It is once again time to continue
our blog posts, and this time we have chosen a topic that surely interests most
of those involved in M&A deals, namely escrow arrangements.
As many of you know, escrow
agreements aim to secure buyer's right to monetary compensation in case of
claims and to provide protection for the due fulfilment of the seller's
post-closing obligations. Typically, this protection is needed after the seller has
already received his or her compensation, as without an escrow or similar
arrangement the seller could comfortably lay back and say "if they (the
buyer) want their money, let them sue me, and let the buyer work for his or
her money”.
Before
going into more detail on escrow agreements, let us take a bit wider view on
the matter and see what possibilities a buyer has in this regard already in the
SPA that does not refer to an escrow arrangement. In any case this issue has been discussed in all our deals at TRUST and included in one form or another in the documentation.
As
it often happens in real life, the buyer might predict already in the
negotiation phase that there could be problems in the future requiring him or
her to present a claim for monetary compensation to the seller. Here the
question naturally is: how could the buyer consider these?
Obviously,
one possibility is that the parties agree on some deferred payments on top of
the initial cash component, where the initial cash component would be payable
upon closing and the deferred payments later on, in which case the buyer would
merely set-off his or her claims against such deferred payment. However, as is
well known, set-off is not always available as it requires, among others, mutual
claims and that both amounts (the payment of the purchase price and claim) have
fallen due, which is not always the case. For instance, there might be a
situation where a part of the deferred payments should be paid within the near
future but at the same time the buyer sees that there are several
potential claims resulting in liability for the seller, which are not yet due. To
avoid the problem, it might be advisable for a prudent lawyer representing the
buyer to try to expand the scope of set-off a bit in the SPA, e.g., as follows:
"If at the time any deferred cash price or earn-out
purchase price is or will be due to be paid to any of the sellers, any
claim or receivable by the buyer against any of the sellers under this
agreement (such claim a "Counter-Claim")
may be set off by the buyer or withheld by the buyer until the Counter-Claim
becomes due and payable in respect of such Counter-Claim. The sellers hereby
waive all their rights to receive such deferred cash price or earn out purchase
price up to the amount of the withheld amount (until settled) and, in case of
set-off, up to the actual set-off amount. Any withheld sum under this Section
shall not carry interest..."
Here,
the buyer expands the scope of set-off by adding a right to withhold, enabling
the buyer to wait until the preconditions for the set-off are present.
As
regards traditional escrow arrangements, where a portion of the purchase price
is delivered to a third party stakeholder, it usually comes down to the
question of what would be the correct amount transferred to an escrow amount.
Typically, the buyer, in whose interest the arrangement is usually made in the
first place, wishes to have an as large an amount
as possible in
the escrow and for as long time as possible, while
the view of the seller is quite the opposite.
Unfortunately, it is however often
the case that there is no guidelines for determining the amount, unless there
are elements in the case that support a certain level, such as identified risks
and their possible monetary outcome if realized. In the absence of such
specifics, one could always use figures that reflect the market practice, if
available. As regards the term of the escrow, one could present a few
general rules that are often accepted: 1) it is never longer than
indemnification period; and 2) one
seldom sees periods significantly less than one year. Finally, an additional
point to consider is whether the escrow amount covers all claims or only the
representations and warranties in the SPA, but that is another matter subject
to negotiations,
and depends on the position and power of the parties in the negotiations.
To provide some guidance, let us
briefly summarize the structure and content of a typical escrow agreement.
Firstly, the background section could
be, for example, as follows:
"The parties entered into a share purchase agreement on
_________2015 (the "SPA") by which the seller has agreed to
sell and the buyer has agreed to purchase shares in _______________.
Pursuant to the SPA it has been agreed that the escrow amount
(USD 15,000,000) will be paid at closing into the escrow account with the escrow
agent.
The escrow amount shall be held as collateral for partial
satisfaction of the seller's obligations and potential claims against the seller
and it shall be paid out by the escrow agent in accordance with the terms of
this escrow agreement and the SPA.
This escrow agreement sets forth the terms on which the escrow
agent will hold and administer the funds to be held in escrow pursuant to the
SPA."
After background or the "WHEREAS"
clauses, the agreement usually states that an interest-bearing escrow account
shall be opened. Here one should pay attention to the fact that recently the
applicable interest rates have been negative, and there have been interesting
discussions whether one should actually pay something to banks, but typically banks
have waived these negative interests. Who is entitled to interest is also of
course relevant. A point which is evidently in the sellers interest as without the
escrow, the money would "work for them", but also something that the
buyer's typically do not present automatically in their first drafts.
The technical release of the escrow
funds is typically determined on the basis of the separate escrow agreement. In
this regard, it is worth noting that it is definitely in the buyer's interest
that the funds are released only upon joint instruction by both parties,
thereby excluding the possibility of the funds being released automatically, e.g.,
on the basis of a certain time period having lapsed (regardless of, e.g.,
pending claims). However, there seems to be a trend that in any case banks are
more and more reluctant to accept automatic releases and nowadays mutual
release is often required. There might be variations between the banks, but
this has been our experience from the past deals and this development naturally
negatively affects the Sellers.
When
determining the time for releasing the escrow funds, it is typically in the buyer's
interest to accept the release only after the audited annual accounts following
closing have been prepared, and the time
limits for presenting claims have lapsed (we will return to these time limits
in our future postings, so we encourage you to stay tuned!).
In order to provide additional protection, the escrow
account may also be subject to a pledge. A pledge may be recommended e.g. in in
distressed deals where there might be financial difficulties lurking behind the
corner, and a pledge would secure the release. Also, especially if mutual
release applies, a pledge in the escrow account (tilipantti in Finnish) might prove to be handy depending naturally
under what conditions such pledge may be realized.
To give you some more practical
tips, the beginning of the pledge section might look, for example, like this:
"Effective as of the date of the closing, the seller
as a continuing security for any claims and indemnities under the SPA hereby
unconditionally and irrevocably pledges to the purchaser, as a first ranking
security, all of its rights and interests in the escrow account, including the escrow
amount.
At any time upon or after the issuance of an
arbitration decision or any other binding and final judgment referred to in section
X to the benefit of the buyer, the buyer may to the fullest extent permitted by
applicable laws enforce all of its rights hereunder as well as any other rights
which a pledgee may have under applicable laws, and for this purpose dispose of
the escrow account, including the escrow amount (or any part thereof), in any
manner at its discretion. The pledge created hereunder and all obligations of
the seller in relation thereto shall continue in full force from the date of
the closing until the closing of the escrow account..."
Hopefully this gives to you a good
background on the matter and helps you navigate through tricky post-closing
claims you might have in your pocket.
Splendid Autumn for everybody and I
hope to see as many of you as possible in our house warming party on 12th
November (remember to register from here!). See you soon!
Regards,
Limppu
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