What are Escrow Shares?

Last Updated: 8 Jul 2022

The idea behind shares representing your money value is ideal, as the shares will appreciate and multiply to the wealth. However, it isn’t as easy as it sounds. As shares represent ownership, corporations, investors, executives, etc. there is always a chance that a separate party can claim the ownership of the shares resulting in a dispute. In such cases, the common or preference shares become Escrow shares. This article talks about Escrow shares meaning in detail.

What are Shares?

In simple words, a share indicates a unit of ownership of a particular company. If you own shares of a company, it implies that you, as an investor, own a percentage of the issuing company. These shares are listed on the stock exchanges through an Initial Public Offering, and investors can buy and sell them based on their current price. If you buy the shares of a company, you become the owner of the company in the proportion of the percentage of the purchased shares. From the day you buy the shares, you are a shareholder.

What Escrow Shares means?

Escrow shares are defined as the shares that are kept in an escrow account which is where securities or financial instruments are kept by two parties and are governed by a separate third party. The main goal behind escrow shares is to keep them safe and not prone to being sold by a party before any corporate action or any other predetermined event.

Under escrow shares, they can not be used by any of the three parties until they are legally allowed to do so. However, one party is always the owner of the escrow shares that are kept in an escrow account. The third party is hired to govern and manage the shares and ensure the two parties achieve the terms and conditions mentioned in the transaction or escrow agreement.

Understanding Escrow Shares

Suppose you are an employee of the company and were granted 100 shares of the company as a part of their employee compensation plan. You were let go by the company, which you thought was wrongful. However, before leaving, you wanted to sell the 100 shares in your notice period as you won’t be able to claim them after leaving the company. But, the company restricted you to sell them, saying you are not allowed to sell the shares in the notice period.

If you sue the company for not letting you sell the shares, the shares become disputed until the legal action is completed. Hence, the shares are put into an escrow account where a third party governs the shares. Since the day the shares are put into the escrow account, they are called escrow shares, which you can only access after the completion of the legal process.

When are shares Escrowed?

Here are the situations in which shares are escrowed:

• Employee Compensation: A company offers its shares to its current employee as a way of bonus or internal employee policies. These shares are restricted, meaning that the employees have to wait for a specified period before they can sell the shares. The shares are called restricted shares, and the specified period is known as the vesting period. The company holds these restricted shares in an escrow account until the vesting period is over.
• Mergers and Acquisitions: When a company announces that it is merging with or acquiring a different company, they are always fearful that the acquiree company’s promoters may sell their shares as soon as they get them. It can force the acquirer company’s share price to go down. Furthermore, the acquiree company may also feel fearful in case the acquirer company’s financial performance becomes negative. Hence, they both can request the shares to be held in an escrow account until they are sure of a preferable business deal.
• Bankruptcy or Reorganisation: A company’s shares are suspended from the stock exchanges if it has filed for bankruptcy. It is done to protect the interest of its shareholders owing to the fear of panic selling. In such a case, the shares are transferred to an escrow account until the resolution of the corporate action. Once it is completed, you get back the shares in your Demat account.

Benefits of Escrowed Shares

The concept of Escrow shares was made to protect the rights of both the parties, be it employees-employers, acquirer-acquiree, or company-shareholders. If there is a corporate or legal action, escrow shares allow for a transparent process where an unbiased third party keeps the shares safe until a legal resolution occurs. It also allows for protecting the interest of the shareholders in case the company files for bankruptcy.

As corporate actions are complex, investors do not understand what can happen to their investments. Hence, escrow shares ensure that they do not take negative decisions based on external events and get the shares back once the corporation resolves the actions.

Final Words

In an escrow account, some specific terms and conditions need to be set and agreed upon by the two parties. They also hire the third party after a mutual agreement and do not interfere in the escrow share process until the corporate action or dispute is resolved. The concept of escrow shares is used widely in India by numerous corporations and even the government to ensure transparency and unbiased resolutions of any pending action.

Frequently Asked Questions

What is the purpose of escrow?

The purpose of escrow is to transfer the shares from general ownership to an external account that is governed and managed by a third party. The aim is to mitigate interference and ensure that a party does not sell the shares until a legal dispute or corporate action is completed.

Can you sell shares in escrow?

Although a stock that is kept in an escrow account is owned by one of the two parties, it is not allowed to access or sell the shares until a dispute or corporate action is legally resolved.