Escrow Holdback Becomes a Fight After a Restaurant Sale

The situation

Eun-ji spent years working as a line cook before she and her brother Ji-ho, who worked security shifts at a warehouse to help fund it, built up a small chain of casual restaurants across the North. By early last year they were ready to grow through acquisition rather than another ground-up build, and they found a fit: a similarly sized operation in Elliot Lake owned by Pratheep, who was ready to retire.

The deal was structured as a purchase of the business's assets — the equipment, the lease, the supplier relationships, the goodwill — for a price of roughly $5.5 million, sitting within the broader $3 million to $8 million range typical for a transaction of this size. Eun-ji and Ji-ho didn't have a corporate deal team in the way a larger company would; the two of them, together with their accountant, were the deal team, and our firm acted for them on the purchase agreement.

Like most agreements of this kind, theirs included a set of representations and warranties — the seller's promises about the state of the business, made as of the closing date. Pratheep represented that the kitchen equipment was in good working order, that all supplier accounts were current, and that the lease was in good standing with no defaults. To back those promises, roughly $550,000 of the purchase price — about 10 percent — was held back in escrow for twelve months rather than paid out at closing, specifically to cover any breach of those representations that surfaced after the buyers took over.

What the review found

Within the first two months of operating the business, problems appeared. Two of the kitchen's larger pieces of equipment — a walk-in cooler and a commercial oven — failed and needed replacement rather than repair, at a combined cost of roughly $140,000. A mechanic who inspected the equipment for the buyers concluded the failures weren't sudden; the wear pattern suggested both units had been operating past the end of their reasonable service life for some time, which was inconsistent with a representation that everything was in good working order as of closing.

Separately, invoices began arriving from two of the business's food suppliers for amounts the buyers had never seen on the books they'd reviewed during due diligence — the pre-closing investigation into the company's finances, contracts and operations. Together, the unrecorded supplier debt came to about $210,000. It appeared the previous owner had been paying some suppliers late and letting balances roll forward without recording them as a current liability, so the picture buyers received during diligence understated what they were actually taking on.

Combined, the equipment shortfall and the unrecorded debt came to roughly $350,000 — an amount well within the $550,000 escrow holdback, which was exactly the situation that holdback existed to cover. Eun-ji and Ji-ho came to us wanting to draw against it rather than pay the difference out of the business's own cash flow while it was still finding its footing under new ownership.

An indemnity claim under a purchase agreement is a formal notice to the other side that a representation was breached and that the buyer is entitled to be compensated for the resulting loss, usually first out of any escrow or holdback set aside for that purpose. It isn't automatic — the seller can dispute the claim, and often does, particularly where the line between a disclosed and an undisclosed problem is genuinely blurry.

What we did

1. Reviewed the representations against what the diligence file actually showed. Before sending any notice, we confirmed the specific wording Pratheep had agreed to and cross-checked it against the financial records and equipment list provided during due diligence, to be sure the claim rested on a genuine gap between what was promised and what was disclosed — not on ordinary wear the buyers should have anticipated.
2. Sent formal indemnity notice within the claim period. Most purchase agreements set a window during which a buyer must notify the seller of a claim against the escrow, after which the seller's obligation lapses and any remaining holdback is released automatically. We prepared and sent a detailed notice — itemizing the equipment failures, the unrecorded supplier balances, and the dollar amount claimed against each — well inside that window.
3. Anticipated Pratheep's likely defence. Sellers in this position commonly argue that a problem was either disclosed somewhere in the data room during diligence or fell below a threshold the parties agreed wouldn't trigger a claim. We reviewed the data room index ourselves to confirm neither the equipment's condition nor the supplier arrears had in fact been disclosed, so we could respond to that argument before it was even raised.
4. Opened direct settlement discussions rather than escalating immediately. Formal indemnity disputes can end up in the Superior Court of Justice if the parties can't agree, but litigation over an escrow this size would likely have cost both sides more in time and expense than the amount in dispute. We proposed a negotiated resolution and set out our clients' position clearly, with the equipment inspection report and the supplier statements attached as support.
5. Negotiated a division that reflected the strength of each item. The equipment claim was well documented and difficult to dispute; the supplier debt claim was strong but Pratheep's side raised a fair point that a small portion of it related to invoices issued after closing, for goods ordered before the sale. We factored that distinction into where we ultimately landed rather than holding out for the full claimed amount on every line.

The outcome

The dispute settled without a court application. Pratheep's side agreed to release roughly $320,000 of the $550,000 escrow to Eun-ji and Ji-ho — covering the full equipment replacement cost and the large majority of the unrecorded supplier debt, with a modest reduction reflecting the post-closing invoices that fell into genuinely disputed territory. The remaining balance of the escrow, about $230,000, was released back to Pratheep once the twelve-month holdback period ended and no further claims were made.

For Eun-ji and Ji-ho, the practical result was that the business absorbed the equipment replacement and the supplier arrears without either partner having to put in additional personal capital or take on new debt to cover a gap that, by their reading of the agreement, shouldn't have existed in the first place. The escrow did the job it was designed to do: it turned a dispute that could have dragged on for a year or more into a settlement resolved within a few months of closing, because the money to satisfy a valid claim was already sitting somewhere both sides had agreed to look.

The case also underlined something buyers in smaller deals sometimes skip past: an escrow holdback is only useful if the notice and claim process in the agreement is followed precisely and on time. Had the notice gone out even a few weeks after the claim period closed, Pratheep would have had a strong argument that the full amount should be released to him regardless of what the equipment inspection showed.

What you can learn from this