automated. This means that the funds are automatically transferred to the seller once all the clauses in the agreement have been fulfilled.
Being Compliant with RBI Guidelines
As mentioned above, co-lending players require an escrow account to stay compliant with the latest RBI guidelines on digital lending.
Facilitates Agreement
The escrow agent acts as the middle person during the agreement process between the two parties and ensures that both parties come to an agreement.
Simple And Efficient
Opening an escrow account is very a simple and quick step. An escrow agent helps both parties to have an efficient and smooth transaction during the tenure.
Confidentiality
The details of the escrow account holder’s names are maintained confidential and are not public.
However, parties can use escrow accounts depending upon both of their individual interests. Some multinational companies and government agencies do make it a strict rule to have an escrow account, while others have the freedom to avail of the services as per their liking.
Frequently Asked Questions On Escrow Accounts in India
Is there interest in an escrow account in India?
According to RBI guidelines, escrow accounts in India are non-interest bearing.
Is an escrow account frozen if a party does not hold their end of the deal?
No, the funds in an escrow account in India are never frozen.
Moreover, if the seller is delaying the delivery of the asset, the buyer can call off the deal. They have to instruct the escrow account agent and withdraw the funds from the account
More importantly, an escrow account in India is only created for 6 months at first. If the buyer or seller wants to increase that duration, they need special permission from the RBI.
Can the escrow agent siphon off the funds in the account?
No, the escrow agent cannot use the escrow funds for personal purposes.
According to RBI Guidelines, the agent can only transfer the funds to the seller after the buyer agrees. The buyer has to approve any action affecting the funds.
Can the escrow agent have a bias towards the buyer and seller?
The escrow agent is a third-party player that does not have loyalties towards the buyer or the seller.
Moreover, they work under a regulatory framework by RBI. Hence, they cannot afford to take any mal-intentioned steps with regard to the escrow funds.
Wrap Up:
With the advancement in technology, features such as escrow accounts are becoming more and more relevant, by the day. Escrow accounts are being used everywhere, right from real estate to Cryptocurrency trading.
With the growing demand for escrow services, service providers are also increasing by the day. In such a scenario, it is imperative to do thorough research before availing of the services as frauds around escrow accounts are also rising.
