Suppose a buyer recovers a $1 million tax refund after closing that is to be paid to the sellers under the terms of the merger agreement, but incurs $100,000 in professional fees in connection with such collection. The buyer may assume that it should pay the sellers the $900,000 net amount, but a question sometimes remains as to whether this is the proper treatment. The alternative may be that the buyer should pay the sellers the $1 million gross amount collected and take $100,000 from the escrow.

There are three practical consequences to the distinction between these options. First, if the buyer takes the fees from escrow, it reduces the amount the sellers continue to have at risk and the amount that the buyer has available for protection should it later be entitled to indemnification for certain other types of claims. Second, taking the fees from escrow puts more money in the sellers’ pockets now. Since escrows may have months or years remaining, this can have a significant impact on cash flows. Third, a claim against the escrow could be subject to a basket, potentially resulting in such expenses being paid by the buyer rather than the shareholders.

Many merger agreements do not make clear which option is the intended treatment. Because both sides have reasonable positions, clarification in the agreement can eliminate a potential controversy.

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