We are structuring a five-year Section 453 installment note, but the buyer demands a unilateral right of set-off to deduct indemnification claims directly from our annual note payments. How do we restrict this right of set-off so our deferred payout is not held hostage by subjective disputes?

Question

Tyler Smith · Accepted Answer

A Section 453 installment sale defers capital gains taxes across the payout term, but an unrestricted right of set-off effectively turns your promissory note into an unsecured indemnity pool. If the buyer experiences buyer remorse, operational missteps, or disputes a minor representation and warranty, a unilateral set-off allows them to stop paying you immediately without judicial oversight or independent verification.

You should eliminate unilateral set-off provisions entirely and require the buyer to rely on a capped indemnity escrow funded at close for any warranty breaches. If the buyer insists on a set-off right to bridge financing gaps, you must enforce rigid operational and procedural restrictions:

- The right of set-off must apply solely to final, non-appealable legal judgments or mutually agreed written settlement amounts, never to disputed, unresolved claims.
- If a claim is asserted, require the buyer to deposit the contested note payment into an independent third-party escrow account rather than retaining the cash. This stops the buyer from manufacturing artificial claims simply to preserve their working capital.
- Set-off rights must be subject to the standard indemnity basket (deductible) and overall cap established in the purchase agreement.
- The note must carry an accelerated default clause stating that any improper withholding of principal or interest that does not strictly comply with these escrow mechanisms constitutes an immediate event of default, accelerating the entire remaining note balance.

Treat your installment note like a commercial bank note. Commercial lenders never grant borrowers unilateral rights to withhold interest over operational disagreements, and neither should you.