Allocating the Risks of Embezzlement by an Escrow Holder: Bio-electronics v. C and J Partnership, 268 Neb. 252, 682 N.w.2d 248 (2004)

• Publication year: 2021

84 Nebraska L. Rev. 1266. Allocating the Risks of Embezzlement by an Escrow Holder: Bio-Electronics v. C and J Partnership, 268 Neb. 252, 682 N.W.2d 248 (2004)

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Allocating the Risks of Embezzlement by an Escrow Holder: Bio-Electronics v. C and J Partnership, 268 Neb. 252, 682 N.W.2d 248 (2004)

TABLE OF CONTENTS

I. Introduction ...................................................... 1266
II. Legal Background ................................................. 1268
A. Development of the Entitlement Rule: Ownership
and Agency .................................................... 1268
B. Equitable Considerations in Risk Allocation ................... 1270
III. Factual Background .............................................. 1270 I
V. Analysis ......................................................... 1273
A. Ownership Theory .............................................. 1273
B. Agency Theory ................................................. 1274
C. The Least Innocent Bears the Loss ............................. 1276
1. The District Court Opinion ................................. 1276
2. The Possible Role of the Least Innocent Theory
in the Nebraska Supreme Court's Decision ................... 1277
V. Conclusion ........................................................ 1278

I. INTRODUCTION

In real estate transactions, escrows are often used to help facilitate the deal and provide piece of mind to the parties involved. In the typical escrow arrangement, the seller agrees to place the deed and other documents related to title of the property with a disinterested third party who serves as the escrow holder or agent.(fn1) The buyer similarly

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deposits all or a portion of the purchase price with the escrow agent. These items are held in escrow until the conditions set out by the two parties in the escrow agreement are met.(fn2) Upon occurrence of the stated conditions, the escrow agent delivers the deeds or documents to the buyer and the money to the seller, thus completing the transaction.(fn3)

The use of an escrow is beneficial in these transactions because it protects both parties--neither is left vulnerable to fraudulent acts by the other. The escrow holder essentially acts as a safeguard during the transitional period when the ownership of the property is in limbo. Unfortunately, both parties are still exposed to the possibility of fraudulent or negligent behavior on the part of the escrow agent who is supposed to be protecting them. One potential problem of the escrow arrangement is that the escrow holder will take advantage of the position of trust in which he has been placed and embezzle the money under his custody.(fn4)

Determining which party should bear the loss when the funds are embezzled by the escrow holder is often a difficult and troublesome task. The one who is responsible for the hardship has typically either disappeared or become insolvent, so the two parties to the transaction are left to battle between themselves over the missing funds. An equitable remedy seems impossible in such a situation as both parties are generally innocent of any wrongdoing.(fn5) The inevitable result is that one blameless party will suffer a substantial loss while the other will still reap the benefits of the deal.(fn6)

This unfortunate situation is exactly where the parties in Bio-Electronics v. C and J Partnership (fn7) found themselves. In deciding this case, the Nebraska Supreme Court backed away from the previous escrow embezzlement jurisprudence where the purchaser alone had to bear the risk of loss. Instead, the court focused its analysis solely on a technicality of the Nebraska Uniform Commercial Code ("U.C.C."), with

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almost no reference to the way loss allocation has historically been applied.(fn8)

Part II of this Note explores the development of the rules behind allocation of risk in an escrow transaction, focusing in particular on two cases that had significant roles in establishing these rules. Next, the factual background of Bio-Electronics is discussed in detail in Part

III. In Part IV, this Note discusses the implications of the court's holding in relation to the theories of ownership and agency in loss allocation, suggesting that this decision seems to put these two theories at odds in the rare situation like the one involved in Bio-Electronics. In addition, this Note addresses the underlying policy considerations that, although not discussed by the court, may have been at the heart of the holding. Finally, in Part V, this Note concludes that because of the unusual facts of this case and its somewhat anomalous result, the court's holding should and will be narrowly limited in its application to future cases.

II. LEGAL BACKGROUND

A. Development of the Entitlement Rule: Ownership and Agency

Every jurisdiction that has addressed the issue of escrow loss has turned to what has been referred to as the "entitlement rule" in deciding which party must bear the loss.(fn9) This rule has generally been credited to two separate but similar California cases: Hildebrand v. Beck (fn10) and Shreeves v. Pearson .(fn11) While both cases arose out of the misconduct of the same escrow agent, the California Supreme Court based its findings for these cases from two somewhat different theories of liability.(fn12)

In Shreeves, the first of the two cases, the seller and buyers entered into an agreement for the sale of real property. The transaction was to take place through an escrow, conditioned upon the seller's ability to deliver a valid deed to the property and to prove that she had an unencumbered title.(fn13) During the period before all the conditions were met, the parties agreed that the buyers would take immediate possession of the house prior to the close of the escrow, and in consideration, the seller would be paid a portion of the funds held in escrow.(fn14) The

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seller was issued a check from the escrow company, which was returned unpaid, and the escrow agent subsequently disappeared with the funds.(fn15)

The seller prevailed in an action to regain possession of the premises. The court based its holding on the theory of agency, stating that the escrow holder is the agent of the buyer with respect to the money, and the agent of the seller with respect to the deed or other documents. The escrow holder's role does not change until each party has become completely entitled to the item that is to be transferred to him under the agreement.(fn16) Before all the conditions precedent to the exchange have been met with respect to the money in escrow, the escrow holder remains the agent of the buyer or the depositor.(fn17) In Shreeves, all the conditions of the escrow had not been met at the time of the embezzlement, and as a result, the buyers had to bear the loss caused by their agent.(fn18)

In Hildebrand, the court employed a different theory to reach the same conclusion that the buyer must bear the risk that his funds will be embezzled before the time to complete the transaction has arrived. The facts were substantially similar to those of the Shreeves case: the buyer of property deposited the purchase price in escrow, which was then embezzled before the title to the property could be guaranteed as required by the terms of the agreement.(fn19) This time, the California Supreme Court focused not on the relationship of the escrow agent to each party, but instead on the ownership of the funds.(fn20) The court determined that because the money was embezzled before all the conditions of the exchange had been satisfied, it remained under the ownership of the buyer and was therefore the buyer's money to lose.(fn21)

These two theories both lead to the rule that the "wrong of an escrow holder, must, as between the parties to the escrow transaction, be borne by the one who, at the time of its occurrence, was lawfully entitled to the right or property affected."(fn22) However, while both theories lead to the same conclusion, most jurisdictions seem to address the issue in terms of ownership, as in Hildebrand, instead of using the

1270 agency terminology of Shreeves .(fn23) Nebraska follows the general rule that "if an escrow agent `embezzles the funds before the time has come to release them, he has embezzled the funds of the depositor.'"(fn24) This language is also more in line with the allocation of risk based on ownership; however, Nebraska has referred to the agency theory as well in escrow cases.(fn25)

B. Equitable Considerations in Risk Allocation

One final consideration in allocating loss is the rule that "when one of two innocent parties must suffer, the one [who] made the occurrence of...