The seller note is where an indemnity gets paid

The seller note is usually the largest sum a buyer still controls after closing, which makes it the practical source of payment for an indemnity claim. That takes an express setoff right in the note, a defined trigger, non-negotiability language, and a reduction mechanic that still works under the SBA lender’s standby agreement.

Why is the seller note the buyer’s best protection after closing?

The seller note is money the buyer has not yet paid. In an SBA 7(a) acquisition of a privately held business, the seller is usually an individual, the escrow is small or absent, and representation and warranty insurance is uncommon at this size. Withholding beats collecting, but only if the note permits it.

An indemnity is only as good as the person who made it and the assets you can reach. After closing the seller holds proceeds that can be spent, gifted, or moved, and collecting a judgment is harder than winning one.

Setoff inverts the posture. You keep money you already owe and make the seller come to you, which usually leaves the seller to fund the fight. It is not free self-help. If the note does not give you the right in writing, withholding is a default. The seller can accelerate the balance, add default interest and costs, and sue on the note rather than on the representations, where his case is simpler than yours.

Setoff does not win the argument. It decides who holds the cash while the argument runs, and at this deal size that is usually the whole contest.

Does the setoff right belong in the seller note or the purchase agreement?

Both documents need it. A setoff right that appears only in the asset purchase agreement invites the argument that the promissory note is a separate and independent obligation, payable on its own terms whatever is happening under the purchase agreement. Put the operative right in the note, cross-reference it in the purchase agreement, and make both describe the same trigger.

Start with the draft note. Most forms say the maker’s obligation to pay is absolute and unconditional and that payments will be made without defense, setoff, counterclaim, or deduction. That sentence is the whole fight, decided against you. Strike it, or carve it out expressly.

Then reconcile the papers. The purchase agreement should say you may satisfy an indemnification obligation by reducing amounts outstanding under the note in accordance with its setoff section, and the note should say the payment obligation is subject to that section. One gate, stated once, referenced twice.

I mark up the note first and the purchase agreement second, so the remedy ends up drafted where the money is.

Courts read these clauses as written. In a 2023 Delaware federal decision, a note let the buyer set off damages for which it was entitled to indemnification as determined under the deal’s other agreements, and those agreements required damages, notice, and then the seller’s agreement or a final determination before the buyer could keep the money. One court reading one contract binds nobody else, but the gate you draft is the gate you get.

Case: Corso v. Concordia Healthcare USA, Inc., No. 21-cv-353-SB (D. Del. Mar. 24, 2023).

One useful side effect: a promise is not unconditional for negotiability purposes if it states an express condition to payment, or that it is subject to or governed by another writing. Making payment subject to the setoff section pushes the note toward non-negotiable. Do not lean on that alone; a reference to another writing for collateral, prepayment, or acceleration rights does not make a promise conditional.

Law: U.C.C. 3-106(a), (b).

When should a buyer be allowed to set off, on an asserted claim or a final determination?

Three gates are in circulation. Setoff on a good-faith asserted claim; setoff only on a claim finally determined by judgment or written agreement; and withholding of disputed amounts into a segregated account pending determination. The third answers the seller’s strongest objection, but an individual seller funding a retirement with the note often refuses it.

Be honest about the middle column. An unqualified right to stop paying on a claim you declare lets a buyer with remorse manufacture a dispute while the seller funds a suit to recover the price of his own business. A determination-only gate costs you the other way: you prosecute the claim and pay the note at once, and if the note amortizes over five years while the claim takes two, your collateral shrinks before you win.

Be honest about the third column too. The segregated-account structure comes out of deals with institutional sellers and funded escrows. A retiring owner financing part of his own price often refuses to park money he cannot touch, and no seller has to agree to any of it. Where it can be negotiated:

• Written notice describing the claim and estimating the loss, before any payment is withheld.
• A cap at that estimate, everything else paid on schedule, and deposit of the withheld amount into a segregated account or with a third party.
• A diligence covenant: start the agreed dispute process within a stated number of days after notice, or release the funds.
• Fee shifting against a party that withholds or resists in bad faith.
• On final determination or written agreement, a permanent reduction of principal as of the setoff date, applied to the last-maturing installments.

Can the seller sell the note and wipe out your setoff rights?

Only if the note is negotiable and the transferee qualifies as a holder in due course. That status requires value, good faith, and no notice of your claim or defense. A holder in due course takes free of ordinary contract defenses and of claims in recoupment against anyone else. Setoff is an ordinary defense.

Law: U.C.C. 3-302(a); U.C.C. 3-305(b).

Two qualifications cut your way. A narrow set of defenses survives even a holder in due course, and they concern the making of the instrument, not the deal. A transferee who takes after written notice of your claim, or takes a defaulted note, struggles to prove it lacked notice.

The risk is real. The seller transfers the note to a family member or a note buyer, and you owe someone who made no representations. Draft against it:

• Put a conspicuous statement in the note that the promise is not negotiable and is not an instrument governed by Article 3. A promise other than a check is not an instrument if it carries that statement when issued.
• Make the note payable to the named seller only, never “to the order of” or “or bearer.”
• Refuse any clause waiving claims or defenses against an assignee; that waiver is enforceable by an assignee taking for value, in good faith, and without notice. State instead that any assignee takes subject to your defenses, setoffs, and claims in recoupment.
• Add a transfer restriction, prior written notice of any assignment including by operation of law, and a setoff right running against the payee and any transferee.

Law: U.C.C. 3-104(d); U.C.C. 9-403(b); U.C.C. 9-404(a).

Know the limit. Article 9 makes some anti-assignment terms in a promissory note ineffective, with a carve-out for outright sales, so treat the covenant as a notice and damages tool, not a wall. These are uniform texts enacted state by state with variations; read your state’s version.

Law: U.C.C. 9-406(d), (e); U.C.C. 9-408.

How does the SBA standby agreement affect a setoff right?

Standby suspends payments. Where the seller note counts toward the buyer’s required equity injection, SBA’s operating procedure has required full standby, no principal and no interest, for the life of the SBA loan. That is the position as of October 2026. A setoff written only as a right to withhold then bites on nothing.

State the rule with a date on it. As of October 2026, SOP 50 10 8.1 governs loans receiving an SBA loan number on or after October 1, 2026, and gathers change-of-ownership requirements into Appendix 15. SOP 50 10 8 governs loan numbers issued from June 1, 2025 through September 30, 2026, and SOP 50 10 7.1 those issued earlier. Under SOP 50 10 8, a complete change of ownership carried a minimum equity injection of 10 percent of total project costs, and seller debt counted only on full standby for the life of the loan and only up to half the requirement. SOP 50 10 8.1 keeps the 10 percent injection for an initial acquisition and again caps standby seller debt at half. Ask your lender which version governs your loan number before you draft.

SBA: Information Notice 5000-866746 (SOP 50 10 8); Information Notice 5000-880695 (SOP 50 10 8.1); Information Notice 5000-882227 (technical updates); SOP 50 10 8.1, Appendix 15.

The drafting consequence is specific. Write the setoff as a permanent reduction of outstanding principal and accrued interest, effective on the setoff date, whether or not a payment is then due or permitted. A note on full standby still has a balance. Reduce the balance. A clause that only suspends installments takes nothing standby has not taken already.

I read the seller note and the standby agreement side by side before I read the indemnification article, because the first two decide whether the third has a remedy.

Where the note is not credited toward the injection, it is still subordinated and governed by what the lender permits. A lender may use SBA Form 155 or its own form, so read the one in your file. On Form 155 the standby creditor agrees to take no action to enforce claims against the borrower until the lender’s loan is satisfied, to take no action against the borrower’s collateral without the lender’s written consent, and to subordinate secured interests. That restrains the seller, but it is the lender’s protection and the lender decides whether to consent.

SBA: Form 155, Standby Creditor’s Agreement.

The note attached to the standby agreement should be the note carrying your clauses. If the bank’s form replaces it late in closing week, read the payment covenant again before signing.

Standby does not pause the seller’s indemnity obligation. It pauses your payments. If your setoff clause reaches only payments, standby pauses your remedy too.

What should the seller note say about security and subordination?

Subordination of the seller note to the SBA loan is not negotiable in practice. What remains negotiable is the note’s maturity, whether the seller receives any lien at all, whether the note is still outstanding when the indemnity survival periods expire, and whether the individuals behind a selling entity stand behind the indemnity personally.

• Match maturity to survival. If the representations survive eighteen months from closing and the note is paid off in twelve, the setoff fund is gone before the claims window closes. A note on full standby will usually still have a balance, which is one place the rules work for you. A second lien for the seller is the lender’s call, not a formality.
• Reach the entity’s owners. If the seller is an entity that will distribute proceeds and wind up, the indemnity is a promise from a shell. Have the owners join or guarantee it, and bar distributions below a stated amount until survival expires.
• Sweep in every deferred dollar. The setoff should reach principal, accrued interest, and consulting, transition, non-compete, and earnout payments.

What should you do with the seller note draft this week?

Three documents control the outcome: the promissory note, the purchase agreement’s indemnification article, and the lender’s standby agreement. Read them together, in that order, before the next turn of drafts. Every item below is a sentence or two of text that either exists in your note or does not.

• Search the note for “absolute,” “unconditional,” “without setoff,” and “deduction,” and strike or carve out every hit.
• Insert a setoff section: notice, estimate, cap, segregated account, diligence deadline, and permanent reduction of principal on determination.
• Add the non-negotiability statement, delete “to the order of,” add the transfer restriction and assignment notice, and state that an assignee takes subject to your defenses.
• Cross-reference the setoff section in the purchase agreement, confirm both documents describe the same gate, and check maturity against every survival period.
• Ask your lender which SOP version governs your loan number and what it requires of seller debt, then send your language to the lender’s counsel before the closing set circulates.

Negotiate those terms and the indemnity has a defined place to be paid from. Skip them, and it is a promise you will enforce against someone who already has your money.