At a real estate closing, title companies typically escrow funds to
satisfy various outstanding obligations of a buyer or seller (or in
the context of a refinancing, the owner of the property).
These outstanding obligations, most commonly tax liens,
mechanic’s liens and judgments, would otherwise be deemed an
“exception” to title coverage. Title companies then use the
funds being escrowed (the “Escrow Funds”) to satisfy these
outstanding obligations, and “omit” these obligations from the
“exceptions to coverage” section (schedule B) of the title
policy. By omitting the exception to coverage, the title company
insures over the subject outstanding exceptions.
As a general practice, to accommodate their clients (the
buyer, seller or owner), title companies often place the Escrow
Funds into interest bearing bank accounts.
These accounts are typically identified by the client’s
name and the client’s federal tax identification number, or social
security number. This accommodation permits the title company’s
client to receive the accrued interest on the Escrow Funds.
But what happens when a judgment creditor of the client
endeavors to attach the Escrow Funds before the title company is
able to satisfy the outstanding obligation it has insured?
The title company can be forced into an awkward dilemma.
On the one hand, it has accepted the liability of the title
“exception” (by omitting it from the schedule of title
exceptions), on the other hand it may lose access to the very funds
that were escrowed to satisfy the outstanding exception that it is
now insuring. In this
event, if the judgment creditor successfully attaches the bank
account, a title company must choose between two distasteful
alternative courses of action: suing its client to replenish the
Escrow Funds (which brings with it obvious negative customer
relations issues), or, on behalf of its client, engage in a legal
battle with the judgment creditor over entitlement to the Escrow
This article will outline the legal issues that title
companies face, the applicable substantive and procedural law and
make suggestions as to what title companies can do when escrowing
such funds to avoid attachment by third party creditors while
maintaining good client relations.
Assume the following facts: In connection with a real estate
closing on February 15, 2000, a deposit and escrow agreement is
entered into between: (i) the building owner, John Owner; and (ii)
ABC Title Company, pursuant to which Escrow Funds are deposited with
ABC Title Company to hold and use to cure and ultimately remove an
outstanding exception and clear title.
The escrow agreement states that the Escrow Funds are to be
held in an interest bearing account.
After the closing, ABC Title opens a bank account at XYZ Bank
and identifies the account holder as “John Owner, social security
number 123-45-6789.” However,
the only signatory on the account is ABC Title Company because the
only party intended to have possession and use of the Escrow Funds
is ABC Title Company.
On March 15, 2000, Samantha Creditor, an unrelated third
party, procures a judgment against Mr. Owner and thereafter seeks to
enforce her judgment. Through
information subpoenas, she discovers the account at XYZ Bank in
Owner’s name and serves a restraining notice upon the bank.
Despite the fact that ABC Title opened the account, and that it is
the sole signatory on the account, banks typically take the position
that because Mr. Owner’s federal tax identification number was
used in connection with opening the account, the monies on deposit
belong to Mr. Owner. Therefore,
presumably XYZ Bank will obey the restraining notice and pay the
amount remaining in the account over to the judgment creditor.
position is not without merit.
Case law interprets section 5209 of the Civil Practice Law
and Rules (“CPLR”) as providing a bank with immunity from
liability when it pays out according to an execution where a
judgment creditor has specified certain property of the judgment
debtor as being subject to levy.
Chin v. Riggs Nat'l Bank, 670 N.Y.S.2d 187 (1st Dep't
1998) (Garnishee’s compliance with CPLR 5209 is a safe harbor that
pre-empts the judgment debtor’s common law claim that the
garnishee should have investigated the validity of the execution).
On the other hand, ABC Title contends that the designation of
Mr. Owner as the named account holder
and the use of his social security number were done solely for
convenience purposes and to clarify that the interest earned on the
escrow funds would be taxable solely to Mr. Owner, not to the title
PROCEEDINGS UNDER CPLR 5239
XYZ Bank is likely to be immune from liability should it pay out the
Escrow Funds as directed by a valid execution, the most appropriate
and most expedient remedy for the title company involves the
commencement of a special proceeding to determine adverse claims to
the Escrow Funds on deposit at the bank.
Such a special proceeding is the procedure authorized under
CPLR 5239. CPLR
5239 states in relevant part that:
Prior to the application of property or debt by a Sheriff or
receiver to the satisfaction of a judgment, any interested person
may commence a special proceeding against the judgment creditor or
other person with whom a dispute exists to determine rights in the
property or debt.
Special proceedings are
relatively speedy and abbreviated (though not inexpensive) court
proceedings sanctioned by Article 4 of the CPLR.
A notice of petition, petition and answer, take the place of
formal pleadings. Typically,
the proceedings are commenced by way of an order to show cause,
particularly where a temporary restraining order (“TRO”) is
required in order to preserve the status quo of the Escrow Funds
while the ultimate rights to relief are litigated.
A TRO request, pursuant to CPLR 6313, would seek to restrain
the bank from paying out the Escrow Funds to the judgment creditor.
In order to secure the TRO, however, a bond will need to be
filed with the order to show cause.
Additionally, in order to have the bonding company waive a
collateral deposit, the bonding company normally requires a copy of
the title company’s certified financial statement or annual report
to satisfy its underwriting requirements.
Since the bond premium and the financial statement or annual
report need to be delivered to the bonding company at least 24 to 48
hours before the TRO is requested, the application for the TRO bond
should begin promptly.
The venue for a special proceeding is dictated, under CPLR
5239, to be those counties specified under CPLR 5221(a).
The venue provisions involved are mandatory and can lead to
dismissal if not strictly followed.
In re Sharon Towers, Inc., 673 N.Y.S.2d 138 (1st Dep't
The ultimate success of the special proceeding under CPLR
5239 depends upon the title company’s ability to convince the
court that the Escrow Funds are not subject to the control of
the client (the named account holder), and that the special purpose
for which those funds were deposited still exists, that is, the
satisfaction of the client’s outstanding title exception.
The factual presentation in support of the application for
the special proceeding will need to include an affidavit attesting
to the special purpose for which the escrow account was established,
and that the title company is the sole signatory upon the escrow
account and the client has no ability or legal right to withdraw or
direct the disposition of funds in the account.
Copies of account cards, applications and bank statements
reflecting the account signatories should be produced as exhibits.
Also, perhaps the most relevant evidence of the title
company’s superior right to the Escrow Funds is the escrow
agreement (the “Agreement”) itself.
Some title company escrow agreements, for example, may
provide a specific purpose for which the Escrow Funds are to be use
by the depositary, the title company.
To the extent that the client retains any interest in the
Escrow Funds over and above the amount necessary to actually and
ultimately satisfy or discharge the outstanding obligation, such
excess does constitute the client’s property and will be subject
to levy and garnishment.
company’s request for relief is supported by Rafkind v. Chase
Manhattan Bank, 1992 WL 380291 (S.D.N.Y. 1992).
In Rafkind, the Court summarized the applicable law as
“A judgment debtor may contract with a third party to
withhold funds to which the judgment debtor would otherwise be
entitled, for purpose of paying certain of the judgment debtor's
creditors. See M.F.
Hickey, 258 N.Y.S.2d at 130 (1st Dept. 1965).
Once the judgment debtor has contracted away his rights to
funds to pay certain creditors, his interest in the funds is limited
to the funds remaining after such creditors are paid.
Id. (citing United States Fidelity & Guaranty
Co. v. Triborough Bridge Auth., 297 N.Y. 31, 37, 74 N.E.2d 226
(1947)). Any subsequent
judgment creditor has only a contingent interest in the funds that
vests only if there is a surplus after paying the other creditors.
See M.F. Hickey, 258 N.Y.S.2d at 130; see
also U.R.C. Inc. v. Applied Images, Inc., 106 Misc.2d
1034, 1040, 431 N.Y.S.2d 859, 862 (Sup. Ct. 1980) (citing M.F.
Hickey); United States v. Sterling Nat'l Bank and Trust Co.,
494 F.2d 919, 922 (2d Cir. 1974) (citing United States v. Hampton
Garment Co., 71-1 U.S. Tax Case 9357 (S.D.N.Y. 1971).
In so holding,
the Rifkind court relied in part upon M.F. Hickey, v. Port
of New York Authority, 258 N.Y.S. 2d 129 (1st Dept.
1965), where the Appellate Division, First Department, found that a
contractor had an “interest, albeit a contingent one, in the
withheld fund, and this interest will vest if any surplus remains
after the payment of all just claims. . . . Consequently, the
judgment creditor was entitled to a declaration that it will be
entitled to recover any such surplus as may remain.” Id. At
Other cases also
support the relief requested in the special proceeding.
For example, U.R.C. Inc. v. Applied Images, Inc., 431
N.Y.S.2d 859 (Sup. Ct. Nassau Co. 1980) has been widely followed in
New York State. Distilled
to its legal significance, U.R.C. holds that traditional
escrow or collateral deposits should be considered exempt from
execution, except for any “excess” over the balance due to the
party which established the escrow fund for security purposes.
have followed and applied the authorities collected in U.R.C.
in analogous situations where funds or property were placed for
security or collateral purposes.
In each instance, the controlling and determining factor
appears to be that the property in issue must be dedicated to a
specific bona fide purpose and placed beyond the
ability of the judgment debtor to control or assign such property.
American Federal Group Ltd. v. Rothenberg, 1998 WL
273034 (S.D.N.Y. 1998) (defendant had no power to assign or transfer
appeal bond or letter of credit securing it, therefore, plaintiff
could not attach either asset).
title company can and should claim that it holds a pledge of and
security interest in the bank account which was specifically set up
to be an escrow account in connection with a single transaction.
Typical title company escrow agreements include language to
the effect that in consideration of its obligations under the
Agreement, the client-Depositor assigns (and preferably
“pledges”) to the title company a security interest in the
Escrow Funds “superior to all other liens and claims.”
would satisfy the traditional requirement that in order for a
security interest to arise, the secured party must produce a written
agreement by which the debtor grants the secured party a security
interest in certain identified property.
In addition, however, the secured party must “perfect”
its security interest. In
this case, the filing of a UCC-1 Financing Statement is not
required, as Section 9-104 of the Uniform Commercial Code (“UCC”),
expressly excludes “deposit accounts” from the scope of Article
9. Perfection of a
security interest in property outside of Article 9 of the UCC
therefore requires that the secured party take possession of the
collateral and exercise dominion and control over the collateral to
the exclusion of the debtor. For
example, a passbook savings account would typically be pledged by
delivery of the passbook and a power of attorney to sign on the
account of the debtor to the secured party, thereby removing the
debtor's ability to access the bank account without the passbook,
and giving the secured party exclusive possession and dominion.
Escrow accounts related
to title policies typically will not lend themselves to the
convenience and certainty of a “passbook” type pledge.
Instead, a master account with individual sub-escrow accounts
for each individual client are typical with commercial banks.
Usually, the sub-accounts will carry account names such as
“ABC Title Company f/b/o John Owner” and carry the corresponding
Social Security or tax identification number of John Owner.
As a practical matter the title company needs to use the
client's name and Social Security number on the sub-account in order
to accurately account for and report interest income accruing on the
escrow deposit. However,
these practical necessities associated with tax reporting
requirements also present an inviting target for the judgment
creditor's information subpoena, restraining notice, or execution.
Collection firms often will blanket all financial
institutions in a specific area with information subpoenas and
restraining notices containing the judgment creditor's name and tax
identification number, knowing that most banks have a so-called
“liens and levies” unit which will attempt to match the
creditor's information against the bank's computer record of account
names and tax identification numbers.
A computer match or “hit” will generally cause an
automatic restraint on the account.
Fortunately, most banks provide notice to account holders of
any restraint or levy, thereby perhaps allowing the title company an
attempt at convincing the judgment creditor to voluntarily withdraw
the restraint. However, since the escrow account may (and usually
does) contain additional security by way of funds potentially in
excess of the amount that will actually prove necessary to cure any
insured title exceptions, voluntary dismissal of the escrow
restraint by the judgment creditor may prove problematic.
It would be wise to produce proof in any special proceeding
that the account in question: (i) was established by the title
company for payment of specific debts; (ii) was solely within the
control of the title company; and (iii) that such funds were
segregated funds pledged for a particular purpose.
If proven, these facts would enable the title company to make
a convincing argument that it had established a common law lien and
security interest in the Escrow Funds that comprise the portion of
the escrow account necessary to satisfy the subject outstanding
It is important to anticipate, however, that a judgment
creditor might argue that under UCC Section 9-305, a security
interest in “money” was not adequately perfected due to the
ambiguous designation placed upon the bank account by the title
company of the client’s name and the use of the client's federal
tax identification number on the account.
But UCC 9-305 allows a security interest in “money” to be
perfected by possession.
A practical way a party can “possess” the Escrow Funds is
by depositing them in a bank account which is carried in the name of
the secured party (i.e., the ABC Title Company of earlier
proposed revisions in UCC 9-109, one way for a secured party to
“control” a deposit account is to be named as the bank’s
“customer” on the account.
However, common law precedents in this area of security
interests in bank accounts are not entirely clear or uniform.
For example, in Miller v. Wells Fargo Bank, 540 F.2d
548, 560-63 (2d Cir. 1976), the Court rejected a pledge where the
account was solely in the name of the debtor and no “indispensable
instrument” was issued to the secured party to control the
account, such as a passbook. However,
the signature cards to the account and reliance upon the doctrine
set forth in M.F. Hickey Co., supra., should permit
the title company to prevail, assuming that the ambiguous title to
the bank account can be clarified by showing the title company as
the exclusive signatory on the account and by showing the exclusion
of any right in the client to transfer or assign those monies.
Although UCC 9-305 allows an interest in money to be
perfected by possession, UCC-9-104 excludes “deposit accounts”
from the scope of the filing requirements of Article 9.
Therefore, the filing of a UCC-1 financing statement is not
necessary or effective even under the revised Article 9 (the only
exception being Certificate of Deposit under the revised UCC
sections 9-311(a) and 9-310(a)).
and PRACTICAL SUGGESTIONS
dispositive test should be whether the client has the right to
direct the disposition of funds contained in the escrow account.
Once the Escrow Funds have been attached by a judgment
creditor, commencing a special proceeding is the only viable means
to protect the Escrow Funds.
Practical suggestions to assist a title company in this
A title company’s deposit and escrow agreement should
clearly recite the purpose for which the escrow funds are being
used, and that it has a superior right to the funds over all other
liens and claims, whether contingent or otherwise.
It may also recite that the designation of the client and the
client’s federal tax identification number is for the sole purpose
of assigning accrued interest to the client and that the client has
no rights in the underlying Escrow Funds until the obligation is
The deposit and escrow agreement should also be specifically
entitled as a security agreement (e.g., “Deposit, Escrow
and Security Agreement.”)
In addition to specifically granting (not merely assigning)
the title company a paramount security interest in the escrow
deposit, the Agreement should recite that the actual amount which
will be needed to cure the title defect is not capable of being
precisely known until the defect is actually removed.
Therefore, the title company's security interest extends to
all funds on deposit, to be held as collateral security against
additional costs, legal fees and the uncertainties inherent in
clearing a clouded title; and
Given the foregoing, title companies should seriously
consider using non-interest bearing accounts for small escrow
amounts or where the escrow is short-term.
In this way, by depositing the funds in one of their
segregated accounts, with no reference to the client, they can avoid
the attachment problem.
Under the pending revisions
to UCC Article 9 and UCC § 9-203(a)(1), security interests in
“deposit accounts” are enforceable if: (i) the secured party has
“control” pursuant to the debtor's agreement; or (ii) the debtor
has signed a security agreement that contains a description of the