Friday, 30 October 2015

SPA Series Part 9: How to Negotiate M&A Deals in Finland - Escrow Arrangements, Set-Off and Other Similar Tricks

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!