M&A Stories
Discover how to prevent the “Cash Hostage” squeeze in lower middle market M&A deals. When buyers refuse a “No Setoff” provision, sellers often surrender control of their deferred payments—but they don’t have to. This post analyzes the 2023 ruling in SAT Technology, Inc. v. CECO Environmental Corp. to demonstrate how a “Restricted Setoff” clause can ring-fence critical payouts like Seller Notes and consulting fees. Learn why negotiating the specific sources of setoff is a vital risk management tool that keeps your cash flow secure, even when post-closing disputes arise.
December 1, 2025
In the lower middle market, it is rare for a seller to walk away from the closing table with 100% of the purchase price in cash. To bridge valuation gaps or finance the deal, sellers frequently agree to deferred payments. These often take the form of Seller Notes, earnouts, consulting agreements, or payouts for specific assets like inventory or accounts receivable.
To a founder relying on these proceeds for retirement or a new venture, these deferred payments are just as real as the wire transfer at closing. To a sophisticated buyer, however, these future payments often represent something else entirely: a source of leverage.
The nightmare scenario for any seller is the “Cash Hostage” squeeze. This occurs when a buyer alleges a post-closing breach—perhaps a warranty claim or an accounting dispute—and immediately stops making payments on the Seller Note or other deferred obligations. The buyer effectively uses the seller’s own money to fund the dispute, forcing the seller to sue to get paid.
Sellers often try to prevent this by demanding a “No Setoff” provision, which forbids the buyer from withholding payments for any reason. However, sophisticated buyers often reject this outright. They argue that if the seller breaches the contract, the buyer should not have to keep writing checks.
When the buyer says “no” to a No Setoff provision, many sellers make the mistake of giving up and accepting a standard Broad Setoff clause. A 2023 decision from a federal court applying Delaware law, SAT Technology, Inc. v. CECO Environmental Corp., demonstrates why sellers should instead pivot to a middle ground: the Restricted Setoff.
The transaction in this case involved the sale of a private Delaware corporation to a public company buyer. The deal structure included several post-closing adjustment mechanisms. The buyer held back $100,000 in escrow for working capital adjustments. Separately, the buyer agreed to pay the seller for any accounts receivable collected and inventory sold after closing.
Months after the deal closed, the buyer alleged that the seller had misrepresented the company’s financials. The buyer claimed there was a massive working capital shortfall of nearly $700,000.
At the same time, the buyer admitted that it owed the seller approximately $383,000 for collected accounts receivable and sold inventory. However, the buyer refused to pay this amount. They argued that because the seller owed them $700,000 for the working capital breach, they had a right to set off the debts and withhold the inventory and receivables payments.
The buyer was attempting to use the “self-help” remedy found in many standard merger agreements. If a seller agrees to a Broad Setoff Clause, a Seller Note effectively becomes a second indemnity escrow. The moment a dispute arises, the checkbook closes. The burden of litigation shifts entirely to the seller, who must now pay legal fees while their expected cash flow is frozen.
In this case, the seller avoided that fate because their counsel did not accept a broad right of setoff. Instead, they negotiated a Restricted Setoff Clause.
The Purchase Agreement explicitly stated that if the buyer had a claim, they could offset that loss against two specific sources of funds: the Earn-Out payments and the $100,000 Working Capital Holdback. Crucially, the contract did not list the inventory payments or the accounts receivable payments as eligible sources for setoff.
The Ohio federal district court ruled in favor of the seller on this issue. The judge noted that the parties had negotiated a specific list of sources available for setoff. By explicitly listing the Earn-Out and the Holdback, but failing to list the inventory and receivables payments, the contract implicitly forbade the buyer from touching those other funds.
Even though the buyer claimed the seller owed them nearly $700,000, the court ordered the buyer to pay the $383,000 in inventory and receivables proceeds immediately. The buyer was not allowed to squeeze the seller’s cash flow.
The SAT Technology case offers a pragmatic blueprint for private sellers. When a buyer refuses to agree to a “No Setoff” provision, the negotiation is not over. The seller should pivot to a Restricted Setoff.
Sellers should identify their most critical streams of post-closing cash—typically Seller Notes or consulting fees—and fight to exclude them from the setoff provision. The goal is to “ring-fence” these payments. If a buyer alleges a breach, they should be required to pursue a claim against the escrow or file a lawsuit, rather than simply turning off the tap on the seller’s monthly payments.
By narrowing the scope of the setoff clause, the seller in SAT Technology ensured that a dispute over accounting did not freeze their liquidity. For lower middle market owners, ensuring that a Seller Note is treated as a debt obligation, and not an offset account, is a vital step in securing the full value of the deal.
See: SAT Technology, Inc. v. CECO Environmental Corp., Case No. 1:18-cv-907, United States District Court, S.D. Ohio, Western Division (September 19, 2023).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.
By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5
and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM
Legal Disclaimer
The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.
Recent Comments