Picking Up the Tab Post-Closing

We’ve had other posts on the advisability of forming an expense fund for a variety of reasons, primarily to provide a means to mount a defense against a claim from Buyer, if necessary. Another reason for having an expense fund came up recently on one transaction that raises an issue some M&A attorneys may not be thinking of when drafting.

Many agreements contain a mechanism that essentially says that the parties will attempt to resolve any disputes for some period and, if they are unsuccessful, an independent accountant or arbitrator will be appointed. The language will usually be something along the lines of “Following the Stockholders Representative’s receipt of any Objection Notice, the Stockholders’ Representative and Buyer shall attempt to negotiate in good faith to resolve such dispute. If the Stockholders Representative and Buyer fail to agree on any of the proposed adjustments set forth in the Objection Notice within 45 days after the Stockholders Representative delivers the Objection Notice, the Stockholders Representative and Buyer agree that ABC Accounting Firm (the “Independent Auditors”) shall, within the 30-day period immediately following such 45-day period, make the final determination of the adjustment in accordance with the terms of this Agreement.”

That’s fine. It then typically adds that the expenses of such accounting firm or arbitrator will be split between Buyer and the former selling stockholders or will be paid by the loser in the dispute. Well, if there is no expense fund, there is no way to pay the selling stockholders’ portion.

Most stockholders won’t pay more than their pro rata share of expenses and, if there are dozens or hundreds of former stockholders, collecting from them all will be very difficult or impossible. The Buyer will likely resist having these fees paid from the main escrow, often saying that this isn’t what that escrow is for and that it should not be depleted for other purposes. To compound the problem, the accountant or arbitrator usually won’t start their work without some level of comfort of getting paid. This can significantly stall the process which, at times, comes up when it is important to resolve the issue quickly.

An expense account, usually in an amount between $50,000 and $500,000 depending on the size and complexity of the transaction, can take a lot of friction out of resolving disputes and, if it isn’t needed, it’s redistributed back to the shareholders. Typical language might include:

“Buyer shall deduct the Escrow Expense Amount from the Total Consideration and deposit with the Escrow Agent such Escrow Expense Amount without any act of the Indemnifying Parties, such deposit of the Escrow Expense Amount to constitute a separate escrow fund to be governed by the terms set forth herein. The Escrow Expense Amount shall be available solely to (i) compensate the Shareholders’ Representative in accordance with the terms hereof, and (ii) pay any third-party expenses incurred in connection with the defense, investigation, or settlement of any claim from an Indemnified Party or any Third Party Claim under or related to this Agreement, as well as any costs and expenses associated with the Escrow Expense Amount. The Shareholders’ Representative shall have full discretion over the Escrow Expense Amount, and the Escrow Agent shall follow any lawful directive of the Shareholders’ Representative regarding the use or disbursement of all or a portion of the Escrow Expense Amount to third parties and in amounts authorized in writing by the Shareholders’ Representative.”

As a second choice alternative to forming an expense fund, consider adding a term that says the selling stockholders’ portion will be paid from the escrow or make sure to figure out some other mechanism for payment. Otherwise, expect that this will be a problem if it ends up being necessary to hire an outside referee.