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Negotiating and Drafting M&A Escrow Agreements
Practical Law Legal Update 1-549-7438 (Approx. 6 pages)
Negotiating and Drafting M&A Escrow Agreements
by Practical Law Corporate & Securities
| Published on 21 Nov 2013 • USA (National/Federal) |
A discussion of the negotiation and drafting of escrow agreements for private M&A deals, drawing from Practical Law resources.
In private M&A transactions, the buyer often requires that a portion of the purchase price be held back until a later date to satisfy the seller's post-closing obligations. These obligations are most commonly either potential indemnification claims, a purchase-price adjustment payable to the buyer, or both. In return for agreeing to a holdback, sellers typically prefer that these amounts be placed into escrow with a third-party escrow agent, rather than being retained by the buyer.
To establish the escrow, the parties enter into an escrow agreement with an escrow agent to set out the terms and conditions by which the escrow agent holds and distributes the escrowed funds. In most M&A transactions, the escrow agent is a bank or other financial institution that often has its own set of standard terms and conditions for the escrow agreement. In some cases, the escrow agent insists on using its own form of escrow agreement, but usually the agent is amenable to negotiating the terms to avoid conflict with the terms and conditions negotiated between the buyer and seller.
Practical Law Corporate & Securities contains several resources that guide the negotiation and drafting of the escrow agreement.
M&A Escrow Agreements Checklist
Negotiating M&A Escrow Agreements Checklist sets out the key issues negotiated between the buyer and seller once they have agreed to establish an escrow of a portion of the purchase price, along with the typical positions or concerns of each party regarding these issues. It also describes certain key considerations for escrow agents, including both negotiated and non-negotiated points.
The Checklist divides the issues into three categories:
- Issues negotiated between the buyer and seller before involving the escrow agent, including, among others:
- the obligations covered by the escrow;
- whether or not the escrowed funds should be held in one account, even if they are securing multiple obligations;
- the amount of the escrow and length of the escrow period; and
- the release of escrowed funds.
- Issues for negotiation often raised by the escrow agent, such as:
- the buyer and seller's indemnification of the escrow agent;
- the compensation of the escrow agent;
- the governing law and venue for disputes.
- Non-negotiable issues for the escrow agent, including:
- disclaimers of any obligation or duty to advise, recommend or make investment decisions;
- disclaimers of liability for losses sustained by the parties related to their investment choices;
- a requirement that all instructions to the escrow agent to be in writing and signed by designated authorized representatives of the applicable party or parties; and
- disclaimers of any fiduciary or other implied duties or obligations or any knowledge of terms of other agreements between the parties.
For each negotiated issue, the Checklist presents in table format the position of the buyer, seller and escrow agent, as applicable. For example, on the issue of whether to establish a single escrow account or multiple accounts for each respective obligation, the buyer and seller's positions are presented as follows:
Issue | Buyer's Position | Seller's Position |
Consolidated or Separate Accounts | Hold all escrow funds in one account, even if they are securing multiple obligations, to ensure all escrow funds are available to satisfy the seller's obligations. If the buyer agrees to multiple accounts, ensure that escrow funds from one account can be used to satisfy obligations that may be secured by another account. For example, if there are separate accounts for purchase price adjustment and indemnification claims, the buyer may want escrow funds in the indemnification escrow account available to satisfy any purchase price adjustment in excess of the amount held in the purchase price adjustment escrow account. | Hold escrow funds in separate accounts with different escrow amounts and disbursement dates if there are multiple obligations being secured by the escrow. Explicitly state that escrow funds held in one account are not available to cover liabilities that are covered by another account. |
Standard Escrow Agreement
Practical Law's Standard Document, Escrow Agreement assumes an escrow that secures the seller's obligations to pay any adjustments to the purchase price and any potential indemnification claims. The agreement is drafted in favor of the buyer, but aims to be reasonable and includes provisions commonly included in many escrow agreements. As with all Practical Law Standard Documents, the escrow agreement has integrated drafting notes with important explanations and negotiating tips.
For example, on the issue of whether the escrowed funds are to be contained in a single, consolidated account or in multiple accounts for each secured obligation, the agreement provides in Section 2 for a single account. The Section reads in part:
2. Escrow Deposit. Simultaneously with the execution and delivery of this Agreement, $[DOLLAR AMOUNT] (the "Escrow Amount") have been deposited, by wire transfer of immediately available funds, with the Escrow Agent pursuant to Section [NUMBER] of the Purchase Agreement. The Escrow Amount, together with all interest, dividends, income, capital gains and other amounts earned thereon or derived therefrom ("Escrow Income") pursuant to the investments made on such amount pursuant to Section 3 (collectively with the Escrow Amount, the "Escrow Funds"), will be available (a) for the payment of any [Post-Closing Adjustment] owed by Seller to Buyer pursuant to and in accordance with Section [NUMBER] of the Purchase Agreement and (b) to satisfy any [Losses] incurred or sustained by, or imposed upon, the [Buyer Indemnitees] that are recoverable by the [Buyer Indemnitees] against Seller pursuant to and in accordance with the provisions of Article [NUMBER] of the Purchase Agreement [...]
The Drafting Note to this Section describes the debate between the buyer and seller on this issue and offers alternative language to each party for its position. The following is the relevant section of the Drafting Note:
Single Account versus Separate Accounts
This escrow agreement includes a single escrow account in which the escrow funds are held even though the escrow is securing multiple obligations. In this case, the escrow agent holds all the escrow funds until they are depleted from paying the buyer's claims for purchase price adjustment and indemnification amounts or until the expiration of the escrow period, whichever is earlier.
Buyer
A buyer should try to have one consolidated escrow fund to secure all of the seller's obligations. This ensures that all of the escrow funds are available to satisfy the seller's obligations, even if one of the seller's obligations has already been satisfied.
If the buyer agrees to have multiple escrow accounts, it should try to ensure that funds from one account may be used to satisfy obligations that may be secured by another account if that account has not been released. For example, if there were separate escrow accounts in this escrow agreement and the buyer wanted the indemnification escrow to be available to satisfy a purchase price adjustment in excess of the amount in the escrow account for the purchase price adjustment, it can define the two separate escrow accounts and funds in this Section 2 and include the following when describing the purpose of the indemnification escrow:
"...and for the payment of any [Post-Closing Adjustment] in excess of the [Purchase Price Adjustment Escrow Funds]."
Seller
If there are multiple obligations being secured by the escrow, the seller should try to create separate escrow accounts with different escrow amounts and disbursement dates. This allows the seller to get some of the escrow funds back earlier (assuming the escrow account is not entirely exhausted by the obligation it is securing).
If the buyer agrees to have multiple accounts, the seller may want to limit the use of one escrow account to the particular obligation it is securing. For example, if there is an escrow account securing the seller's indemnification obligations, it cannot be used to pay the seller's purchase price adjustment obligation even if the escrow account for the purchase price adjustment is not sufficient to pay the entire obligation. The following is an example of language the seller may want to add:
"No Escrow Funds held in any one Escrow Account shall be used for the purposes of the other Escrow Account[s] or for any other purposes other than as set forth in this Agreement, including in the event that any Escrow Amount held in another Escrow Account shall become exhausted or released."
Market Practice
Parties negotiating an M&A deal often appeal to market practice to either resolve an issue in dispute or at least inform the negotiation. To that end, Practice Note, What's Market: Indemnification Provisions in Acquisition Agreements updates, on a quarterly basis, with examples of recent publicly filed private acquisition agreements contained in What's Market. This Practice Note provides a summary of the agreed-upon escrow, among other indemnification-related provisions, for each deal contained in the table, and links to the underlying provisions of the purchase agreement. For example, for three recent transactions containing indemnification provisions, the table provides the following summaries:
Deals | Escrow |
$18 million (10%) held in accordance with the escrow agreement (not publicly disclosed), to cover (i) Seller's indemnification obligations and (ii) at Buyer's election, any purchase price adjustment amount payable to Buyer if Seller fails to timely make payment (subject to subsequent reimbursement of the escrow fund by Seller). | |
5% of the adjusted purchase price held in escrow for 180 days after closing, to cover Seller's indemnification obligations and any purchase price adjustment amount payable to Buyer. Escrow is delivered at signing and will either be returned to Buyer or paid to Seller if the purchase agreement is terminated. | |
None |
More recent summaries and market information can be found in the What's Market database of private acquisition agreements. Simply narrow the selection of deals as desired using the facets on the left-hand side, checkmark the deals chosen for comparison, click the "Compare" button and select field No. 17, "Escrow," to compare the escrow provisions among the selected deals.