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Buying A Business: What Should Be Included In Escrow Instructions?

Posted By: Transactional Attorney

Once you have successfully negotiated the Asset Purchase Agreement ("APA") for your acquisition it's natural to relax a little and let your guard down. Attorney Specialist Mark Chatow discusses what business buyers should look out for when opening escrow and getting escrow instruction in place.

Tags: buying a business, deal structures, escrow bulk sales, selling a business
Contributor: Transactional Attorney

Once you have successfully negotiated the Asset Purchase Agreement ("APA") for your acquisition it's natural to relax a little and let your guard down. But it's still important to carefully review every document you receive for signature from the broker or escrow.

One of the most common places I have been finding potential problems in transaction documents lately is the Escrow Instructions. While they seem to be an afterthought for many buyers and sellers, Escrow Instructions are important documents and formalize the agreement between the buyer, seller, broker and escrow. When not properly drafted, escrow instructions can create critical problems.

For example, I represented the buyer in one recent transaction. I had carefully revised the APA to make sure that the seller was making the representations and warranties as to the assets and the business we needed to protect the buyer. In one particular representation the seller represented that the financials fairly and accurately portrayed the business' financial position as of their dates.
But when escrow sent out the Escrow Instructions, they had decided (without asking either party) to include a provision where the buyer acknowledged that they were not relying on the financials in deciding to purchase the business.

If it turned out that the Seller had intentionally misrepresented the financials we'd typically have a claim against them for fraud. But a fraud claim for misrepresenting the financials requires that the buyer reasonably relied on the representation that the financials were accurate.

If we had left in the new provisions, it would be much harder for the buyer to pursue the seller on a fraud basis if the seller had intentionally (or even negligently) misrepresented the financials.

Unfortunately I see issues like frequently. While most escrow instructions state that conflicts between the purchase agreement and the instructions are governed by the purchase agreement language, you may not always have a direct conflict. It's much easier to simply not have conflicting provisions in the escrow instructions in the first place.

I also frequently see escrow drafting promissory notes, personal guarantees and security agreements if they are not drafted along with the APA. These documents frequently have (or lack) important provisions that can substantially change the balance of rights from the buyer to the seller or vice-versa.

On the buyer side, these include rights to notice if there is a missed payment (and time to cure that delinquency) and rights to offset claims against the seller by withholding payments on the note.

As a seller your rights to accelerate the note and the way you address whatever security interest and personal guarantee you have in place can make a major difference in your rights if you ever have to sue to collect. You can also put in provisions which make it much easier for you to sell the note to a third party down the line if you know how to structure it-- such as provisions allowing you to audit the business, run credit checks and get notification of issues with the business down the line.

Before you sign anything from escrow, including instructions, amendments, or additional documents, make sure you know what you're signing and that you aren't giving away any rights the purchase agreement provides or failing to acquire rights that you should have in your promissory note, security agreement and personal guarantee.


I'm a member of my local board of Realtors, so I use California Association of Realtors (CAR) forms, even though there is boiler plate language in the Business Purchase Agreement (BPA) dealing with contingencies and timelines, I have also instructed escrow officers to include language, which protects both buyer/seller. The most important thing is that buyer states that they have done their due diligence and accepts the seller's books and records, and understands that all future profits will be under their own endeavor. I agree it's very important for a buyer and seller to read the escrow instructions very carefully, because in regards to changes, the last thing signed may supersede previous agreements, but that would be something a buyer and seller may want to ask for legal advice about.

Replies To This Comment
Contributor: Transactional Attorney
As an attorney, that's the concern I've been running across when I provide legal advice to buyers in a transaction. The APA will state one thing with regard to reps and warranties and the escrow instructions will then add something completely different that wasn't in the original purchase agreement. Those changes in escrow are material changes to the purchase agreement and it can make it difficult for both parties to sort out their obligations if there's ever a dispute.

It's also frustrating to see conflicting reps and warranties in the APA itself, where a seller represents that the financials fairly and accurately represent the financial position of the business, but the buyer is then asked to acknowledge that they are not relying on past financials.

We know, of course, that other than in businesses where the value is primarily in hard assets such as inventory and equipment, buyers are almost always also relying on the financials when purchasing a business. That's not the same as relying on past financials to warrant future performance, but I still see escrow instructions (and even some APA's) that state the buyer is not relying on the financials.

If you are adding provisions to escrow, my recommendation is always to negotiate those provisions ahead of time and put them in an addendum to the asset purchase agreement instead. That will provide much stronger protections on both sides as there won't ever be a dispute as to whether a representation was or wasn't part of the original purchase agreement.


Contributor: Business Broker: Southern California

Mark makes a great point about conflicts between the purchase agreement and the escrow instructions. If you are going to take the time and incur the expense of drafting a well thought out purchase agreement, make sure that that purchase agreement is the prevailing document in the event of conflicting language-not the escrow instructions.

In my experience, some brokers will write offers on a single page and then let the escrow company write up the details. I guess in that case, since there is little more than an overview of the agreement, then the escrow instructions should prevail. But if the parties are using a well drafted CABB purchase agreement that has been reviewed and amended as necessary by an attorney, make sure the prevailing document is the asset purchase agreement.



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