Daily Development for Thursday, November 18, 1999

Daily Development for Tuesday, November 23, 1999

By: Patrick A. Randolph, Jr.
Professor of Law
UMKC School of Law
Of Counsel: Blackwell Sanders Peper Martin
Kansas City, Missouri
randolphp@umkc.edu

Thanks to Edward Hill of the Connecticut Bar for this choice little tidbit. Note the class action implications if this case proves to have general application.

VENDOR/PURCHASER; ESCROWS: Funds deposited with an attorney or agent for a party cannot be viewed as a valid escrow regardless of parties' intent.

Galvanek v. Skibitcky 55 Conn. App. 254, 738 A.2d 1150 (1999)

Buyer and Seller were negotiating over the sale of a condominium unit in a small complex facing Long Island Sound. Some time before, a hurricane had damaged the seawall in front of the complex. The owners' association had obtained an estimate of $60,000 to repair the seawall, and had announced an assessment of $7500 per unit to pay the cost.

The parties apparently agreed that the Seller would be responsible for the assessment. It appears, however, that as of the time of closing, the assessment was not yet due and payable the court does not explain why this was the case. The parties agreed upon an addendum stating as follows:

"It is further agreed and understood by the parties hereto, that the seller shall place in escrow the sum of $7500 to be used for proposed future assessment to repair or improve the embankment. . . . Said escrow shall be held by the seller's attorney in an interest bearing account, interest going to the seller, who will then pay the assessment when billed up to, but not exceeding $7500."

Seven years later, again for reasons not explained by the court, the association had never carried out the planned repair or the planned assessment. The association then voted to absolve the units of the assessment responsibility. Seller brought an interpleader action demanding that the money held by Seller's attorney be returned to him. Buyer opposed the motion on the grounds that the agreement for the escrow did not set a termination date, and presumable that as a consequence the escrow remained in effect for "possible future assessments to repair or improve the embankment."

The trial court, ruling eleven years after the original agreement, concluded that the parties necessarily intended this escrow to be shorter term than eleven years, that its purpose never came to pass, and ruled for Seller.

On appeal: held: Affirmed, but on different grounds.

The Connecticut Court of Appeals dodged the somewhat tricky question of whether the parties in fact intended a term on the escrow and instead ruled that the escrow was an invalid escrow from the outset because, under Connecticut law, there can be no escrow with an attorney of one of the parties. Consequently, as there was no valid escrow, the monies must be returned to the Seller. The attorney held the money as Seller's agent, and not as an escrow.

The court relied upon another recent Connecticut case, Kallas v. Harnen, 48 Conn.App. 253, 258, 709 A.2d 586, cert. denied, 244 Conn. 935, 717 A.2d 232 (1998). In Kallas, also involving the sale of a condominium, the buyer deposited earnest money in an escrow with the seller's attorney. Subsequently, for reasons not explained by the court, the attorney failed to return the escrow monies to buyer and the buyer sued the seller. The seller defended on the grounds that the seller was not responsible for the escrow, and that the buyer's sole remedy was against the escrow holder. The court disagreed, holding that there was no valid escrow when the property was held by an attorney *or agent* of one of the parties and that the seller was responsible for the failure by seller's agent to return the funds. The Kallas court relied, in turn, upon a Pennsylvania decision, Paul v. Kennedy, 376 Pa. 312, 102 A.2d 158 (1954) in which a seller was bound to complete a sale after a broker, seller's agent, absconded with the purchase proceeds.

Comment 1: Eleven years. Too bad the parties didn't provide that the escrow would be invested in Microsoft stock.

Comment 2: All joking aside, this case, if right, and if followed elsewhere, has significant implications. Of course it's a terrible idea for an attorney to act as escrow, in light of the professional responsibilities of loyalty to one client. Can there be adequate disclosure of the inherent conflict here? In any event, the editor doubts that where these situations arise, the attorney already demonstrably a bonehead would have the savvy to even attempt to make disclosure and seek waivers.

But note that the case also applies to brokers, and it is quite common, although equally boneheaded, for a seller's broker to provide in standard form agreements that the broker gets to hold the escrow monies. In fact, in the editor's area, broker's form contracts provide that the broker gets to keep the interest on the escrow money.

This case would invalidate all those escrows. Is there a class action here for all the interest earned by the brokers?

Comment 3: Note that the invalidation of the escrow shouldn't necessarily invalidate the terms of the agreement, although that appears to be the practical result of the court's decision in this case. Let us assume, for instance, that the seawall had been built and the assessment levied. Under the reasoning of this case, the Seller could have instructed the attorney not to use the escrowed funds to pay the assessment, and the attorney would have had a duty to obey, even to the extent of returning the escrowed funds to the Seller.

But shouldn't the Buyer in a case like this then have an action against the Seller to enforce the agreement that the funds be placed in a true escrow? In fact, wasn't there a mutual mistake of law that the attorney was serving as the escrow for both parties, justifying a reformation of the contract?

Comment 4: All the editor is saying is that the court really should have undertaken the hard work of evaluating whether there really was an implied time period in the escrow agreement. Instead, it swept the problem under the rug and created uncertainty as to the validity of all escrow arrangements where the parties manifestly intend that one of the parties' agents hold the funds. Note that the cases relied upon were different in that the agent had defalcated. Here, the question was not one of allocating an unforeseeable loss, but rather one of carrying ouit the intent of the parties.

Readers are urged to respond, comment, and argue with the daily development or the editor's comments about it.

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