Indemnity escrow
An indemnity escrow is the holdback of a portion of the purchase price in a neutral third-party escrow account to cover buyer claims for breach of the seller's representations and warranties after closing. The typical amount ranges from 10% to 20% of the price, with a 12- to 24-month term. If no valid claims arise within the period, the balance is released to the seller. It is standard in M&A transactions in Mexico to align post-closing incentives and give the buyer certainty without extending negotiation or immediate litigation.
How does an indemnity escrow work?
At closing, the buyer deposits a portion of the price in an escrow account administered by a neutral third party (bank, law firm, escrow agent). The seller does not receive that tranche immediately. If during the agreed period the buyer presents a valid claim for breach of representations and warranties, the agent releases escrow funds to the buyer up to the claimed amount (subject to cap and basket). If no valid claims arise by expiration, the balance is released to the seller.
- Closing: amount is deposited in escrow.
- Claims period: buyer may notify R&W breaches.
- Resolution: valid claims are paid from escrow; disputes follow agreed procedure.
- Release: remaining balance goes to seller at period end.
How much is held back and for how long?
| Parameter | Typical range | Factors that move it |
|---|---|---|
| Amount held | 10–20% of purchase price | Due diligence risks, sector, seller track record. |
| General term | 12–24 months | R&W complexity, type of contingencies covered. |
| Tax term | 24–36 months or until statute of limitations | Tax contingencies, pending SAT audits. |
| Indemnification cap | 100% of escrow or fixed amount | Negotiated in definitive agreement with basket. |
These parameters are negotiated indicatively in the LOI and specified in the definitive agreement together with the consideration structure.
What claims does the escrow cover?
The escrow covers breaches of seller representations and warranties documented in the definitive agreement:
- Inaccurate financial information or poorly normalized EBITDA.
- Undisclosed tax, labor, or legal contingencies.
- Breach of key customer or supplier contracts.
- Permit, intellectual property, or pending litigation issues.
It does not cover post-closing commercial disagreements, revenue decline from market conditions, or buyer breach. The buyer must notify within the agreed period with documentary support; claims below the agreed basket do not trigger the escrow.
What do sellers ask about the escrow?
- How much is held in an indemnity escrow?
- Typically 10% to 20% of the purchase price (enterprise value or equity value, as agreed in the LOI). In transactions with higher risk identified in due diligence — tax contingencies, pending litigation, customer concentration — the buyer may request higher percentages or longer periods. Amount is negotiated together with indemnification cap and basket in the definitive agreement.
- How long is the escrow maintained?
- Standard term is 12 to 24 months from closing. Claims for breach of general representations usually have a 12–18 month period; tax and fiscal contingency claims may extend to 24–36 months or until the statute of limitations expires. At period end, unclaimed balance is released to the seller.
- What claims does the indemnity escrow cover?
- Breach of seller representations and warranties in the definitive agreement: inaccurate financial information, undisclosed contingencies, contract breach, undisclosed labor or tax issues. It does not cover post-closing commercial disagreements or market changes. The buyer must notify within the agreed period, with documentary support; the escrow agent releases funds if the claim is valid per the contract.
- How is the escrow negotiated in a LOI?
- The LOI sets indicatively: percentage of price to hold back, holdback period, and whether escrow is the sole indemnification mechanism or complemented by seller guarantee. Details — cap, basket, exclusion of minor claims, dispute procedure — are specified in the definitive agreement. The seller seeks to minimize amount and term; the buyer seeks sufficient coverage for risks identified in due diligence.
In this glossary:
Representations and warranties — basis for escrow claims.
LOI — where indicative escrow terms are set.
Consideration structure — escrow as a price tranche.
Due diligence — risks that determine amount and term.
Earn-out — another post-closing contingent tranche.
Sources
- Investopedia — Escrow: What It Is, How It Works, Types, and Example
- Fox, David & Wolf, Daniel (Kirkland & Ellis) — Letters of Intent: Ties that Bind? (Harvard Law School Forum on Corporate Governance, January 2010)
- American Bar Association — Indemnification Escrow in M&A Transactions (Business Law Today, 2022)
Negotiating escrow amount, term, and procedure in the LOI avoids surprises in the definitive agreement and speeds closing. For the full due diligence and closing framework in Mexico, see the due diligence guide Mexico.
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