Gain insights into the legal complexities of using set-off provisions in M&A transactions. Understand how disputes over indemnity claims can impact post-closing payments and buyer protections.
M&A Stories
October 14, 2020
Introduction:
When a business buyer purchases another company, they often worry that the acquired business might not match its advertised state. To manage this risk, buyers sometimes delay certain payments to the seller until after the deal is closed.
The Scenario:
In this case, a buyer acquired an online business and agreed to make post-closing payments to the seller. The agreement also allowed the buyer to deduct amounts it believed the seller owed under the deal.
The Disagreement:
After the deal closed, the seller disputed the buyer’s claims for adjustments to the purchase price and indemnification. In response, the buyer held back a payment of $500,000 using the set-off provision in the purchase agreement.
The Dispute’s Legal Path:
The disagreement ended up in a Louisiana state trial court. The seller argued that the buyer couldn’t use the set-off provision for disputed claims because they were not confirmed and thus not considered as “owed” under the agreement.
The trial court agreed with the seller’s interpretation. The buyer then appealed to a higher court, which posed the question of whether the buyer’s claims for indemnification had to be clear before applying the set-off provision. The appellate court ruled that the buyer could only use the set-off provision for claims that were confirmed, as “confirmed” essentially meant “owed.”
This case is referred to as Admin-Media, LLC v. AC of Lafayette, LLC, No. 19-691, Court of Appeal of Louisiana, Third Circuit, (March 11, 2020)
Insight:
If the post-closing payments were held in an escrow account as part of a well-structured escrow arrangement, the dispute could have been resolved without affecting the payment process.
Another consideration is when deferred payments are outlined in a promissory note with an acceleration clause. If the buyer invokes the set-off right, they risk speeding up the repayment of the entire note’s balance.
To address this, the ABA Model Asset Purchase Agreement’s set-off provision offers protection to the buyer. It states that the buyer’s good-faith use of the set-off right, even if later found unjustified, won’t trigger a default event under the Promissory Note or any associated instruments.
By John McCauley: I help people manage M&A risks involving privately held companies.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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