Legal Recommendations for the Application of the Locked Box Mechanism in M&A Transactions

In mergers and acquisitions (M&A), purchase price determination is a critical factor that directly affects the overall success of the transaction. Alongside the Earn-out mechanism, the Locked Box structure has gained traction in high-value deals, particularly where the target company maintains a transparent and robust financial reporting system. This article analyzes the legal structure, advantages, potential risks, and practical recommendations for enterprises and investors considering the Locked Box mechanism as a tool for price adjustment in M&A transactions.

1.Legal nature and structure of the locked box mechanism

The Locked Box is a pricing mechanism under which the purchase price is fixed based on a balance sheet prepared as of a specific date in the past (the “Locked Box Date”). As of this date, the audited financial statements are presumed to fairly reflect the target company’s financial position. From the Locked Box Date to the closing date, the seller is prohibited from extracting any economic value from the target business, except for specifically agreed “permitted leakage” items, which must be clearly listed in the share purchase agreement (SPA).

Unlike the Earn-out mechanism, the Locked Box does not allow for purchase price adjustments after the signing date, thereby reducing administrative costs, shortening the execution timeline, and minimizing future disputes over financial performance metrics.

2.When to Apply the Locked Box Mechanism?

The Locked Box mechanism is best suited for transactions that meet the following criteria:

• The target has recently audited financial statements prepared under recognized accounting standards (e.g., VAS or IFRS) with high-quality disclosures;
• The target’s business operations are stable with limited short-term volatility;
• The parties maintain a high degree of mutual trust and transparency, allowing for a clear agreement on leakage and permitted leakage;
• The transaction does not rely on post-closing performance outcomes.

Selecting an appropriate Locked Box Date and relying on independently audited figures ensures transparency and reduces the likelihood of post-closing financial disagreements.

3.Controlling cash flow and preventing unauthorized leakage

The principal legal risk under a Locked Box structure arises from unauthorized “leakage,” which reduces the actual value of the target company prior to closing. Common types of leakage include:

• Dividends not reflected as of the Locked Box Date;
• Transfers of assets to related parties without fair valuation;
• Unjustified executive bonuses or sudden salary increases;
•  Commercial transactions conducted at non-market prices.

To mitigate these risks, the buyer should:

• Require the seller to represent and warrant that no leakage has occurred except for the expressly agreed permitted leakage;
• Include indemnification provisions for any leakage, regardless of fault;
• Utilize holdback or escrow provisions to offset losses if necessary. In addition, the contract should clearly specify the seller’s obligation to provide financial reports, the buyer’s inspection rights, and the mechanism for independent verification of any expenditures incurred after the Locked Box date.

4.Considerations regarding enforceability and legal structure

Under Vietnamese law, the Locked Box mechanism is recognized as a valid arrangement pursuant to the principle of freedom of contract under the 2015 Civil Code. To ensure enforceability, parties should address the following in the SPA:

• Clearly specify the Locked Box Date, the applicable financial statements, and confirm that the purchase price shall remain fixed;
• Provide a detailed list of permitted leakage items (e.g., salaries, social insurance contributions, operating expenses);
• Attach the relevant financial statements as an annex to the agreement;
• Include a dispute resolution clause (it is advisable to agree on resolving disputes through commercial arbitration).

5.Enhancing legal certainty with additional protective instruments

To reinforce the legal effectiveness of the Locked Box structure, parties are encouraged to integrate complementary safeguards, such as:

• Escrow accounts: Retain part of the purchase price to offset potential leakage or breaches of representations and warranties;
• Supplemental representations and warranties: The seller should confirm that no material adverse events have occurred post-Locked Box Date;
• Contractual remedies: Define the consequences of detected leakage (e.g., compensation, price adjustment, or transaction termination).

6.Practical recommendations

• Buyers should prioritize the use of recent, independently audited financial statements over internal reports as the Locked Box baseline;
• The SPA must define the buyer’s rights to monitor financial transactions between the Locked Box Date and closing;
• The parties should clarify the seller’s liability cap, claim period, and any exclusions from liability;
• Avoid using the Locked Box mechanism in volatile market conditions or where reliable financial data is lacking.

The Locked Box is a highly efficient pricing mechanism in M&A transactions, especially for deals involving transparent financials, swift execution, and limited post-closing fluctuations. However, its success depends on a clearly structured legal framework, robust anti-leakage controls, and proper integration with complementary tools such as escrow accounts and representations and warranties clauses. Engaging legal counsel, auditors, and financial advisors early in the negotiation phase ensures not only effective risk management but also optimal legal and financial outcomes for the transaction.

This article, titled “Legal Recommendations for the Application of the Locked Box Mechanism in M&A Transactions” is presented by TNTP. For further advice or legal support, please contact us for timely assistance.

Sincerely.