What is locked box?

Answer 1

"Locked box" is an alternative to a completion accounts mechanism (familiar to advisors working under UK law) used in legal agreements when a target business is sold.

A traditional completion accounts mechanism:

- Is designed to be fluid: post deal a firm of auditors measures net assets for the target business. If actual net assets, as measured by the auditors, are less than previously-agreed target net assets, the seller will have to compensate the buyer;

- Takes time and is prone to argument and dispute. Potentially every item measured by the auditors, and every accounting treatment applied, could be questioned by either side. Because the audit and any argument happen after the sale, buyer and seller are left with price uncertainty.

Given the potential problems outlined above, a locked box mechanism replaces the fluid completion accounts mechanism with a "sticky" alternative. Only if, say, actual net assets prove to be 10% less than expected does the seller compensate the buyer. This is designed to deliver price certainty to both sides.

A locked box mechanism is not without its problems though. Net assets still need to be measured after the deal, there is plenty of scope for argument over actual net assets and a claim could still easily result. However, because of the "stickiness" of the mechanism, you would expect a reduced chance of claim.

Sceptics have commented: "Accountants like completion accounts mechanisms because they create more work for them (completion accounts policies, post-completion audit) but lawyers like locked box because it's more work for them (drafting the mechanism)".

The reality is both mechanisms have their faults. A few more details are provided below:

- Locked box has been imported into the UK from the US as an attempt to get around the arguments that inevitably arise out of a traditional completion accounts adjustment;

- Locked box replaces a fluid "£ for £" adjustment mechanism where one side is bound to have to compensate the other for one where one side might have to compensate the other;

- Under locked box the seller guarantees a completion balance sheet which is typically an historic balance sheet (e.g. the last audited balance sheet or a very good management accounts balance sheet) plus the adjustment to net assets arising from profitably up until completion, less permitted adjustments e.g. an agreed pre-sale dividend;

- There is no completion accounts process. It is replaced with the risk of claim against the seller if the guaranteed balance sheet (less, say, 10%) is not delivered.

Where lawyers and accountants are involved arguments are still likely to result!