Escrow of the sale price consists in entrusting a third party, a lawyer, a notaire (French public officer) or a bank, with a fraction of the price paid for the shares, generally 5% to 15%, in order to secure the buyer against claims brought under the seller's warranty or to hold an earn-out that is still uncertain. Its value lies entirely in the agreement that organises it: release conditions, handling of claims, entitlement to the interest earned and the outcome in the event of a dispute.
What is escrow of the sale price on a share transfer?
Escrow of the sale price is the delivery by the buyer of part of the price of the shares into the hands of a third party, which will hold it until an agreed event occurs and will then release it to whichever party is entitled to it. In a sale of shares or of corporate units, that event is the expiry of the warranty and indemnity agreement without a claim, the final settlement of the claims made, or the determination of an additional element of the price. Escrow turns a promise to pay or to repay into a sum that is already available, which changes the nature of the negotiation.
A security for performance above all. The liabilities warranty creates a contingent claim of the buyer against the seller. Without escrow, that claim is worth no more than the seller's solvency on the day it falls due, often several years after closing, by which time the price will have been reinvested, distributed or passed on. Escrow sets aside a fraction of the price from that risk. It does not remove the need to negotiate the cap, the deductible and the duration of the warranty, but it makes those provisions effective.
How does this differ from escrow of the price of a business as a going concern (fonds de commerce)?
Escrow of the price of the business is imposed by the statutory periods for creditors' objections and for joint tax liability, and its duration follows from specific legislation. On a share transfer there is nothing of the kind: the company keeps its assets, its debts and its creditors, no objection procedure is open and no joint tax liability falls on the buyer of the shares. Escrow is therefore purely contractual here, its duration and its amount are a matter of negotiation alone, and it serves to cover the risk of undisclosed liabilities rather than the risk that the price will be unavailable.
What is the legal framework for contractual escrow?
Articles 1955 to 1960 of the French Civil Code provide the framework. Article 1956 of the French Civil Code defines contractual escrow as the deposit made by one or more persons of a disputed thing into the hands of a third party who undertakes to return it, once the dispute has ended, to the person who is adjudged entitled to it. Article 1957 of the French Civil Code allows it not to be gratuitous, which is always the case in practice, and article 1958 of the French Civil Code refers for the remainder to the rules on deposit. Article 1960 of the French Civil Code lays down the cardinal rule: the escrow agent may be discharged, before the dispute has ended, only with the consent of all interested parties or for a cause held to be legitimate.
The disputed thing: the case law reads this notion flexibly. It is enough that the sum is tied to the outcome of an uncertain situation, a possible claim or a calculation still to come, for the deposit to fall under escrow and not under simple deposit. The agreement must nevertheless describe that contingency precisely, failing which the escrow agent could be required to return the funds to the depositor on simple request, as with an ordinary deposit.
Who can be appointed as escrow agent?
A lawyer, a notaire (French civil-law notary) or a credit institution are the three third-party holders whose undertaking carries real weight. The lawyer receives the funds into an account opened with the Caisse des règlements pécuniaires des avocats, on the terms of article 53, 9° of Law no. 71-1130 of 31 December 1971 and of Decree no. 96-610 of 22 July 1996, under the supervision of the CARPA, which checks every movement. The notaire deposits the sums with the Caisse des dépôts et consignations (the French State deposit institution) in accordance with Decree no. 45-0117 of 19 December 1945. The bank opens an escrow account in the name of both parties, known as a compte escrow. A firm carrying on a structured escrow practice further brings the capacity to examine claims and to apply the agreement rather than merely holding an account.
Why hold part of the price in escrow to secure the warranty and indemnity agreement?
Escrow securing the warranty against liabilities answers an asymmetry: the buyer pays in cash a price based on reference accounts, whereas the liabilities capable of contradicting those accounts will come to light only over the following financial years, a tax audit, a URSSAF reassessment (URSSAF being the French social security contributions collection body), a claim before the conseil de prud'hommes (the French employment court) or a commercial dispute arising from a fact predating closing. The warranty and indemnity agreement transfers that risk to the seller; the escrow ensures that the seller will be able to meet it.
How much should be held in escrow?
Between 5% and 15% of the price is the prevailing practice for an SME, the range varying with the quality of the acquisition due diligence, the exposure of the sector to reassessments and the solvency of the seller. The amount held in escrow need not match the cap on the warranty. It covers the most likely risk over the first period, generally the tax and social security audits bearing on the financial years still open to reassessment, and leaves the cap to deal with exceptional claims.
Calibration against the identified risk: where the due diligence has revealed a specific risk, a questionable tax position or pending litigation, practice distinguishes a specific escrow, sized on that risk and released once it disappears, from a general escrow covering unidentified claims. That distinction prevents the settlement of a known risk from exhausting the cover available for unknown risks.
How long should the warranty escrow run?
A duration aligned with the tax limitation period is the benchmark. The authorities' right of reassessment may be exercised until the end of the third year following that in respect of which the tax is due, under article L. 169 of the French Tax Procedure Code (Livre des procédures fiscales), and the same period governs social security contributions under article L. 244-3 of the French Social Security Code. A warranty escrow therefore frequently runs for three years, with partial releases in stages, for example one third on each anniversary date, so as not to tie up the seller's funds beyond what is necessary.
Claims outstanding at the expiry date: the agreement provides that any claim notified before the release date blocks, to the corresponding extent, the matching portion of the funds until it is finally settled, the balance being released. Without that clause, the automatic expiry of the escrow would cause the buyer to lose its security at the very moment it becomes useful.
Escrow, on-demand guarantee or price holdback?
Three competing techniques meet the same need to secure the warranty and indemnity agreement:
- Escrow: the seller receives a price reduced by the portion held in escrow, but the funds remain earmarked for the seller and revert to it in the absence of a claim. It is neutral for the buyer, who has paid out the price in full.
- The on-demand bank guarantee: the seller receives the whole of the price and provides an on-demand guarantee issued by its bank, governed by article 2321 of the French Civil Code. It costs the seller an annual fee and a counter-guarantee, but leaves it free to use the funds.
- The holdback or the vendor loan (crédit-vendeur): the buyer keeps part of the price, which it will pay at a later date, subject to set-off against its claims. Set-off is governed by article 1347 of the French Civil Code and the articles that follow it, but the seller bears the credit risk of the buyer, which no seller's adviser accepts without security.
How can deferred consideration and the earn-out be placed in escrow?
Deferred consideration is the portion of the price whose amount depends on the future results of the company sold, turnover, EBITDA or the award of a contract, and which is paid after closing. Placing it in escrow consists in asking the buyer to deposit with a third party, as from closing, the maximum amount of the deferred consideration, which will be released to the seller or returned to the buyer once the result has been established.
Does the price remain ascertainable where there is an earn-out?
The condition of validity lies in article 1591 of the French Civil Code, which requires a price that is determined and designated by the parties, supplemented by article 1592 of the French Civil Code, which allows it to be left to the determination of a third party. An earn-out is valid provided that its calculation rests on objective factors, defined accounting aggregates, a specified scope and method, independent of the will of either party. A clause leaving the buyer free to decide, without any framework, which costs are charged to the company sold would expose the sale to nullity for want of an ascertainable price, a penalty the Cour de cassation (the French supreme court for civil and commercial matters) applies consistently.
Protection of the seller during the earn-out period: a seller who has left the management no longer controls the decisions that make the aggregate vary. The sale and purchase agreement provides for management undertakings by the buyer, maintenance of the scope, no excessive management fees, continuation of the commercial policy, and a right to audit the calculation. Placing the deferred consideration in escrow adds to those undertakings the certainty that the funds exist on the day of payment.
Why does the buyer agree to place in escrow a price that is not yet due?
The negotiated trade-off is most often a higher earn-out cap, or a relaxation of the management undertakings, in exchange for the funds being tied up. A buyer financed by debt is, by contrast, reluctant to do so, as its lenders refuse to allow funds drawn on the acquisition debt to be deposited for an indefinite period. The middle way consists in placing in escrow only part of the maximum deferred consideration, or in substituting a bank guarantee for the deposit.
How is a disagreement over the calculation settled?
The determination procedure takes place in successive stages, all of them set out in the sale and purchase agreement:
- Notification of the calculation: the buyer sends the seller, within a period set after the finalisation of the accounts for the reference financial year, generally thirty to sixty days, the calculation of the deferred consideration and the supporting documents.
- Challenge period: the seller has a period, often thirty days, in which to notify its reasoned disagreement, silence amounting to acceptance.
- Amicable phase: the parties have a negotiation period, fifteen to thirty days, in which to converge.
- Independent expert: failing agreement, a chartered accountant appointed by mutual agreement or by the president of the tribunal de commerce (commercial court) decides the matter, acting as third-party expert within the meaning of article 1592 of the French Civil Code, with a decision binding on the parties save for manifest error.
- Instruction to the escrow agent: the expert's decision, or the parties' agreement, constitutes a release instruction and the escrow agent pays each of them the share due to it.
Bank escrow, CARPA or notaire: which escrow should you choose?
The choice of third-party escrow agent brings three parameters into play: the security of the funds, the speed at which instructions are carried out and any interest paid on the sums deposited. No solution comes out ahead on all three counts, and the preferred option depends on the amount, the duration and the likelihood of a dispute.
What are the advantages of a CARPA escrow?
The CARPA guarantees that the funds can be accounted for, through a control and insurance mechanism specific to the profession of avocat. Every movement is checked by the caisse, which verifies that it corresponds to an identified legal transaction and to an instruction complying with the agreement. The funds held by the lawyer cannot be seized for the lawyer's personal debts and are not merged with the lawyer's own assets. The lawyer acting as escrow agent, whether or not they drafted the instrument, is able to assess whether a claim meets the conditions of the warranty, which a bank will never do. The limitation lies in the absence of any return: the financial income generated by funds deposited with the CARPA is allocated to the funding of the profession and does not go back to the parties.
When should a bank escrow be preferred?
The bank escrow account is the obvious choice for large amounts held in escrow over a long period, because it can bear interest, and for transactions involving a lender that wants an account pledged in its favour. The bank carries out joint instructions signed by both parties, without assessing whether they are well founded. In the event of disagreement, it freezes the funds and waits for a court decision or an agreement. The account opening and maintenance fees, often charged at a flat rate, are shared between the parties in accordance with the agreement.
Does a notarial escrow still have a place in a share sale?
The notaire is involved where the sale of the shares is accompanied by a notarised deed, the transfer of units in a société civile immobilière (a French property-holding civil company) or a related property transaction. The funds are deposited with the Caisse des dépôts et consignations, which offers a level of security equivalent to the CARPA, with a low but real return on the deposits after a certain period. The instructions are carried out in accordance with notarial practice and this can prove slower than with the CARPA for a closing involving multiple flows of funds.
| Criterion | CARPA escrow | Bank escrow | Notarial escrow |
|---|---|---|---|
| Security of the funds | CARPA control and the profession's insurance | Limited deposit guarantee, bank counterparty risk | Caisse des dépôts et consignations |
| Return on the sums | None for the parties | Possible, negotiated | Low, after a minimum deposit period |
| Assessment of claims | Yes, by the lawyer acting as escrow agent | No, joint instructions only | Limited |
| Speed of execution | High | Variable, internal procedures | Moderate |
| Cost | Escrow fees | Account opening and maintenance fees | Scale fees (émoluments) |
| Typical situation | Liability warranty, SME earn-out | Large amounts, a lender involved | Sale linked to a property |
What must the escrow agreement contain?
The escrow agreement is a tripartite contract between the seller, the buyer and the escrow agent, separate from the sale and purchase agreement to which it refers. The way it is drafted alone determines whether the mechanism is effective: an escrow whose release conditions are ambiguous leads to a deadlock that only a judge can break, under article 1960 of the French Civil Code.
Which clauses are essential?
Twelve provisions give any agreement for the escrow of the sale price its structure:
- Identification of the parties and of the escrow agent: seller, buyer and third-party escrow agent, with a reference to the sale and purchase agreement and to the liability warranty.
- Purpose and amount: the sum held in escrow, its allocation between the warranty escrow and the deferred consideration escrow, and the date of payment by the buyer.
- Deposit account: designation of the CARPA account, the bank escrow account or the account with the Caisse des dépôts, and the exclusion of any commingling with the escrow agent's own funds.
- Allocation of the funds: a reminder that the sums are allocated exclusively to the warranty or to the deferred consideration, and that they constitute neither a freely available down payment nor a security deposit for the sole benefit of the buyer.
- Release schedule: the dates and the portions released automatically in the absence of any claim, together with the mechanism freezing an amount corresponding to the claims outstanding.
- Claims procedure: the form and content of the notification, the period for the seller to respond, the consequence of silence, and a reference to the conditions for triggering the warranty.
- Release instructions: joint instructions signed by both parties, an enforceable court decision or an arbitral award, and, in the cases provided for, a unilateral instruction once a period has expired without challenge.
- Treatment of interest: allocation of the financial income, if any, to the seller, to the buyer or in proportion to the sums released.
- Costs and fees: apportionment between the parties of the escrow agent's remuneration, provided for by article 1957 of the French Civil Code, and of the bank charges.
- Liability of the escrow agent: limitation to the carrying out of the instructions received, exclusion of any assessment of whether the claims are well founded where the escrow agent is a bank, and enhanced obligations where it is a lawyer.
- Disputes and jurisdiction: the jurisdiction clause, and the option for the escrow agent to deposit the funds with the court or to apply to the juge des référés (the judge hearing urgent interim applications) in the event of a prolonged deadlock.
- Duration and termination: the end of the engagement, the return of the balance, and the fate of the funds in the event of the dissolution, the insolvency proceedings or the death of one of the parties.
How does release work where a claim is made?
The buyer's claim is notified to the seller and to the escrow agent in the form and within the time limits of the liability warranty, together with the amount claimed and the supporting documents. The seller has a period, often thirty days, in which to accept or challenge it. Where the claim is accepted or met with silence, the agreement authorises the escrow agent to pay the amount to the buyer on the buyer's instruction alone, which is the most debated clause of the negotiation. Where it is challenged, the sum remains frozen up to the amount claimed and the balance follows the release schedule.
The deductible and the cap: the escrow can be called on only within the limits of the warranty. A claim below the deductible, or exceeding the cap, gives rise to no withdrawal. The agreement refers expressly to those thresholds so that the escrow does not become a warranty wider than the one stipulated in the sale and purchase agreement.
What happens if the escrowed funds are disputed?
A freeze on the funds is the normal consequence of a lasting disagreement. Article 1960 of the French Civil Code prohibits the escrow agent from releasing itself from its duties without the agreement of all the parties or a court decision, and escrow agreements restate this. The escrow agent may neither rule on the dispute, unless expressly mandated to do so, nor return the funds to the depositing party on the ground that the challenge is dragging on.
Which court should be applied to, and within what time limit?
The juge des référés (the judge ruling on urgent interim applications) of the tribunal de commerce (commercial court) may order the release of all or part of the funds where the obligation is not seriously open to challenge, on the basis of article 873 of the French Code of Civil Procedure. On the merits, an action to enforce the liabilities warranty is subject to the five-year limitation period under article L. 110-4 of the French Commercial Code, but the contractual duration of the warranty, which is often shorter, is the time limit that actually applies to the buyer for notifying its claim. The escrow agent remains bound to hold the funds until the final decision, however long that takes.
What becomes of the escrow if one party enters insolvency proceedings?
Insolvency proceedings against the seller raise the question of who owns the funds. The escrowed sums do not form part of the seller's estate as long as the conditions for their release are not met, and a buyer who brings a well-founded claim obtains payment without ranking alongside the seller's creditors, while lodging its claim in the proceedings for the balance in accordance with article L. 622-24 of the French Commercial Code. This situation shows why escrow is stronger than a mere undertaking by the seller, whose warranty claim would be, without escrow, an unsecured claim subject to the stay of proceedings under article L. 622-21 of the French Commercial Code.
Insolvency proceedings against the buyer: the escrowed deferred consideration likewise escapes the buyer's creditors, since the buyer has parted with it in favour of the third party. The seller of a company whose buyer is a debt-laden vehicle therefore has a direct interest in placing the earn-out in escrow, which protects it against the default of a holding company with no asset other than the securities acquired.
What tax and accounting treatment applies to the escrowed price?
The escrowed price is acquired by the seller for tax purposes as soon as title to the shares is transferred. The portion placed in the hands of the escrow agent forms part of the sale price and is included in the taxable capital gain for the year of the sale, even though the seller cannot dispose of it. Escrow is not a form of deferred payment; it is an earmarking of a price that has already been paid.
How is the capital gain of an individual seller taxed?
Taxation in the year of the sale follows from article 150-0 C. civ. A of the French General Tax Code, the gain being computed on the total price, escrow included, and subject to the single flat-rate levy of 30 % or, by election, to the progressive income tax scale with the allowances for length of holding available for shares acquired before 2018. If the seller then has to pay back part of the price under the seller's liability warranty, article 150-0 C. civ. D, 14 of the French General Tax Code provides that the amount repaid reduces the sale price, which opens the right to file a formal tax claim within the time limit set by article R. 196-1 LPF.
The additional price payment: article 150-0 C. civ. A, I, 2 of the French General Tax Code taxes an additional price payment received under a clause indexed on the company's business activity in the year in which it is received, and not in the year of the sale. Escrow does not alter this rule, receipt being understood as the actual payment to the seller by the escrow agent. This deferred taxation is a cash-flow advantage which, where an escrow is used, is combined with security of payment.
What treatment applies to a corporate seller and to the buyer?
The selling holding company recognises the sale proceeds in full at the date of transfer of title and, where the shares are participating interests held for more than two years, benefits from the exemption regime of article 219 C. civ., I, a quinquies of the French General Tax Code, subject to the taxable share of costs and expenses of 12 %. The escrowed sum appears in assets as a receivable from the escrow agent, written down if a claim becomes probable. The indexed additional price payment is estimated where it can be measured reliably, or disclosed in the notes to the accounts.
For the buyer, the shares are recorded at their acquisition cost, including the firm price and the estimated additional price payment, in accordance with the rules of the plan comptable général (the French general chart of accounts) resulting from regulation no. 2014-03 of the Autorité des normes comptables (the French accounting standards authority). The additional price payment is recognised as a liability to the seller where it is probable and measurable, and adjusted at each period end. The registration duties under article 726 CGI are assessed on the total price, including the additional price payment once it has been determined, which requires a supplementary return at the time it is set.
| Event | Individual seller | Corporate seller | Buyer |
|---|---|---|---|
| Payment into escrow at closing | Price taxable in the year of the sale, article 150-0 C. civ. A of the French General Tax Code | Sale proceeds recognised, regime of article 219 C. civ., I, a quinquies of the French General Tax Code | Acquisition cost of the shares, duties under article 726 CGI |
| Repayment under the warranty and indemnity agreement | Reduction of the price, article 150-0 C. civ. D, 14 of the French General Tax Code, tax claim | Expense or reduction of the proceeds depending on the nature of the indemnity | Reduction of the acquisition cost or income depending on the characterisation adopted |
| Release of the additional price payment | Taxable in the year of receipt, article 150-0 C. civ. A, I, 2 of the French General Tax Code | Income recognised at the date of determination | Adjustment of the acquisition cost, additional duties |
What are the common risks and mistakes in escrow of the sale price?
A poorly drafted escrow is the leading risk, more common than a default by the third-party escrow agent. An agreement that requires joint instructions for every release, with no mechanism for unilateral release after a period of silence, gives the seller the power to block sums which the warranty nevertheless requires it to hand over, and sends the buyer to court to obtain what the contract promised.
What mistakes does the seller make?
Expiry with no blocking clause: conversely, a seller who obtains automatic release on a fixed date, with no reservation for notified claims, may face a liability action if well-founded claims remain unpaid, which does not extinguish its debt under the warranty. The escrow protects the seller as much as the buyer by definitively clearing claims on release.
Accepting escrow with a third party that is not covered: entrusting the funds to an intermediary with no client account, no financial guarantee and no insurance, or to the buyer itself under cover of a dedicated account, amounts to granting an unsecured vendor loan. Only a lawyer, a notaire and a credit institution provide effective safeguarding of the funds.
What mistakes does the buyer make?
Escrow confused with the cap: a buyer who limits its due diligence because an escrow exists forgets that the escrow covers only a fraction of the price and that the liability warranty remains bounded by its deductible, its cap and its exclusions. The escrow secures recovery; it does not alter the scope of the warranty.
A poorly synchronised closing timetable: payment into escrow forms part of the closing funds flow, alongside payment of the price, repayment of existing debt and the irrevocable payment instructions that govern them. An escrow whose agreement is signed only after closing, or whose account is not opened in time, delays the whole transaction, something the preparation of the sale timetable must anticipate several weeks in advance. Instructing an adviser who handles both business sales and escrow removes this coordination risk.
FAQ
What is escrow of the sale price of securities?
It is the deposit, by the buyer, of part of the price paid for the shares or corporate units with a third party, a lawyer, a notaire or a bank, which holds it until the seller's warranty expires or an additional price is determined, then pays it to whichever party is entitled to it. It is governed by articles 1955 to 1960 of the French Civil Code.
What percentage of the sale price is held in escrow?
Market practice is between 5% and 15% of the price for an escrow securing the seller's warranty, depending on the risks identified by the due diligence and on the seller's solvency. A specific escrow may be added to cover an identified risk, an ongoing tax audit or pending litigation, sized on that risk.
How long does an escrow securing the seller's warranty last?
Three years in most cases, a period aligned with the reassessment period of the French tax authorities set out in article L. 169 LPF, with partial releases on each anniversary date. Any claim notified before that date blocks the corresponding portion until it is finally settled.
CARPA escrow or bank escrow account: which one to choose?
The CARPA gives a check on every movement of funds, fast execution and the assessment of claims by the lawyer acting as escrow agent, but the funds bear no interest for the parties. A bank escrow suits large amounts held for a long time, because it can bear interest, but the bank acts only on joint instructions and freezes the funds at the slightest disagreement.
Is the escrowed price taxable for the seller?
Yes. The escrowed portion forms part of the sale price and the capital gain is taxed for the year of the sale on the total price, under article 150-0 C. civ. A of the French General Tax Code. Where a sum is later paid back under the seller's warranty, article 150-0 C. civ. D, 14 of the French General Tax Code allows the price to be reduced and the corresponding tax to be reclaimed.
How is an escrowed earn-out taxed?
The additional price linked to the company's business is taxed for the year in which the seller actually receives it, under article 150-0 C. civ. A, I, 2 of the French General Tax Code. Placing the funds with the escrow agent is not a receipt; only release to the seller triggers taxation.
What happens if the seller and the buyer disagree on release?
The escrow agent keeps the funds, article 1960 of the French Civil Code prohibiting it from discharging itself without the agreement of every party or a court decision. The buyer or the seller may apply to the juge des référés of the tribunal de commerce for release of the portion that is not seriously disputable, or to the court on the merits to settle the dispute over the warranty.
Can a bank guarantee replace the escrow?
Yes. The seller may receive the whole price and provide a first-demand bank guarantee, governed by article 2321 of the French Civil Code, for an amount equivalent to the escrow contemplated. The seller keeps the use of the funds but bears an annual fee and a counter-guarantee required by its bank, often a pledge over an investment account.
