The Escrow Agreement: Definition, Elements and Its Place in Turkish Law

The Escrow Agreement: Definition, Elements and Its Place in Turkish Law What Is an Escrow Agreement? An escrow agreement is an arrangement under which, within the framework of a sale or another legal relationship between the parties, a particular asset, sum of money or document is held by a trusted third party and is delivered to the other party once the conditions set out in the agreement have been satisfied. The escrow agreement is a critical instrument for establishing trust between the parties and reducing risk in share transfers and share sales. The secure handling of shares and payments ensures that the parties act in accordance with the terms of the contract. The applicability and advantages of the escrow agreement in Turkish law offer an important solution, particularly for mergers, share transfers and situations calling for financial security. Elements of the Escrow Agreement An escrow agreement is concluded between three principal parties:

1. The buyer: the person or entity wishing to purchase an asset, service or right, who constitutes the party accepting the payment terms laid down in the escrow agreement.
2. The seller: the person or entity wishing to transfer the asset, service or right that is the subject of the sale, and the party who will receive payment once the conditions stated in the escrow agreement are met.
3. The escrow agent (intermediary): an independent and impartial third person or institution involved in the process in order to establish trust between the parties. This agent holds the parties’ funds or assets in accordance with the terms of the agreement and transfers them to the relevant party once those terms have been fulfilled. This intermediary function is generally undertaken by banks and financial institutions. In practice, the assets most commonly transferred to an escrow agent are cash, cheques and securities.

Duration and Conditions of the Escrow Agreement: The period of validity of an escrow agreement varies according to the conditions determined by the parties. That period may differ depending on payment, delivery or the fulfilment of other conditions. In addition, the conditions for terminating the escrow agreement and the rights of the parties must be stated clearly as part of the agreement. The Place of the Escrow Agreement in Turkish Law In Turkish law the escrow agreement is not regulated directly by any statute, but it is accepted as an atypical contract that may be assessed within the framework of the Turkish Code of Obligations (TCO). By virtue of the principle of freedom of contract in the Turkish legal system, the parties may agree among themselves to conclude an escrow agreement. Such an agreement must specify the applicable law and the court with jurisdiction, and must contain no element contrary to law, morality or public order (Article 27 of the Turkish Code of Obligations). The escrow agreement may be regarded as a combination of both a contract of deposit and a mandate relationship. Fields of Application of the Escrow Agreement

1. Share transfers: where, in share transfer agreements, the parties make processes such as the transfer of shares or the making of payments subject to particular conditions, an independent third party provides the escrow service.

Application of the Escrow Agreement in a Share Transfer: Sale of shares: The seller deposits the shares into the escrow account. The buyer deposits the payment amount into the escrow account. Once conditions such as the financial position of the company or the attainment of particular performance indicators have been satisfied, the escrow agent transfers the shares to the buyer. The payment is not released from the escrow account unless the specified conditions have been met Share transfer and the discharge of tax obligations: Documents evidencing that tax payments have been made in the course of the share transfer are submitted for the escrow agent’s examination. The shares are not transferred until the tax debts have been paid. Payment is made into the escrow account and, once the documents have been duly delivered, the escrow agent arranges for the payment to be transferred to the seller. In this way the buyer secures the fulfilment of the conditions before making payment, while the seller obtains security as to receiving payment. Mergers and acquisitions (M&A): In this case the buyer deposits a certain payment amount into the escrow account and the shares in question are likewise delivered to the escrow agent. However, until the financial position of the company becomes clear over a given period, the shares and the payment are held in the escrow accounts. Once the company’s financial position reaches the desired level, the escrow agent transfers both the payment amount and the shares to the relevant parties. Escrow thus provides security for both parties in merger and acquisition processes. The buyer is spared uncertainty as to the company’s future financial position after making payment, while the seller is assured of the certainty of payment.

2. Commercial transactions: it is used in processes involving payment of the price of goods or the fulfilment of delivery conditions.
3. Transfer of intellectual property: escrow agreements offer a secure solution in situations such as software licences and the transfer of patents.

Tax Implications The tax dimensions of an escrow agreement may vary according to the structure of the transaction and the situation of the parties. Since escrow transactions are not regulated directly in Türkiye, the implications for the following types of tax must be taken into account: - VAT (value added tax): if a delivery of goods or a supply of services takes place within the scope of the escrow transaction, that transaction may be subject to VAT. -Withholding tax: if the escrow account holds an amount bearing interest, withholding tax may be deducted from that interest income. -Stamp duty: if the escrow agreement is drawn up in writing, it may be subject to stamp duty. -Income or corporation tax: where income arising from the escrow constitutes an element of gain for a natural or legal person, it must be included in the income tax or corporation tax base. Escrow in International Trade In international commercial transactions escrow provides an important security mechanism, because the parties are in different countries and do not know one another. It is used in particular in high-value contracts or in trade in goods that pass through complex processes such as customs. Escrow services are generally provided by international escrow companies or large financial institutions and may be used as an alternative to instruments such as the letter of credit. In conclusion, Escrow agreements not only build trust between the parties but also minimise legal and commercial risk by providing a secure transactional environment in commercial dealings, in transfers of intellectual property and in transactions carried out in the digital sphere. They stand out as an important instrument both in Turkish law and at the international level.