In our purchase agreement drafts, the buyer wants broad rights of setoff against our seller note for any indemnification claims or working capital deficits. How do we limit setoff provisions so our deferred payments cannot be frozen over disputed claims?

Question

Tyler Smith · Accepted Answer

A setoff right allows the buyer to withhold payments on your seller note if they believe you breached a representation or owe money on a working capital true-up. Without strict limitations, a broad setoff clause gives an unscrupulous buyer a license to manufacture bad-faith indemnity claims simply to freeze debt service and force you to renegotiate the purchase price.

First, eliminate unilateral setoff rights. The purchase agreement must state that the buyer cannot withhold payments based on an unadjudicated claim. Withholding should only be permitted for resolved claims, meaning claims that you have agreed to in writing or that have been finalized through a non-appealable judgment from an arbitrator or court.

Second, if the buyer insists on protecting themselves against pending claims, establish a third-party escrow mechanism rather than letting them hold the cash. If a good-faith dispute arises, the contested payment amount must be deposited into an independent bank escrow account, not retained in the buyer's operating account. The buyer continues to part with the cash, and you are protected if the claim is dismissed.

Third, require that any setoff proceed through your general indemnity escrow first before touching the seller note. The seller note should be the last recourse, not the first. Finally, make any improper payment withholding an immediate event of default under the note, triggering an acceleration of all outstanding principal and attorney fee recovery.