Building Voluntary Disclosure Rights Into the Purchase Agreement

Target companies frequently have unregistered nexus in states where they have been selling for years, and that exposure does not disappear at closing. It transfers to the buyer, along with all of the accumulated back tax, interest, and penalties that come with it.

Buyers who identify this risk during diligence often negotiate indemnification provisions to address it. But indemnification alone is frequently not enough. Without additional contractual mechanics, a buyer can find itself holding an indemnity right in theory while lacking the practical tools to actually resolve the exposure efficiently, control the process, or ensure that funds are actually available to cover the liability when it comes due. A well-drafted purchase agreement should go further and give the buyer three specific rights: the ability to require the target to pursue voluntary disclosure agreements (VDAs), a dedicated escrow to fund the resulting liability, and control over both the VDA process and the selection of the tax advisor running it.

Why a General Indemnity Isn't Enough

A standard tax indemnity typically obligates the seller to reimburse the buyer for pre-closing tax liabilities that are later assessed. That structure has real limitations when it comes to historic sales tax exposure:

• It is reactive, not proactive. The buyer must wait for a state to audit or otherwise discover the exposure, at which point the look-back period, penalties, and interest have often grown substantially larger than they would have been under a voluntary disclosure program.

• It creates collection risk. An indemnity is only as good as the seller's ability and willingness to pay years after closing, particularly once escrow funds (if any) have already been released and the seller's business interests have diverged from the buyer's.

• It leaves the resolution process to chance. Without clear contractual rights, the buyer may have no ability to dictate how the exposure gets resolved, which states are approached, or who manages the process, even though the buyer is the party bearing the ongoing risk as the entity that now owns the business.

Addressing sales tax exposure proactively, through a negotiated right to pursue VDAs, closes these gaps.

The Case for a Contractual Right to Pursue VDAs

A voluntary disclosure agreement allows a company to come forward to a state proactively, before the state has identified it through an audit or other enforcement action, in exchange for a limited look-back period and, typically, abatement of penalties. This is almost always a materially better outcome than waiting for the state to find the exposure on its own.

The purchase agreement should therefore expressly provide that the purchaser has the right, following closing, to require the acquired company to pursue VDAs in any state where historic sales tax exposure meets or exceeds an agreed materiality threshold. Tying the right to a threshold, rather than to any identified exposure regardless of size, keeps the mechanism focused on exposures that are actually worth the time and cost of a VDA, and avoids turning every immaterial or ambiguous nexus question into a contractual trigger.

Key elements to include:

1. A defined threshold. The parties should negotiate and specify a dollar amount (or a formula, such as estimated tax plus interest exceeding a set figure) below which the buyer's VDA right is not triggered. This threshold should be set with input from the tax advisor conducting diligence, informed by the size of the target's business and the states where exposure is most likely.

2. A scheduled list of known states. Ideally, the purchase agreement itself will identify, in a schedule, the specific states where diligence has already shown exposure exceeding the threshold. Listing these states at signing removes ambiguity about which jurisdictions are covered from day one and lets the buyer begin coordinating VDA outreach for those states immediately after closing.

3. A mechanism to add states post-closing. Diligence rarely surfaces every jurisdiction with exposure, and some exposures only come into focus once the buyer has integrated the target's systems and sales data. The agreement should therefore give the buyer the ability to add states to the schedule after closing, provided that newly identified exposure in that state also meets the agreed threshold. This should be a unilateral notice right for the buyer (backed by supporting analysis, typically from the tax advisor) rather than something requiring the seller's agreement or renegotiation.

4. An affirmative obligation on the target/seller to cooperate. For any state on the schedule, whether listed at signing or added later, the target company (and, where relevant, the seller) should be contractually obligated to execute the VDA process once the buyer elects to pursue it: providing historical sales data, signing necessary state filings, and cooperating with the tax advisor.

5. A defined process for measuring exposure against the threshold. The agreement should specify how exposure is calculated for threshold purposes (e.g., estimated tax and interest for the applicable look-back period, before or after anticipated penalty abatement) so that there is no dispute later about whether a given state's exposure actually crosses the line.

Escrow: Funding the Liability Before It's Needed

A contractual right to pursue VDAs is only meaningful if funds are actually available to pay the resulting liability. For that reason, the purchase agreement should establish a dedicated escrow, separate from, or in addition to, any general indemnity escrow, sized to the states already scheduled at signing, with a mechanism to true up the escrow if additional states are later added under the threshold, and scoped specifically to cover:

• The underlying sales tax liability for the applicable look-back period in each state where a VDA is pursued

• Interest accrued on that liability through the date of payment

• Any penalties that are not abated as part of the VDA process (some states only partially waive penalties, or exclude certain categories from relief)

• Tax advisor fees and costs associated with conducting the nexus study, preparing and submitting VDA applications, negotiating with state authorities, and completing the resulting filings

Structuring the escrow around these specific categories, rather than relying on a general working capital or indemnity escrow, reduces the risk of disputes over what the escrow is meant to cover and ensures the fund is not inadvertently released before the VDA process concludes. The agreement should also address escrow duration (tied to the expected timeline for VDA resolution across all identified states, which can take many months per jurisdiction) and the mechanics for releasing any remaining balance once all VDAs are finalized and paid.

Buyer Control Over the Process and the Advisor

Perhaps the most operationally important, and most frequently overlooked, provision is control. The purchase agreement should specify that the purchaser controls the VDA process, including the authority to:

• Select the tax advisor who will conduct the nexus analysis and manage the VDA submissions, rather than leaving that choice to the seller or target

• Determine which states to approach and in what sequence, based on the buyer's own risk assessment

• Make final decisions on positions taken in the VDA applications, including how historic activity is characterized and what look-back period is proposed to each state

• Control communications with state taxing authorities throughout the process

This is important for reasons beyond simple negotiating leverage. The buyer is the party that will own the ongoing multistate compliance obligations after the VDAs are complete, and the party ultimately responsible for the business's tax posture going forward. Allowing the seller, whose interests may be focused primarily on minimizing pre-closing liability rather than establishing a clean go-forward compliance position, to control the advisor selection or the process itself can lead to conservative or rushed VDA filings that leave issues unresolved or create inconsistencies the buyer has to clean up later.

Giving the buyer this control also ensures continuity: the tax advisor selected can be the same firm engaged during diligence, who already understands the company's historic exposure, rather than requiring the buyer to onboard a new advisor mid-process or accept work product from an advisor chosen without the buyer's input.

Practical Drafting Considerations

When negotiating these provisions, buyers should also consider:

• Cost allocation if escrow proves insufficient. The agreement should specify what happens if actual VDA liabilities and costs exceed the escrowed amount, typically falling back to the general indemnification framework.

• Timing coordination with closing. Some buyers prefer to begin nexus studies and even initiate VDA outreach shortly after signing (where permitted) so that the process is already underway at or shortly after closing, rather than starting the clock from scratch post-closing.

• Confidentiality and disclosure sequencing. VDA applications in most states are anonymous until the state accepts the disclosure and a taxpayer identity is revealed as part of finalizing the agreement; the purchase agreement should not conflict with this sequencing or require premature disclosure of the entity's identity.

• Survival period. The right to require VDAs, and the related escrow, should have a survival period long enough to account for the reality that exposure exceeding the threshold is sometimes only identified well after closing, once the buyer has integrated the target's systems and records.

• True-up mechanics for added states. The agreement should specify how the escrow (or a supplemental escrow) is funded when a new state is added to the schedule post-closing. for example, a defined process for the buyer's tax advisor to estimate the additional exposure and a corresponding adjustment to escrowed funds, subject to the seller's right to review the supporting analysis.

The Bottom Line

Historic sales tax exposure is a common and often substantial risk in acquisitions, but it is also one of the more manageable risks, provided the purchase agreement is drafted to actually manage it rather than simply shifting theoretical liability through a general indemnity. By expressly giving the buyer the right to require the target to pursue VDAs, establishing a dedicated escrow to fund the resulting tax, interest, penalties, and advisor costs, and placing control of the process and advisor selection in the buyer's hands, the purchase agreement transforms a passive risk allocation into an active, buyer-controlled remediation mechanism, one far more likely to produce a favorable and complete resolution than waiting for the exposure to surface on its own.

This article is intended for general informational purposes and does not constitute legal or tax advice. Buyers and sellers should consult with qualified M&A and state and local tax counsel when negotiating provisions addressing historic tax exposure in any transaction.