Legal Regulation of the Escrow Account in Iraqi Legislation

In the world of complex financial and commercial transactions, “trust” is the most valuable currency, yet at the same time the rarest and most fragile. With the development of economic systems and the increasing complexity of contractual relationships, mere mutual consent between the parties (offer and acceptance) is no longer sufficient to ensure the performance of obligations—especially in contracts characterized by time-lag performance, such as real estate development contracts, or those involving high risks such as international trade and mergers and acquisitions. Hence, an urgent need has emerged for legal and banking mechanisms that fill the gap between the “moment of contracting” and the “moment of full performance,” and that secure the parties’ rights against market fluctuations or the bad faith of one of the contracting parties.

An Escrow Account represents the modern legislative and banking response to these challenges. It is not merely a financial container for holding funds; rather, it is an integrated legal institution based on the idea of the “positive neutrality” of a third party, who undertakes risk management on behalf of the contracting parties. In the Iraqi context, this topic gains exceptional importance due to the stage of reconstruction and the accelerated growth in the real estate investment sector, and the legal problems that accompanied it—particularly those related to the sale of residential units off-plan.

Chapter One: The Conceptual Framework and Jurisprudential Rooting of the Escrow Account

The Functional Concept of the Escrow Account: Beyond a Mere “Deposit”

A bank escrow account is defined in legal and banking doctrine as a separate and independent account, established pursuant to a special agreement, and deposited with a neutral third party (Escrow Agent)—usually a licensed bank—to hold funds, assets, or documents on behalf of two or more parties participating in a specific transaction. The essence of this account lies in “conditional suspension”; the deposited funds are not freely disposable by either party, but rather remain legally restricted until precisely defined conditions in the escrow agreement are fulfilled.

The protective function of the escrow account becomes evident in addressing the problem of “payment in exchange for performance.” In traditional commercial transactions, the buyer fears paying the price before receiving the goods out of concern for fraud or non-conformity, while the seller fears shipping the goods before receiving the price out of concern for the buyer’s insolvency. The escrow account intervenes as a safe buffer zone: the buyer deposits the funds (which proves seriousness and solvency), and the agent does not release them to the seller until verifying that the obligation has been performed (the arrival of the goods, or the completion of a construction stage). Thus, dual security is achieved:

• Protection of the buyer from fraud

• Protection of the seller from the risk of non-payment

Applications of the Escrow Account Across Multiple Contexts

Although the current focus in Iraq is on the real estate sector, global and local applications of the escrow account cover a wide spectrum of transactions:

1. Mergers and Acquisitions (M&A):
   When one company acquires another, the buyer often retains part of the transaction price in an escrow account for a specified period (Holdback Escrow). The purpose is to secure coverage for any hidden obligations that may be discovered later, or to ensure compensation for any misrepresentation in the financial statements submitted by the sold company.

2. Intellectual Property and Software:
   In vital software licensing agreements, “Source Code Escrow” is used, whereby the developing company deposits the source code with a third party, to guarantee the licensee’s right to access and develop the code in the event of the developer’s bankruptcy or cessation of technical support.

3. International Trade:
   The escrow account facilitates cross-border trade by reducing trust risks between an importer and an exporter in two different countries, as funds are withheld until shipping and conformity documents are presented.

4. Online Transactions:
   In e-commerce and freelancing platforms, the platform acts as an escrow agent, holding the buyer’s money and releasing it to the seller only after confirmation that the service or goods have been received.

The Composite Legal Nature of the Relationship

The legal characterization of the relationship in an escrow account raises doctrinal debate, as it is neither a simple deposit relationship nor a mere agency. Under Iraqi law, it can be characterized as a “composite banking transaction” that combines the features of several contracts:

1. Deposit Contract (Deposit):
   The bank undertakes to safeguard the funds. However, it differs from an ordinary deposit in that the depositor (the buyer) loses the right to recover it by unilateral will, and the depositary (the bank) does not have the freedom to use it in its ordinary investment operations in the same absolute manner as current accounts.

2. Agency Contract (Agency):
   The bank acts as an agent for both parties in implementing the instructions of the escrow agreement. Nevertheless, its liability goes beyond that of an ordinary agent, as it is obligated to physically verify the conditions (such as completion percentages) rather than merely execute orders.

3. Stipulation for the Benefit of a Third Party:
   The contract may include terms in favor of supervisory entities (such as the Investment Commission), which makes it a contract with public regulatory dimensions, not merely private ones.

Chapter Two: Distinguishing the Escrow Account from Traditional Banking Instruments

To understand the depth of protection provided by the Escrow Account, it is necessary to distinguish it from similar instruments regulated by Iraqi Commercial Law No. (30) of 1984, namely the Documentary Credit and the Letter of Guarantee. This distinction is as follows:

Distinguishing Between the Documentary Credit and the Escrow Account

Both the Documentary Credit and the Escrow Account are instruments aimed at enhancing trust and reducing the risks of non-performance in transactions. The distinction between them is as follows:

1) In Terms of Definition

• Documentary Credit (Letter of Credit):
  Under Article (273) of Commercial Law No. (30) of 1984, the documentary credit is a banking contract whereby the bank undertakes to open a credit in favor of the beneficiary at the request of the applicant (the orderer), and this is secured by documents representing movable goods or goods prepared for shipment.
  Accordingly, the documentary credit is based on a bank undertaking to pay / accept / discount once documents that conform to the conditions of the credit are presented.

• Escrow Account (Escrow):
  The escrow account is based on the idea of holding funds with a neutral third party (often a bank acting as the account trustee/custodian) so that the funds are disbursed once agreed conditions are met. It was defined in Article (1/Second) of the Controls for Maintaining a Real Estate Development Escrow Account as:
  “The special bank account of the real estate project into which the amounts of buyers of off-plan residential units or the project’s financiers are deposited.”
  Accordingly, the escrow account is not a “financing or payment contract against documents” as much as it is a mechanism for control and restricted disbursement of the movement of funds associated with the project.

2) In Terms of the Subject Matter of the Obligation

• In the Documentary Credit:
  The subject of the bank’s obligation is dealing with documents, not the goods themselves. The bank is committed to implementing the agreed payment, acceptance, and discount conditions as long as the documents conform to what is stated in the credit, pursuant to Article (273) of Commercial Law No. (30) of 1984.
  The bank is also obligated to verify the conformity of the documents with the applicant’s instructions; if it rejects the documents, it must notify the applicant and state the reasons for rejection pursuant to Article (279) of Commercial Law No. (30) of 1984.

• In the Escrow Account:
  Its primary subject is the deposited funds themselves, and disbursement is conditioned by regulatory and procedural restrictions set out in the Real Estate Development Escrow Account Controls issued by the Central Bank of Iraq.
  It is not possible to withdraw from the escrow account except with the approval of the Investment Commission, supported by a report from a consulting entity, pursuant to Article (2/M) of the Controls.
  The decisive factor here is the fulfillment of disbursement conditions linked to project progress and release requests, not the submission of shipping/trade documents.

3) In Terms of Independence

• Documentary Credit:
  It is clearly characterized by the principle of independence; Article (273) provides that the documentary credit contract is independent of the contract for which the credit was opened, and the bank remains a stranger to it.
  This means that disputes regarding performance of the underlying contract (sale/supply, etc.) do not suspend the bank’s obligation as long as the documents conform.

• Escrow Account:
  It is usually closely linked to the project/contract for which the account was created, because disbursement is restricted by executive and supervisory conditions (approval by the licensing authority and a consultancy report).
  Thus, the escrow account is closer to execution risk management and monitoring cash flow in line with project stages, rather than a merely independent undertaking to pay against documents.

4) In Terms of Liability

• Bank’s Liability in the Documentary Credit:
  The legislator defined the scope of the bank’s liability on the basis of the “apparent compliance of documents.” The bank is not liable if the documents appear, on their face, to conform to the instructions received from the applicant, and it bears no obligation related to the goods for which the credit was opened, pursuant to Article (280) of Commercial Law No. (30) of 1984.
  Here, the bank is responsible for examining documents according to the credit conditions, not for the safety of the goods or their actual conformity.

• Bank’s Liability in the Escrow Account (Account Trustee):
  The bank’s responsibility is linked to its duty to release amounts when the release conditions are met, pursuant to paragraphs (D–T–M–Ṣ) in Article (2) of the aforementioned Controls.
  The Controls also established, in Article (2/K), a special sanction when the bank fails to release the due amounts, namely a delay fine of (5,000,000) Iraqi dinars for each day of delay.
  This shows that the bank’s role here is not to examine shipping documents, but rather to comply with restricted disbursement within the regulatory framework and within the specified timelines.

5) In Terms of Revocation (Cancellation)

• Documentary Credit:
  Article (275) of the Commercial Law provides that the documentary credit may be irrevocable or revocable, but the general rule is that it is revocable unless it is agreed to be irrevocable. This characteristic affects the stability of the beneficiary’s position and the possibility of amending/terminating the credit.

• Escrow Account:
  Its concept is based on “freezing funds” and subjecting them to disbursement conditions. By nature, it is less susceptible to manipulation because the funds are present and restricted inside the account, and are not released except in accordance with the restrictions (including the approval of the licensing authority and the consultancy report in the real estate development escrow account), pursuant to Article (2/M).

6) Sanctions (Penalties)

• In the Documentary Credit:
  The law, pursuant to Article (275) of Commercial Law No. (30) of 1984, established a mechanism to address the applicant’s failure to pay the value of conforming documents. If the applicant does not pay the value of the conforming shipping documents within (6) months from the date of being notified of the documents’ arrival, the bank may sell the goods by public auction after notifying the applicant of the date and place of sale.

• In the Escrow Account:
  The sanction highlighted by the Controls in the event of the account trustee’s negligence is the delay fine, and it is understood from this that the Central Bank of Iraq issued the Real Estate Development Escrow Account Controls and set the sanction contained in Article (2/K) by imposing a delay fine of (5,000,000) Iraqi dinars (five million dinars) for each day of delay, or by replacing the account trustee in the event of default in releasing the payments according to the specified schedule.
  This aims to prevent the disruption of due disbursements in a manner that harms the project or the rights of buyers/financiers.

Accordingly, it can be said that the Documentary Credit is an independent banking payment mechanism that is activated through the formal precision of documentary conformity, and in which the bank remains a stranger to the sale relationship and its goods (Articles 273, 279, and 280).

As for the Escrow Account, it is a mechanism for the safekeeping and restricted disbursement of funds with a neutral third party, where the movement of withdrawals is determined by the fulfillment of executive and supervisory conditions (and in real estate development: the approval of the Investment Commission and a consultancy report), with sanctions imposed in the event of obstructing the release—making it closer to guaranteeing “the management of funds in line with progress of performance” rather than “payment against shipping documents.”

If you need a reliable law firm in Iraq to draft escrow agreements, ensure compliance, and protect your deal, contact Osama Tuma for Legal Services and Advisory today.