RIGHT OF SET-OFF in a BUSINESS ACQUISITION
Business Purchase - Letter of Intent - Due Diligence - Negotiations - Asset vs Share - Purchase Agreement - Closing
Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
The right of set-off (or offset) in a business acquisition is a contractual mechanism that empowers the buyer to unilaterally withhold or deduct future payments owed to the seller to satisfy outstanding claims or indemnification obligations. The intention is that rather than pursuing a separate lawsuit to recover damages for a breach of contract, misrepresentation, or undisclosed liabilities, the buyer effectively "sets off" these damages against the money they still owe the seller. This mechanism typically applies to deferred consideration vehicles, such as promissory notes, earn-out payments, or holdback escrows, creating a direct link between the seller's post-closing obligations and the buyer's payment duties.
From the buyer's vantage point, the right of set-off is a vital form of self-help remedy and financial security. It acts as a collateral substitute; instead of relying solely on the seller’s creditworthiness or suing a potentially liquidity-constrained seller to recoup losses, the buyer simply reduces the cash outflow. This is particularly crucial when discovering post-closing issues like tax liabilities, working capital discrepancies, or breaches of representations and warranties. By controlling the cash, the buyer shifts the leverage dynamic, forcing the seller to dispute the withholding rather than the buyer having to chase the seller for reimbursement.
For the seller, a broad right of set-off presents significant liquidity risk and uncertainty. It grants the buyer considerable power to act as judge, jury, and executioner regarding potential claims, potentially allowing the buyer to withhold substantial sums based on alleged (and possibly frivolous) breaches. Consequently, sellers often negotiate vigorously to limit this right. Common protective measures include requiring that claims be undisputed or adjudicated before a set-off can occur, instituting a deductible or "basket" (a threshold of loss that must be exceeded before set-off applies), or limiting the set-off to specific types of severe breaches, thereby protecting their expected stream of deferred proceeds.
Ultimately, the right of set-off is inextricably linked to the structure of the purchase price, particularly the use of seller's paper. It is most frequently found in the terms of a promissory note or an earn-out agreement, serving as the counter-weight to the seller’s financial continued interest in the business. While legal statutes in some jurisdictions provide a common-law right of set-off, corporate business lawyers almost always codify it explicitly in the asset purchase agreement or share purchase agreement to avoid ambiguity. This explicitness ensures that the mechanism functions smoothly as a liquidating tool, aligning the final price paid with the actual value received, net of any defects discovered after the closing signature.
For knowledgeable and experienced legal representation when purchasing or selling a business, contact corporate business lawyer Christopher Neufeld at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.
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