Distinguishing Between an Escrow Account and a Bank Guarantee

1) Definition

Bank Guarantee

Article 287 of the Iraqi Commercial Law No. 30 of 1984 defines a bank guarantee as an independent banking undertaking issued by a bank, at the request of the applicant (the instructing party), in favor of the beneficiary. Under this undertaking, the bank commits to pay a specified or determinable amount, unconditionally, upon the beneficiary’s demand within the period specified in the bank guarantee, while stating the purpose for which it was issued.

The relevant provisions also confirm:

• The independence of the bank’s undertaking.

• The prohibition on the bank refusing payment due to the parties’ relationships.

• The prohibition on the beneficiary claiming the guarantee amount for a purpose other than the specified purpose.

• The bank’s subrogation to the beneficiary, enabling the bank to seek recourse against the applicant for the amount paid.

Escrow Account

Article 1/Second of the Instructions on Maintaining a Real Estate Development Escrow Account, issued by the Central Bank of Iraq under No. 9/3/109 dated 8/3/2020, defines it as:

• A bank account opened in the name of the project.

• Managed by the “Account Trustee” (the bank responsible for managing the account).

• Subject to special regulatory controls.

• Withdrawals are linked to:

  • Supervisory mechanisms, and a payment schedule tied to the percentage of completion, and approval requirements from the competent authorities.

2) Purpose

Bank Guarantee: A Security/Credit Instrument

A bank guarantee creates a personal obligation on the bank toward the beneficiary to make immediate payment upon demand (within the guarantee’s timeframe and for the specified purpose).
It is therefore a guarantee of the applicant’s obligation toward the beneficiary and aims to enhance trust and credit in transactions.

Escrow Account: A Mechanism for Safeguarding and Managing Funds

An escrow account does not create an independent payment obligation on the bank in favor of a specific party merely upon demand.
Instead, it is a regulatory mechanism for depositing project funds and disbursing them under controls set out in the instructions, such as:

• Payment schedules

• Progress of completion

• Approvals

• Advisory/consultant reports, etc.

3) Parties to the Relationship

In a Bank Guarantee (Article 287, Commercial Law No. 30 of 1984)

Parties:

1. Applicant (the bank’s customer / the party requesting issuance)

2. Bank (the guarantor / issuer)

3. Beneficiary (the party entitled to demand payment)

Core of the relationship:
An independent banking undertaking in favor of the beneficiary.

In an Escrow Account (E-account) (Real Estate Development Escrow Account Instructions)

Parties:

1. Developer / Investor, and financiers (if any)

2. Account Trustee (the bank managing the account)

3. Relevant supervisory / regulatory authorities (as stipulated by the instructions)

Core of the relationship:
Managing an account in the project’s name, with disbursement controlled by procedures.

4) Entitlement to Amounts

Bank Guarantee

Entitlement arises immediately upon the beneficiary’s demand within the guarantee period.
The bank may not invoke the applicant/beneficiary relationship—or their relationships—to refuse payment, pursuant to Article 290 of the Commercial Law.

Escrow Account

Withdrawal/release is not automatic upon a single party’s request. It is restricted by regulatory and procedural controls set by the instructions dated 8/3/2020, including:

• Linking payments to the work-progress schedule (Article 2/Ṭ).

• Disbursement only through an approvals mechanism and a report from a classified consultancy entity (Article 2/M).

• Commencement of withdrawals only after achieving a specified completion percentage (25% under Article 2/Ṣ).

5) Independence

Bank Guarantee

A bank guarantee enjoys a high degree of independence under Articles 290 and 293 of the Commercial Law:

• The bank may not refuse performance for reasons related to its relationship with the applicant/beneficiary or the applicant’s relationship with the beneficiary.

• The beneficiary may not claim the guarantee value for a purpose other than the purpose specified in the guarantee.

Escrow Account

An escrow account aims to allocate and protect project funds. The account is not subject to other obligations arising from other contracts entered into by the developer before/during/after opening the account, pursuant to Article 2/N.

The instructions also address judicial attachment in a distinctive manner, as stated in Article 2/Sh of the Real Estate Development Escrow Account Instructions dated 8/3/2020, whereby the escrow account is not subject to any decisions of guardianship, liquidation, or rehabilitation issued by the Central Bank of Iraq against the Account Trustee.

6) Subrogation Upon Payment

Bank Guarantee

If the bank pays the beneficiary under the bank guarantee, it is subrogated to the beneficiary and may seek recourse against the applicant for the amount paid, pursuant to Article 292 of Iraqi Commercial Law No. 30 of 1984.

Escrow Account

The concept is not based on an “independent bank payment then subrogation,” but rather on releasing installments from the account balance under the instructions dated 8/3/2020, with penalties imposed on the Account Trustee in case of delay, including:

• A delay fine of IQD 5,000,000 for each day of delay.

• The possibility of replacing the Account Trustee upon procrastination, pursuant to Article 2/K.

The Legal Regulation of the Real Estate Development Escrow Account in Light of the Instructions on Maintaining a Real Estate Development Escrow Account

Given the sensitivity of the real estate sector and its direct impact on citizens’ savings, the Central Bank of Iraq issued the “Instructions on Maintaining a Real Estate Development Escrow Account” under No. 9/3/109 dated 8/3/2020. These instructions constitute a regulatory framework governing financial operations in modern housing projects.

Procedures for Opening and Managing the Escrow Account (E-account)

The Real Estate Development Escrow Account (E-account) is a precautionary regulatory mechanism aimed at:

• Tightening oversight over the financial flows of real estate projects.

• Ensuring that project funds are directed to their designated purposes.

• Preventing the commingling of project funds with the developer’s other obligations.

• Shielding funds from execution risks and default scenarios.

The importance of this account stems from its character as a “project-designated account in the name of the project”, administered under a multi-party contractual and supervisory structure in which:

• The bank’s role as Account Trustee intersects with the powers of the regulatory authority, investment bodies, and classified consulting/advisory entities.

1) The Preliminary Stage Prior to the Banking Establishment of the Account

The instructions require, at this stage, that:

• The account must be in the name of the project itself, and must be opened in the main branches of the Account Trustees (banks), pursuant to Article (2/A), reflecting the intention to ensure centralized supervision, easy traceability, and effective monitoring.

• Pursuant to Article (2/B), the Account Trustee must verify the eligibility of the real estate developer/investor, whether the developer is a legal person or a natural person:

  • If the developer is a legal person, the general rule—under company law—requires the existence of final accounts and the submission to recognized account auditing.

  • If the developer is a natural person, professional due diligence must be exercised to verify their solvency and capability to implement the project.

  • In all cases, the developer must:

    • Possess real fixed assets,

    • Have a fixed headquarters inside the country, and

    • Obtain approval from the Companies Registration Department,
      establishing a presumption of project seriousness and limiting the phenomenon of unqualified or legally/financially unstable developers.

• In documenting the project’s financial environment, Article (2/C) requires stating the names of other project financiers, clarifying their financial position, and providing all necessary information about them, in reinforcement of transparency and funding-risk assessment.

• Pursuant to Article (2/H), the instructions require listing the names of current and potential suppliers who will provide for the project, with the condition that they enjoy legal personality, aiming to ensure dealing with suppliers of stable legal status who can be held accountable and whose contractual obligations can be verified.

• Pursuant to Article (2/Z), the instructions require separation between projects:

  • One account may not be opened for more than one project

  • A separate account must be opened for each project

  • It is prohibited to open an intermediate bank account branching from the (E-account), which entrenches the unity of the balance, strengthens the accounting chain, and prevents manipulation through sub-accounts that may be used for uncontrolled transfers.

2) Financial Establishment of the Account

The Instructions on Maintaining a Real Estate Development Escrow Account dated 8/3/2020 provide that the account must be opened with an amount equal to (5%) of the project value, pursuant to Article (2/H), to be paid by the developer.

This amount may not be withdrawn except after the lapse of one year from the date of distribution of the residential units or the commercial project, in accordance with the instructions of the authority granting the license.

This restriction indicates that the stated amount performs a guarantee/precautionary function for the post-distribution phase, providing a financial safety margin for subsequent obligations, and enhancing buyers’ and financiers’ confidence in the seriousness of the project and its ability to complete delivery requirements and post-delivery services.

3) Operation and Release of Payments

The concept of the escrow account (E-account) is based on not releasing funds absolutely, but rather under a payment system linked to the project’s actual progress.

Accordingly, Article (2/Ṭ) requires that the (E-account) contract stipulate:

• The payment amounts linked to the work-progress schedule

• Specific dates for those payments (payments made to the developer) ensuring a clear indicator of completion percentages, preventing pressure on the Account Trustee’s deposit portfolio, and preventing the release of funds before the actual completion of execution stages.

In support of this direction, the instructions set a fundamental condition for the start of withdrawals:

• Submitting proof that the project completion percentage has reached (25%) of the estimated project value excluding the land, pursuant to Article (2/Ṣ).

This makes withdrawals contingent on an objective completion criterion that limits early withdrawals and reduces the risk of using funds outside the project’s purposes.

4) Governance of Withdrawals and Control Mechanisms

Withdrawal procedures are characterized by a high level of governance, including:

• Withdrawal from the account is permitted only by:

  • The authorized manager of the company (if the developer is a legal person)

  • The natural person themselves

  • Whoever either of them authorizes, pursuant to Article (2/D).

• The Account Trustee may not approve withdrawals unless:

  • Approval is obtained from the authority granting the license, and

  • Such approval is supported by a report from a classified consulting entity,
    pursuant to Article (2/M), achieving balanced technical and legal oversight prior to releasing payments.

• External transfers are regulated more strictly:

  • the real estate developer may not carry out an external transfer from the (E-account) unless approval is obtained from:

    • The bank’s Board of Directors (Account Trustee),

    • The licensing authority, pursuant to Article (2/W), aiming to prevent capital flight or diversion of funds outside the project cycle in a manner that harms beneficiaries or threatens the project’s ability to complete.

• The Account Trustee must prepare separate final accounts for the project, approved by its Board of Directors.

  • If the project is financed under (SIFP), the final accounts prepared by the Account Trustee must additionally be approved by the project’s designated Sharia officer.

  • The accounts are also subject to periodic inspection by supervisory authorities.

  • The Account Trustee must send a detailed quarterly statement of account movements and balances to the bank and to the investment licensing authority, achieving continuous periodic oversight and contributing to early detection of imbalances and violations, pursuant to the relevant paragraphs (Y, Q) under Article (2) of the said instructions.

To ensure the Account Trustee’s discipline and prevent obstruction of project interests, the instructions impose a financial penalty in case of failure to release installment amounts from the escrow account:

• A delay fine of (IQD 5,000,000) for each day of delay, pursuant to Article (2/K).

In light of this, if the Account Trustee procrastinates in releasing payments according to the specified schedule, the Account Trustee is replaced by another Account Trustee as a remedial measure aimed at:

• Continuity of financing

• Avoiding project stoppage due to failure of the banking intermediary.

In cases of default, non-completion, or delay in completing project stages (including failure to withdraw within two months from the date of the installment under the payment schedule), Article (2/ʿAyn) obliges the Account Trustee to notify the licensing authority and the bank, so that the bank may take appropriate measures, in coordination with the competent authorities, thereby establishing an early-warning system activated upon the appearance of procrastination indicators.

Independence of the Account and Protection from General Claims

The instructions provide, in Article (2/N), that the account is independent from any other obligations arising from contracts entered into by the developer before, during, or after opening the account, representing an application of the concept of allocating the account exclusively for project purposes.

They further provide, in Article (2/S), that the (E-account) is not considered an account subject to judicial attachment in the event of creditor claims, except for creditors registered on the real estate units in cases of project execution procrastination, achieving a precise balance between:

• Protecting the account from general attachments

• Protecting the rights of beneficiaries linked to the project itself.

The instructions also restrict transferring the account from one Account Trustee to another:

• this is not permitted except for legal reasons and in a manner consistent with the condition of opening the account in the main branches, pursuant to Article (2/R).

Regulatory Exceptions and Special Provisions

Finally, the instructions establish related regulatory exceptions as stated in paragraphs (Sh / T / Th) of Article (2), including:

• the (E-account) not being subject to decisions imposing guardianship, liquidation, or rehabilitation issued by the bank against the Account Trustee,

• the (E-account) not being subject to the legal reserve ratio, and

• projects falling under (SIFP) (Islamic financing instructions) and holding an investment license being subject to both:

  • The (E-account) instructions, and instructions of the aggregated Islamic financing account (S-account) together.

Conclusion

It is thus evident that the procedures for opening a Real Estate Development Escrow Account do not stop at the mere opening of a traditional bank account. Rather, they are built upon an integrated system that includes:

• Eligibility requirements,

• Identifying parties connected to the project

• Separation between projects

• Linking withdrawals to actual completion

• Subjecting releases to supervisory approvals and consulting reports

• Periodic inspection mechanisms

• Penalties and remedial measures upon default in a manner that fulfills the core purpose of this account as an instrument ensuring:

• Continuity

• Transparency

• Protection of the rights of parties related to the project.

For tailored legal advice on opening and managing an E-account under the Central Bank of Iraq instructions, contact Osama Tuma for Legal Services and Advisory, a trusted law firm in Iraq.