How do you use escrow accounts to mitigate construction risks and ensure quality and performance?

In a recent construction project, we established an escrow account to facilitate financial transactions. Acting as a neutral intermediary, the escrow account, managed by a trusted third party, played a pivotal role in safeguarding funds earmarked for construction expenses. Payments were released from the account only upon fulfillment of predetermined conditions, including the achievement of project milestones, successful inspections, and resolution of any disputes. This mechanism not only provided financial security but also fostered transparency and accountability among all project stakeholders. The use of an escrow account proved instrumental in ensuring that financial transactions contributing to the success of the construction endeavor.

An escrow account is a bank account administered by an 'escrow agent', who is a neutral, independent third party (often a lawyer or accountant). The paying party deposits a sum with the escrow agent who pays it into the escrow account, where it remains until the conditions for its release are triggered (either the paying party fails to make a payment under the construction contract, an adjudicator directs the paying party to make a payment, or the contract is complete and the Final Payment has been made) - the release either goes to the contractor or back to the paying party.

The parties to the contract agree an escrow agreement (the City of London Law Society has a free precedent which usually serves as the starting point), and the escrow agent will feed into this, and then the parties (and the escrow agent) sign the escrow agreement. The paying party then deposits the agreed sum with the escrow agent, who provides periodic statements to both parties to confirm the balance in the account.

Escrow accounts for construction projects can provide peace of mind for both parties. The contractor knows funds are available and the specific milestones required to receive payment. The owner knows the work must be completed before funds are disbursed. I'm a huge proponent of this arrangement for projects of any size.

Escrow accounts serve as a sensible counterpart to performance bonds and advance payment bonds. They are usually seen by Contractors as the corollary to requiring such bonds - if the Contractor is going to grant several months' of rolling credit to the Employer (particularly if the Employer is an overseas company or trust), then it should at least have the comfort of 3+ months' of forecast valuations deposited in escrow in case the Employer doesn't pay (or is prevented from paying by unforeseen circumstances).

Choose an escrow agent who understands deeply the mechanics of a construction contract and, ideally, has a construction-specific form of escrow agreement that allows for some of the construction-specific requirements. You should also use a regulated entity (either a solicitor, accountant, FCA-regulated payment service provider or similar), as they will have been checked by their regulatory body for the strength of their business, their AML/KYC/compliance systems and their safeguarding/ring-fencing practices.

In addition to escrows, which serve as useful security arrangements for contractors, parties to a construction contract might also consider Project Bank Accounts, Retentions Trust Accounts and similar bespoke arrangements to ensure that neither party is unnecessarily exposed to the other's credit risk.