If two people agree to the sale and purchase of a rare book, they can close the transaction in a single place at a single time. The buyer can examine the book, assess its authenticity, set the book aside, negotiate price, and when agreement is reached, the buyer can hand the seller the funds, and take the book. If agreement is not reached, the buyer and seller part ways.
Buying and selling a corporate aircraft is rarely, if ever, done this way. Instead, a typical transaction will involve the use of an escrow (and sometimes more than one escrow) in order to deal with the logistical complexities of the closing. In an extreme case: (1) the buyer is in one location, (2) the seller is in another location, (3) the aircraft is in a third location, (4) the aircraft is registered in the seller’s location, (5) the buyer needs to re-register the aircraft in its location, (5) the buyer is using financing and the buyer’s bank needs to file a mortgage in the buyer’s location, (6) the seller also has a bank that needs to be paid off to release its mortgage in the seller’s location, and (7) neither the buyer nor the seller is qualified to inspect the aircraft or to make necessary repairs to the aircraft. Often these transactions are spread over multipe time zones.
The starting point and lynchpin is the escrow agent. An escrow agent is an independent party, hired by both the seller and the buyer, and guided in its actions by the contract among the escrow agent, buyer and seller. This contract contains a set of instructions that the escrow agent must follow based on triggering events. In effect, the escrow agent is “programmed” to act in response to instructions written in the escrow agreement, and is not to be controlled by one party or the other.
Using the seven-part transaction above as the model transaction, below is an illustration of how an escrow works, in sequence, to organize and close a transaction.
- Upon signing a basic letter of intent (or memorandum of understanding) the buyer puts a good faith (nonbinding) escrow in place to show the seller its interest and commitment to the transaction.
- Seller and buyer negotiate a full purchase and sale agreement with full escrow terms governing deposits, refunds, closing or rejection and refund.
- Buyer fully funds the escrow with the full deposit.
- The inspection of the aircraft begins, and the parties prepare the necessary documents to be placed in the possession of the escrow agent. The seller will place a bill of sale in escrow. The seller’s bank will place a mortgage release document. The buyer will place its own registration document, and the buyer’s bank will place its mortgage. Even though these documents are signed and are in a condition to close the transaction, they are not effective until the escrow is closed and released. In some cases, the escrow needs to exist in two locations in order to permit the simultaneous or sequential filing of documents in two government locations.
- When the condition of the aircraft is acceptable, and all of the necessary documents are sitting in escrow (but not released), the transaction is ready to close. In a simple transaction, the escrow closing is a set of simultaneous actions approved by a single action. For example, it could be a release of funds, a release of title documents, and filing of aircraft registration, all at once. In a complex transaction, it will be a cascading sequence of actions taken over a period of time. Certain actions will be triggered by a prior action, but once started it will continue to completion. For example, using the example in the second paragraph, above, the buyer, seller and their lenders will need to agree to a cascading sequence that allows the buyer’s lender to fund the pay-off of the seller’s loan (either in escrow or direct to the seller’s bank), so that the seller’s bank will release its mortgage on the aircraft, allowing the buyer’s bank to file its mortgage. In some cases, the mortgages are in widely separated time zones, and the two events will be hours apart, and often cannot occur on the same day. The use of an escrow agent creates a continuous process that is very difficult to stop once it has begun. Without an escrow, it would be impossible to get the lenders to make the necessary commitment.
The escrow becomes very useful when a transaction needs to be terminated and reversed. If the aircraft is inspected and ready to close, but the buyer is unable to meet one or more of its obligations for closing, with proper instruction (as defined in the escrow agreement) the escrow agent will follow a procedure for terminating the transaction. This will include the return or destruction of transaction documents that were placed in escrow, and the disbursement of funds. The seller may be entitled to a portion of the deposit as “liquidated damages” based on the terms of the aircraft purchase agreement, and some or all of the funds may be returned to the buyer. This allows for an orderly and fair end to a failed transaction without resorting to litigation or arbitration. The value of the escrow is that the documents and funds will be distributed based on the prior instructions in the escrow agreement, and not based on the parties’ immediate instructions.
When does an escrow fail? An escrow is only as good as the escrow agreement that creates it. If there is no agreement, or the agreement is unclear, then the escrow agent will only act in response to joint instructions from the parties. In some cases, if the transaction proceeds routinely without controversy, this will work out. However, if the parties end up in disagreement at some point during the transaction, the ungoverned escrow will be deadlocked. The buyer may be asking for its deposit back because the seller is in default, and the seller may be asking to be given the deposit because the buyer is in default. In these cases, the escrow agent will freeze, and take no action until there is either a mutual agreement or a court order directing the escrow agent. Both parties will be committed to seeking a solution because there will be a deposit that remains frozen until a solution is reached. Time will be lost, and the aircraft itself may be tangled in the controversy.
In rare cases, an escrow agent will be under a contractual obligation –in the escrow agreement– to take an action (such as release deposit funds to the seller) but will receive a conflicting demand and a threat from the buyer objecting to that release. This will force the escrow agent to either act in accordance with the escrow agreement (and risk legal action from one party) or freeze (and risk legal action from the other party).
The value of escrow in multinational and multiparty corporate aircraft transactions is obvious. Escrows are a way to compress space and time to make such transactions possible. But, in order to be effective, the escrow agreement must be clear and detailed, considering the many possible events and contingencies, and giving the escrow agent a very clear roadmap for executing the transaction.