How Holdbacks and Indemnities Work When Buying a Business in Alberta

After closing, a buyer may discover a problem the seller did not mention, such as an unpaid debt or a lien on equipment. A seller, meanwhile, wants to be paid in full and move on. Holdbacks and indemnities are the contract tools that balance those two interests.

This article explains in plain terms how they generally work. The specific amounts and time limits are negotiated deal by deal, so treat this as background and have a lawyer review your agreement.

This article covers the law of Alberta.

The basic tools

• Holdback: the buyer keeps back part of the purchase price at closing and pays it later if no valid claims arise.
• Escrow: the held money is placed with a neutral third party, such as a lawyer or trust company, who releases it under written instructions.
• Indemnity: the seller promises to compensate the buyer for specific losses, such as those from a breach of the seller's statements in the agreement.
• Representations and warranties: the seller's written statements about the business, such as that the financial records are accurate and that the assets are free of undisclosed claims.

A holdback or escrow gives the buyer ready money to claim against. An indemnity alone is only a promise, which is only as good as the seller's ability to pay later.

How a claim usually works

Agreements commonly set out a claims process. The details vary, but these steps are typical in concept.

• The buyer gives the seller written notice of the problem within the period the agreement allows.
• The notice describes the issue and, as far as known, the amount claimed.
• The seller has a set period to respond, accept or dispute the claim.
• If the claim is accepted, the held money is paid to the buyer. If it is disputed, the funds stay held until the parties agree or a court or arbitrator decides.
• At the end of the holdback period, money not subject to a claim goes to the seller.

Missing a notice deadline in the agreement can weaken or end a claim, so buyers should diarize those dates. Sellers should likewise track when their money is due for release.

Time limits and amounts

How long money is held, how much is held, and whether there is a cap or a minimum claim size are all negotiated. Longer periods often apply to financial statements or tax matters, and shorter ones to general matters, but this varies widely. Do not assume a standard period. Read the exact terms in your agreement.

There are also legal limits on how long after a problem you can sue. Those rules can interact with the agreement's own deadlines, so a lawyer should confirm how they apply to you.

Reducing the chance of a claim

Careful checks before closing mean fewer surprises. Corporate Registry searches can show the registration date, owners, directors and legal addresses of Alberta corporations, partnerships, trade names and incorporated non-profits. A certificate of status confirms status as of a given date only.

Personal Property Registry searches can be run by business debtor name, serial number, or registration number. They return an exact match, inexact match, no match, or both exact and inexact matches. For inexact matches, you may need to search the inexact name again or search the specific registration number.

Tax and financing points can also affect what sits in the holdback. Without a GST election, each property and service in a business sale is treated as a separate supply, so GST (5% in Alberta) can apply to the taxable parts. If you borrow under the Canada Small Business Financing Program, lender fees such as set-up and renewal fees are charged separately and cannot be financed under the program.

What to do next

• Ask your lawyer to explain the holdback amount, release date, and claim steps in plain terms before you sign.
• Decide whether the money will be held by the buyer or in escrow, and who gives release instructions.
• Confirm the notice deadlines and write them in your calendar.
• Complete registry searches and other checks before closing.
• Keep records of anything that could become a claim, such as invoices, letters and dates you learned of the issue.
• Ask an accountant how tax applies to the price and to any held amount.

Frequently asked questions