Lesser-known aspects of M&A escrows can sometimes derail an otherwise smooth post-closing process. Use these ideas on your next M&A transaction to minimize friction and complicated delays.
The purpose of an escrow in an M&A transaction is to provide a source of recovery for the buyer in case the sellers are required to indemnify the buyer under the terms of the acquisition agreement, whether due to a breach of the agreement or otherwise. That said, escrows can be tricky to structure and manage on the road toward a smooth M&A deal conclusion. The team at SRS Acquiom has been engaged on more than 6,000 deals to date and has a unique vantage point to see various escrow structures and the challenges that can occur. Knowing these potential pitfalls can help ensure your journey through the post-closing process is a smooth one.
Merger Consideration: Account for Unclaimed Transaction Proceeds
Unclaimed merger consideration is generally a liability of the buyer to non-redeeming selling shareholders. This is why merger agreements usually provide that unclaimed closing consideration will be held by or returned to the buyer after a specified period of time, typically one year following the closing date. Eventually, however, this unclaimed property will be deemed abandoned and escheat to the state after a period provided by statute. Under these laws, the buyer is generally considered the holder of these funds, even when the funds are held by a paying agent or an escrow agent. Thus, the buyer is ultimately responsible for determining which state’s laws apply, reporting any abandoned property to the applicable state treasurer, and transferring that property. Failure to comply with these rules can result in penalties or fines.
This is one of several reasons why a shareholder representative should resist the notion of accepting released escrow funds for further distribution to shareholders. Accepting such funds could deem the representative the holder of any unclaimed property and subject it to the reporting, recordkeeping, and property transfer requirements of multiple and varying state escheat laws. Released escrow funds should be sent instead to the buyer’s paying agent, where they will be processed under the terms of the paying-agent agreement, which usually explains what is supposed to happen to unclaimed funds.
Sometimes SRS Acquiom is asked, “But, why can’t you just re-allocate the unclaimed consideration to the other shareholders’ pro rata?” Intuitively, this has some appeal. The selling shareholders might argue that the buyer should have to pay the full purchase price for the business, and that amount should be split among the shareholders that can be located. Unfortunately, that is not the way the law works. Merger consideration payable to a shareholder is generally considered property of that shareholder under abandoned property laws, and these laws provide no authority for reallocation. Rather, the laws preserve the right of the lost shareholder to claim those funds from either the buyer or the state. Therefore, the buyer effectively pays the full purchase price, with some shareholders failing to claim their portion.
Multi-Party Notice Provisions: Avoid Disappearing Money
An acquisition agreement typically requires the buyer to give notice of any indemnification claims to both the shareholder representative and the escrow bank. Many escrow agreements contemplate that if the representative does not object to a claim on behalf of the shareholders within a certain period after notice is given to the escrow bank, the claim is deemed accepted, and the escrow bank shall automatically disburse the claim amount to the buyer. The escrow bank typically does not have any obligation to verify that the representative received notice. This presents two related but meaningful risks.
- First, if notice is given only to the bank, it is possible that money could leave the escrow account without the representative being aware of it until a later date. While escrow agreements usually require joint signatures for most disbursements, this contingency could trigger a release without the representative’s consent or knowledge. The representative likely would have a claim of inadequate notice but at that point would have to recoup the money rather than having the protections that come with establishing an escrow fund.
- Second, the representative and the bank might be working under different assumptions regarding timing. For instance, if the bank received notice by fax and the representative received notice days later by mail, the shareholder representative and the escrow bank may calculate the date of the notice (and therefore the response deadline) differently. While the representative is at least aware of the claim in this situation, it could still result in the same outcome of money leaving the account without the representative having responded on the escrow bank’s timeline.
A common way to address this is to require that releases from escrow may only be completed pursuant to joint written instructions received from both the buyer and seller parties.”
A common way to address this is to require that releases from escrow may only be completed pursuant to joint written instructions received from both the buyer and seller parties. If for some reason joint instructions are not preferable, the merger agreement could require the three parties to confirm and agree upon the timing of the receipt of the notice of claim as part of the notice provisions. Alternatively, the parties could require that if the escrow bank does not receive a response from the representative during the applicable period, the escrow bank would need to give some advance notice that an automatic release is about to occur before disbursing the money. This would at least provide the representative time to assert that it never got the claim or is calculating the response deadline differently. While somewhat cumbersome, one of these options is likely the only way to avoid the possibility of the parties operating under different assumptions that could trigger inadvertent releases.
Knowledge of how to treat these lesser-known entanglements of escrow provisions— such as unclaimed transaction proceeds and the financial risks of multi-party financial notice provisions—can help M&A deal parties achieve clearer, more straightforward M&A agreement terms. The team at SRS Acquiom often helps deal parties understand escrow subtleties and achieve better outcomes. Use this perspective on your next M&A deal to manage escrows more effectively.
Managing Director, Escrow & Payment Solutions and Deputy COO 303.957.2855
Chris is the managing director, escrow & payment solutions and deputy COO. In this capacity, Chris manages our relationship manager, relationship associate, and deal intake teams, and works to ensure that our clients are able to navigate the closing and post-closing escrow and payments process as easily as possible.
Chris also has deep expertise in shareholder representation. For over a decade, Chris worked in the SRS Acquiom Professional Services Group where he led the teams that handled post-closing escrow claims, earnouts, purchase price adjustments, distributions of shareholder proceeds and other activities related to serving as shareholder representative.
Before joining SRS Acquiom, Chris practiced corporate law in the Colorado office of Cooley LLP, where he focused on venture capital transactions and mergers and acquisitions. He began his legal career at Cravath, Swaine & Moore LLP in New York City. At Cravath, he primarily represented underwriters in initial public offerings and high-yield debt offerings and lenders in commercial banking transactions.
Chris is a frequent contributor to M&A thought leadership via work on SRS Acquiom’s data studies, articles and speaking presentations. Chris holds a J.D. from Harvard Law School and a B.A. from Rice University.