An unrestricted setoff right can convert a seller note or earnout into a buyer-controlled indemnification fund. If the buyer can suspend payment merely by asserting an indemnification claim, the seller may lose access to millions of dollars before anyone determines whether the seller is actually liable.
The central issue is not simply whether the buyer ultimately has a valid indemnification claim. The more immediate question is who controls the unpaid purchase price while the claim remains disputed. Without a contractual withholding right, the buyer may be required to make the deferred purchase price payment and pursue the indemnification claim separately. With a broad withholding right, the buyer may retain the disputed purchase price while the seller pursues payment.
The transaction agreement should therefore distinguish between two different remedies. A permanent setoff reduces an amount otherwise payable after an indemnifiable loss has been established under the agreement. A temporary withholding right allows the buyer to retain money before the indemnification dispute has been resolved. The right to recover an established indemnifiable loss does not necessarily give the buyer the separate right to suspend payment immediately after asserting a claim.
How Are Seller Notes and Earnouts Different?
Seller notes and earnouts both defer payment of purchase price, but the payment obligations operate differently.
A seller note ordinarily creates a fixed payment obligation. Principal and interest become payable according to the note unless the seller note, transaction agreement, or another applicable transaction document permits setoff, subordination, payment blockage, or another defense to payment.
An earnout is contingent consideration. The obligation to pay arises only if the contractual performance conditions are satisfied. Once the specified conditions have been satisfied, however, a buyer cannot necessarily add a separate indemnification condition that does not appear in the earnout provision.
Arthur J. Gallagher & Co. v. Agiato demonstrates that an earned earnout payment and a separate indemnification claim remain distinct unless the transaction agreement expressly connects them. The applicable revenue condition for the earnout had been satisfied, making the payment due under the earnout provision. The buyer nevertheless withheld the payment based on alleged breaches of other contractual obligations. The Delaware Court of Chancery rejected the attempted withholding, holding that the buyer could pursue the alleged breaches through the contractual indemnification process but could not use the unresolved indemnification claims to create an additional condition to payment of the earned earnout. Because the transaction agreement did not make satisfaction of the indemnification obligations a condition to the earnout payment, the buyer remained obligated to pay the earnout while separately pursuing any available indemnification remedy.
When Does an Indemnification Claim Permit Setoff?
A buyer may reduce deferred purchase price when the transaction documents expressly authorize setoff and the contractual requirements for exercising the setoff have been satisfied.
The transaction agreement and the applicable seller note or earnout provision should identify:
- The deferred payment against which setoff may be exercised.
- The categories of losses eligible for setoff.
- Whether indemnification baskets, caps, survival periods, causation requirements, and other limitations apply.
- Whether setoff is available when a claim is asserted, when the seller accepts the claim, or only after liability is finally determined.
- Whether setoff is an optional remedy or the exclusive source of recovery.
In re Dura Medic Holdings, Inc. illustrates how a transaction agreement can expressly connect a seller note to the indemnification remedy. The merger agreement permitted the buyer to offset indemnifiable losses against amounts due under the Seller Note, and the Court of Chancery noted that the offset right was optional rather than mandatory. The contractual setoff right therefore expressly identified the Seller Note as a source from which the buyer could recover qualifying indemnification losses.
Why Does the Difference Between a Claimed Amount and an Amount Owed Matter?
The transaction agreement should distinguish among an asserted claim, an undisputed obligation, and a finally determined indemnifiable loss because each stage reflects a different level of certainty about whether the buyer is entitled to retain the seller’s money.
An asserted claim exists when the buyer delivers an indemnification notice alleging a breach and estimating the resulting loss. At that stage, the buyer has made a demand, but the seller may dispute liability, causation, or amount.
An undisputed obligation exists when the seller accepts the claim, fails to object within an agreed period, or otherwise agrees that a specified amount is payable.
A finally determined indemnifiable loss exists after the amount has been established through settlement, judgment, arbitration, or another dispute resolution procedure specified in the transaction agreement.
An asserted claim, an undisputed obligation, and a finally determined indemnifiable loss should not be treated as interchangeable because each may support a different right to withhold or permanently reduce deferred purchase price. The transaction agreement should state whether an asserted claim, an undisputed obligation, or a finally determined indemnifiable loss permits temporary withholding, permanent setoff, or neither.
Post Holdings, Inc. v. NPE Seller Rep LLC demonstrates why the transaction agreement should define the level of certainty required before an indemnification claim permits the buyer to retain or reduce an amount otherwise payable to the seller. The transaction agreement required the buyer to remit certain tax refunds to the sellers but permitted reduction for indemnification payments “owed” by the sellers. The buyer attempted to retain the refunds based on pending indemnification claims. The Court of Chancery rejected the attempted reduction because the unresolved claims were not amounts presently “owed.” The court emphasized that the parties could have negotiated a right to delay payment pending resolution of indemnification claims but had not done so.
Temporary withholding can have its greatest economic effect when the buyer asserts an indemnification claim that equals or exceeds the deferred purchase price then due. A buyer may assert a claim that exceeds the amount currently payable even though the buyer has not yet established breach, causation, or damages.
Assume the buyer owes the sellers a $2 million earnout. Ten days before payment, the buyer alleges a breach of a customer contract representation and asserts $3 million of losses. The sellers dispute the alleged breach, causation, and damages.
If delivery of the claim notice permits immediate withholding, the buyer may retain the entire $2 million earnout while the indemnification claim remains unresolved. If the buyer ultimately establishes only $400,000 of indemnifiable losses, only $400,000 of the $2 million withholding becomes a proper permanent setoff. If the buyer establishes no indemnifiable losses, the buyer was never entitled to retain any portion of the $2 million permanently. The temporary withholding right therefore determines who controls the $2 million when liability remains unresolved, while the permanent setoff right determines how much of the $2 million the buyer may ultimately retain.
Legent Group, LLC v. Axos Financial, Inc. illustrates the risk of permitting an asserted indemnification claim to suspend seller note payments before the buyer establishes entitlement to indemnification. The buyers withheld payments due under seller notes after asserting an indemnification demand arising from a $15.2 million trading loss. After trial, the Court of Chancery concluded that the buyers failed to establish the alleged contractual inaccuracies and causation necessary for the indemnification claim, leaving the sellers entitled to the withheld note payments.
Should a Buyer Be Permitted to Withhold a Disputed Amount?
A temporary withholding provision must balance the buyer’s risk of being unable to collect an indemnification award against the seller’s interest in receiving deferred purchase price that has not yet been established as subject to indemnification. The buyer may face substantial collection risk if deferred purchase price must be distributed among multiple sellers before an indemnification claim is resolved. The seller, however, may reasonably object to allowing the buyer to assert a claim, retain the disputed purchase price, and force the seller to pursue payment.
The transaction agreement can address both concerns by separating temporary withholding from permanent setoff.
For example, the agreement may permit the buyer to temporarily withhold the lesser of the good faith estimated loss and the deferred payment then due. The buyer can be required to provide a detailed claim notice identifying the alleged breach, the contractual basis for indemnification, the estimated loss, and the supporting information reasonably available to the buyer.
The disputed funds can then be deposited into a third-party escrow or segregated account while the buyer pays all undisputed amounts.
The release mechanics are equally important. If the buyer withholds $2 million and ultimately establishes only $400,000 of indemnifiable losses, the agreement should require prompt payment of the remaining $1.6 million. The agreement should also state whether interest accrues from the original payment date so that an unsuccessful or overstated indemnification claim does not provide the buyer with interest-free use of the seller purchase price.
What Should the Setoff and Withholding Provisions Address?
The transaction agreement, seller note, earnout provision, and any applicable escrow agreement should allocate the payment risk expressly rather than leave the parties to argue about whether an indemnification remedy implicitly permits withholding.
The principal provisions should address:
- Payment sources. Identify whether setoff or withholding applies to seller note principal, note interest, earnout payments, holdbacks, escrow releases, or other deferred consideration.
- Permanent setoff. State when the buyer may permanently reduce the deferred payment, including whether the loss must be acknowledged by the seller, resolved by settlement, or established through a final judgment, arbitration award, or other agreed determination.
- Temporary withholding. State whether the buyer may retain disputed funds before liability is established and specify the notice requirements, maximum withholding amount, good faith estimate requirement, and treatment of the withheld funds.
- Undisputed amounts. Require payment of the portion of the seller note, earnout, or other deferred consideration that is not subject to the disputed claim.
- Resolution and release. Establish an expedited dispute procedure, access to supporting records, deadlines for releasing excess withheld funds, and interest on amounts ultimately payable to the seller.
- Indemnification limitations. Confirm whether baskets, caps, survival periods, exclusions, causation standards, and other indemnification limitations apply to amounts recovered through setoff.
- Duplicate recovery. Prohibit the buyer from recovering the same loss through multiple sources, such as an indemnification escrow, holdback, earnout, and seller note.
The transaction agreement should also state whether deferred consideration is the exclusive recovery source. If an indemnifiable loss exceeds the unpaid seller note or earnout, the parties should specify whether the buyer may pursue the sellers directly for the excess amount and how the applicable indemnification limitations apply.
Conclusion
An indemnification claim does not automatically give a buyer the right to offset or withhold a seller note or earnout. The transaction documents should expressly identify the deferred payments subject to setoff and the circumstances under which the buyer may temporarily retain or permanently reduce those payments.
The most important economic question is who controls the unpaid purchase price before liability has been established. Permanent setoff determines when an established indemnifiable loss may reduce the amount payable to the seller. Temporary withholding determines whether the buyer may retain disputed purchase price while the indemnification claim remains unresolved.
A well-drafted transaction agreement should address both remedies separately, require payment of undisputed amounts, establish resolution and release procedures, preserve the negotiated indemnification limitations, and prevent duplicate recovery.
By Joseph R. Luna
Primary Authorities
Arthur J. Gallagher & Co. v. Agiato, C.A. No. 2024-0494-LWW (Del. Ch. July 31, 2025)
In re Dura Medic Holdings, Inc., Cons. C.A. No. 2019-0474-JTL (Del. Ch. Feb. 20, 2025)
Post Holdings, Inc. v. NPE Seller Rep LLC, 2018 WL 5429833 (Del. Ch. Oct. 29, 2018)
Legent Group, LLC v. Axos Financial, Inc., C.A. No. 2020-0405-KSJM (Del. Ch. Nov. 7, 2025)