One of the common tools to mitigate transaction risk is a holdback escrow, where the buyer can retrieve funds in escrow if the seller fails to meet certain terms of the purchase agreement. There are numerous benefits to holdback escrows, such as broad claim coverage, publicly-available payout statistics to assist with cost estimation, and shared risk between buyer and seller.
For practitioners curious about how best to structure holdback escrows in their deals, J.P. Morgan’s 2018 M&A Holdback Escrow Study summarizes recent holdback escrow trends by analyzing 3.5 years of its M&A transactions containing these provisions:
- Amount in escrow: The amount of the consideration put into escrow can be significant, with a median of 8.6% of the purchase price. However, this decreased to a median of 6.1% for deals closed in the last 12 months of the Study. This decrease may partially reflect the recent trend toward larger deals, which tend to have a smaller percentage of the purchase price placed into escrow. The amount in escrow also varies by industry. The information technology sector had the highest average percentage of purchase price in escrow (10.8%) while the energy sector had the lowest (6.9%).
- Indemnity Claims on the Escrow Amount: The most common type of indemnity claim on the escrow amount was for taxes (27%). Litigation claims (25%) and financial statement claims (23%) were the next most common claim types, although many claims contained multiple claim types. Although reasons for litigation claims were usually not provided, commonly stated reasons were for patent infringement and employee-related claims. Financial statement claims were split between misstated assets and misstated liabilities. The industrial sector had the lowest frequency of indemnity claims (10%), while the consumer sector had the highest (22%). There was also a significant reduction in environmental claims over the course of the study.
- Amount of Escrow Paid: Estimating potential liabilities can be difficult, but the publicly-available data for escrow payouts can help parties estimate costs when issues arise. In the 3.5 years of the study, the average percent of the escrow paid for individual claims increased from 51% to 70%. However, as noted above, the amount of the purchase price that was put into escrow also decreased in that time. The average indemnity claim amount was 43% of the value of the escrow.
- Timelines: 88% of escrow agreements specified claim objection periods of 10, 15, 20 or 30 days, with 30 days appearing in 52% of agreements. Initial objections were received within 2 weeks on average, with claims resolved in a median of 73 days (although outliers increased the average to 160 days). Employee-related or financial statement claims had the shortest resolution times while litigation and tax-related claims had the longest average time.
- Structure: 30% of deals had escrows that were bifurcated for distinct purposes. These generally specified a primary general indemnification account with one or more secondary accounts, usually for tax-related indemnity. The buyer and seller generally split the escrow fees (80% of deals), but one party, usually the seller, received the interest over time (58% of deals).
This study provides useful insights into how best to structure holdback escrows to account for typical payouts, timelines, and variations across claim types and industries. In order to facilitate payments from the holdback escrow, the study’s authors recommend that law firms partner with banks to create templates that incorporate these practical considerations. As always, precise drafting is key. Agreements should clearly spell out applicable timelines and all steps in the claim process, including a cut-off date and the specific processes by which parties can submit a claim and/or object to asserted claims.
The author would like to thank Jamie Parker, articling student, for his assistance in preparing this legal update.
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