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M&A: Retention accounts – what’s the point?

June 2015

Rating system:

Reading time (1-10 minutes): 3

Sophistication level (1 (idiot) – 10 (expert)): 5

Entertainment value (1 (turgid) – 10 (side-splitting)): 5

 

Background:

 

In some acquisitions the buyer will not want to pay all the money up front. It may be worried about some potential liability of the seller arising under an indemnity or warranty in the purchase agreement. It won’t want to take the risk of the seller going bust before any claim is finally resolved, which could be many years after completion. So it will want to hold some money back until this risk goes away. But the seller won’t want to take the risk that the buyer might go bust before the money is paid, in which case the seller as an unsecured creditor might never see it. So, the parties might agree that the buyer will pay a sum into a ‘retention’ account operated by one or other (or both) of the parties’ solicitors. This money is effectively held on an escrow basis, which generally creates a form of trust, and so helps to protect the money against either party (or indeed the solicitors) going bust. The agreement will then need to set out very clearly the basis on which the money is held, and when it can be released. This can be the subject of much negotiation. The solicitors operating the retention account will not want to get involved in having to make any decision as to the rights and wrongs of a particular claim. They will just want clear procedural instructions as to how they must operate it. A simple clause might say that if the buyer doesn’t make a claim within an agreed period after completion (perhaps backed up by a statement from a leading barrister saying that the claim has a reasonable chance of success) then the seller can take the money; and that if it does make a claim the money must stay in the retention account until the claim is resolved, when payment can be made out of the retention account in line with the final claim result. If the retention clause has any grey areas then a court might have to be asked to decide what was intended.

 

Case:

 

In this recent case the parties agreed for £250,000 to be put into a retention account operated by the buyer’s solicitors. The retention clause was particularly short and simple. It said that if the buyer made a claim under the warranties or indemnities within a year of completion its solicitors would release the money to the buyer. It didn’t say anything about whether the buyer had to justify the claim or how any disputed claim should be dealt with.

 

So, the buyer simply brought a claim well within the one year period. Its solicitors paid the whole amount in the retention account back to the buyer. The seller said this wasn’t fair, and went to court saying that the money should be put back as there was an implied term that any claim had to be justified.

 

What did the court say?

 

Decision:

 

The court said the retention provisions were perfectly clear, and that there was therefore no reason for it to have to imply any additional terms. The fact that it was an extremely one-sided arrangement in favour of the buyer was not a reason to change it. So, the buyer kept the money.

 

Advice:

 

Think about what you put in your retention account provisions!

 

 

Case: Bir Holdings v Mehta [2014] EWHC 3903

 
 
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Andrew James