Escrow claims on the decline

For the third straight year the percentage of escrow accounts hit with a claim by a buyer post-acquisition declined, according to in-house data from JPMorgan.

Escrow accounts reserve a percentage of a deal price with a third party (such as a bank) so that buyers can make claims against the seller in the event certain terms of the purchase agreement are not met. Private equity firms typically agree between five to ten percent of the deal price to be held in escrow.

Last year 28 percent of escrow accounts suffered a claim, down from 30 percent in 2009 and 40 percent in 2008, according to in-house data from JPMorgan.

The JPMorgan stats do not differentiate between trade buyers and financial sponsors, but multiple sources told PEM it was safe to assume private equity sellers were part of the trend in declining claims. 

A study by Shareholder Representative Services (SRS), a post-closing service provider, investigated a breakdown of claim types by analysing 128 private-target acquisitions between 2007 to 2010.

Undisclosed liabilities and net working capital adjustments together make up 31 percent of all claims, according to the study. Undisclosed liabilities relate to various financial obligations left unmentioned by sellers prior to the sale; net working capital claims occur when a deal price is adjusted shortly after closing, often by using a company’s updated net working capital as the metric used for adjustment.

The third and fourth most cited claims were related to customer contracts (13 percent) and capitalisation (12 percent), according to SRS. Customer contract claims deal with costs a buyer incurs when obligating the target’s unfulfilled contractual obligations to customers of the business; capitalisation claims are typically made when one of the target’s shareholders feels inadequately compensated in the merger agreement. 

Private equity firms are increasingly seeking the services of outside representatives to manage claims against an escrow account, said Mark Vogel, a managing director at SRS. GPs should “always investigate a buyer’s claim to ensure it is factually correct and justified.  If there is a discrepancy, the first step is always to sit down with the buyer to find a mutually acceptable result before taking the dispute to court”.
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