Holdback agreements: Overview, definition, and example
What is a holdback agreement?
A holdback agreement is a provision in a contract, often used in mergers and acquisitions, financing arrangements, or securities offerings, where a portion of the funds or securities due to one party is withheld for a specified period. This withheld amount, known as the "holdback," is kept by a third party (such as an escrow agent) or the other party to the agreement to ensure compliance with certain conditions or to cover potential liabilities. Holdback agreements are typically used to address risks such as potential claims, breaches, or adjustments to the transaction price, ensuring that the seller fulfills all obligations or that certain contingencies are met before the full payment or transfer of assets is made.
For example, in an acquisition, a buyer may withhold a portion of the purchase price for a set period after the deal closes to cover any unexpected liabilities that arise or if the seller's representations are later found to be inaccurate.
Why are holdback agreements important?
Holdback agreements are important because they provide protection for the party making the payment or investment, ensuring that they are not exposed to unforeseen risks or liabilities after a transaction. For the buyer, a holdback serves as a safeguard against future claims, breaches of contract, or issues with the quality of the goods or services being delivered. For the seller, it provides a way to finalize the deal while offering assurances that any legitimate concerns or issues will be addressed. Holdback agreements help to build trust between the parties by ensuring that both sides have a stake in the ongoing performance or condition of the transaction.
Understanding holdback agreements through an example
Let’s say a company is sold for $10 million. As part of the sale agreement, the buyer and seller agree to a $1 million holdback, which will be withheld by an escrow agent for one year after the transaction. If any issues arise within that year, such as a claim for misrepresentation of assets, the buyer can use the $1 million to cover the costs. If no such issues arise, the seller will receive the full amount of the holdback at the end of the year.
In another example, a lender provides a loan to a company, and as part of the agreement, the lender requires a holdback of a portion of the loan proceeds. This holdback is intended to cover any potential defaults or failures to meet certain loan covenants. After a specified period, if the borrower complies with all terms, the holdback amount is released.
An example of a holdback agreement clause
Here’s how a holdback agreement clause might appear in a contract:
“As part of the purchase price, the Buyer agrees to withhold $1,000,000 in escrow for a period of one year following the closing date. This holdback amount will be used to cover any potential claims related to the representations and warranties of the Seller. If no claims are made within the one-year period, the full holdback amount will be paid to the Seller.”
Conclusion
Holdback agreements are essential tools in various business transactions, providing a mechanism for addressing risks, contingencies, and potential issues that may arise after the deal is closed. They offer protection for the party making the payment while ensuring that the transaction is completed fairly. Whether in mergers, acquisitions, or financing agreements, holdback provisions help manage uncertainty, build trust, and ensure compliance with the terms of the agreement.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.