A holdback the buyer never actually set aside

The situation

A first-time buyer acquired the assets of an Ontario commercial cleaning and janitorial services company for $2,400,000. To protect against post-closing indemnity claims, the purchase agreement called for the buyer to retain $240,000 — ten percent of the price — for eighteen months. The seller's lawyer, working from a template, did not push for a separate escrow agreement or a third-party escrow agent. The clause simply said the amount would be “retained by the Buyer.”

The problem

“Retained by the Buyer” is not the same thing as held in trust for the seller, and the difference sat dormant for over a year. The buyer never opened a separate account for the $240,000; it stayed in the buyer's general operating account, indistinguishable from every other dollar the business earned. Fourteen months after closing, the buyer breached a financial covenant in its own senior credit facility. The lender — which held a general security agreement over all of the buyer's present and after-acquired personal property, including its bank accounts — exercised its cash-dominion rights and swept the operating account. The $240,000 went with everything else.

Three months later the seller discovered a real problem: the target's workers' compensation assessment had been understated for two years, and the resulting reassessment was the seller's responsibility to indemnify under the purchase agreement. The seller made a claim against the holdback. The buyer, by then bankrupt, said the money was gone.

The numbers

The $240,000 holdback represented ten percent of the $2,400,000 purchase price. In the buyer's bankruptcy, the senior lender's perfected security interest ranked ahead of every unsecured claim, and there was not enough left over to pay unsecured creditors in full. The seller's proof of claim for the $240,000 was treated exactly like every other trade creditor's claim — no priority, no segregated fund to point to — and the eventual distribution paid unsecured creditors roughly twelve cents on the dollar. The seller recovered about $28,800 of the $240,000 it was owed.

The rule that decided it

No statute converts a retained holdback into a trust fund. Whether money held by one party for the benefit of another is impressed with a trust, rather than simply owed as a debt, is a question of ordinary trust doctrine: the arrangement needs certainty of intention to create a trust, certainty of the property that is its subject matter, and certainty of who benefits from it. Courts do not presume a trust from a bare obligation to pay a sum later — if the parties intend a segregated fund, the agreement has to say so, and the fund actually has to be kept separate.

Treadstone Law's own explainer draws exactly the distinction this file turns on: “Holdback more often refers to an amount the buyer simply retains, rather than paying at closing, governed directly by the purchase agreement's indemnity and adjustment provisions, without necessarily involving a separate third party or agreement.” That is precisely what happened here.

Once the buyer went bankrupt, a federal statute made the trust-versus-debt question decisive rather than academic. The Bankruptcy and Insolvency Act, under the heading “Property of bankrupt,” excludes from the estate divisible among creditors any “property held by the bankrupt in trust for any other person.” Had the $240,000 genuinely been impressed with a trust, s.67(1)(a) would have kept it out of the bankrupt estate entirely, ahead of every secured and unsecured creditor alike. Because the money had been commingled in the buyer's ordinary operating account, with no segregated fund for a trust to attach to, s.67(1)(a) had nothing to bite on — the $240,000 was simply part of the estate, and the seller's claim to it was never more than an unsecured contractual right to be paid, ranking behind the senior lender's perfected security interest in the same funds.

The outcome

The seller's indemnity claim was entirely legitimate on the facts — the workers' compensation understatement was real, and the amount was well inside the $240,000 “holdback.” None of that mattered once the buyer's lender had already swept the account and the buyer went bankrupt. The seller's recovery depended not on the merits of its claim but on where it ranked in a bankruptcy it had no reason to expect and no trust claim or security interest to protect it from.

What it would have cost otherwise

Run the same fourteen months with a true third-party escrow instead. If the $240,000 had been held by an independent escrow agent, or even by a lawyer in a separate trust account under a proper escrow agreement, it would have been legally untouchable by the buyer's lender — the funds would never have formed part of the buyer's own asset pool in the first place, and a general security agreement cannot sweep money the debtor never owned. The seller's recovery on its claim would have turned entirely on the merits of the workers' compensation indemnity, not on the buyer's own balance sheet six months after closing. The $211,200 gap between the $240,000 the seller was owed and the roughly $28,800 it actually recovered is, in substance, the price of one missing clause.

The tell

The tell was sitting in the purchase agreement's own language before anyone signed it: the holdback clause said the amount would be “retained by the Buyer,” not held by a named escrow agent, and not held by any party “in trust for the Seller” in a segregated account. A single sentence naming a true escrow agent, or even just adding express trust language tied to a separate account, would have taken the $240,000 outside the reach of the buyer's own creditors entirely.

Takeaways

• • A holdback and a true escrow are not interchangeable. A holdback the buyer simply retains creates a contractual debt; only a segregated arrangement with a genuine third party (or express, properly funded trust language) creates a fund the seller's creditors can't reach.
• • Even trust language needs a segregated fund behind it. Money left commingled in the buyer's ordinary operating account defeats the certainty-of-subject-matter requirement no matter what the clause says.
• • A buyer-retained holdback is only as good as the buyer's own solvency for as long as it is held — and the buyer's own senior lender's security interest in its bank accounts ranks ahead of an unsecured seller claim.
• • If the deal calls it a “holdback” rather than an “escrow,” read past the label and check who actually holds the money, and how.

Sources

• • No statute creates a trust over a retained holdback in the first place. Whether the arrangement is a trust or a debt is a question of ordinary equitable trust doctrine (intention, subject matter, and objects) — the outcome turns on the agreement's own words and on whether the funds were actually segregated, not on any statutory rule.
• • Bankruptcy and Insolvency Act, R.S.C. 1985, c. B-3 — s.67(1)(a): property held by the bankrupt in trust for another person is excluded from the estate divisible among creditors. This is the statute that makes the trust-versus-debt question decisive once the buyer is insolvent; it does not itself create the trust.
• • Treadstone Law — escrow and holdbacks in an Ontario business sale, explained — sets out the practical distinction between a true third-party escrow and a buyer-retained holdback that this file turns on. It does not address insolvency priority specifically; that analysis is added here.