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Escrow agreements in merger and acquisition transactions: Here’s what you need to know

Escrow agreements play an important part in M&A transactions. In this article, we will explore its unique role and how it should be executed.
The role of escrow agreements in M&A transactions 

The key role of an escrow is to help assure performance of each party’s obligations when their deliverable in the M&A transaction cannot be executed immediately upon signing of the transaction documents. This can occur, for instance, when a seller needs to transfer its shareholding, real property or other assets to an acquirer in a process, which involves delays through registration of title transfer with local authorities, or tender offer announcements; and from the buyer’s side when it seeks to defer payment of the purchase price until confirmation of transfer. In such cases, the transaction parties will typically turn to an independent, professional third party escrow agent, who can assure that the transfer of their deliverable in the M&A transaction will be executed against a corresponding transfer from the other party. Escrows can also be used as a "proof of funds" for a purchaser wishing to comfort sellers by showing their available financing to complete the transaction.

Escrow arrangements help to minimise the counterparty risk of non-completion or failure to deliver for each of the parties.  

Another common use of escrow agreements in M&A transaction is as a "retention" or hold-back of part of the purchase price (typically around 10 to 25 percent depending on the nature of the deal), for a warranty period during which the buyer can confirm that the representations and warranties made by the seller in the sale documents are true and correct. This partial purchase price retention can last from six months to as long as two to three years, during which any undisclosed liabilities can be expected to surface in the process of annual audits, tax filings, licencing applications or legal proceedings. In this situation, the seller will typically demand payment of the “retention” purchase price in cash into an escrow account to ensure that this balance payment will be automatically paid if no warranty claim is submitted.

Execution and timing of escrow agreements

Unfortunately, despite playing such a key role ensuring comfort to both parties to “get the deal done” in an M&A transaction, most parties leave the drafting of an escrow agreement until the last stage of the deal after all the key terms of the sale documents have been finalised. This can leave little time to conclude the escrow agreement terms, despite their importance in assuring the payment of cash and delivery of assets to the parties involved.

When drafting an escrow agreement, the key point to consider is a clear and unequivocal release trigger, which can be relied on the escrow agent to deliver the escrow assets or cash to the relevant parties. This release trigger can be as simple as joint signatures from both buyer and seller, or more complicated such as third-party law firm confirmations or a reference to publicly available information.


Escrow services - product sheet

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