Purchasing a business? Consider a holdback
Purchasers face the issue of asymmetric information when buying a business. Extensive due diligence will help fill in the gaps in knowledge and minimize the risks of surprises, but post-closing liabilities can still be a concern. Once the transaction is closed and funds are paid to the Vendor, it is often difficult and costly to recover the costs of unexpected liabilities from the Vendor.
Purchasers may consider negotiating a holdback, which is a portion of the purchase price that is deposited into a third-party escrow account instead of being paid to the Vendor on closing. The holdback can be used to setoff any costs incurred by the Purchaser for the Vendor’s breach of representations and warranties in the purchase agreement, or even for specific liabilities that the parties are aware of but do not know the exact amount of as of the date of closing (e.g. pending litigation). The holdback is governed by an escrow agreement between the parties and the chosen escrow agent. The escrow agreement, among other things, will indicate how long the holdback will be held for and the conditions for disbursing funds. The law firms involved in the transaction are often tasked with being the escrow agent.
By having the funds available in an escrow account, Purchasers can have the peace of mind knowing that the funds will be available if required.
– Felix Ng, Associate Corporate Counsel
© Kalfa Law 2019