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💧 '''Permitted leakage''' is a concept used in [[Definition:Mergers and acquisitions (M&A) | insurance M&A]] transactions structured on a [[Definition:Locked box mechanism | locked box]] basis, referring to specific, pre-agreed categories of value extraction from the target business that the seller is allowed to make between the [[Definition:Locked box date | locked box date]] and closing without triggering a purchase price adjustment or [[Definition:Indemnity | indemnification]] obligation. In a locked box deal — increasingly common for insurance company and [[Definition:Managing general agent (MGA) | MGA]] acquisitions in Europe and the UK — the purchase price is fixed by reference to the target's financial position at a historical balance sheet date, and any cash leaving the business after that date constitutes "leakage" unless it falls within the agreed permitted categories.

⚙️ The mechanics are straightforward in principle but heavily negotiated in practice. The seller proposes a list of permitted leakage items — typically covering ordinary-course expenditures such as budgeted salary payments, planned [[Definition:Dividend | dividend]] distributions already declared, pre-agreed management bonuses, routine tax payments, and scheduled [[Definition:Reinsurance premium | reinsurance premiums]]. These items are documented in a [[Definition:Permitted leakage schedule | permitted leakage schedule]] annexed to the [[Definition:Share purchase agreement (SPA) | SPA]]. Any extraction of value that falls outside these categories — intercompany loans to the seller's group, unbudgeted management fees, extraordinary [[Definition:Commission | commissions]], or asset transfers at below-market value — constitutes prohibited or "non-permitted" leakage and triggers a dollar-for-dollar indemnity from the seller. For insurance targets, particular attention focuses on whether [[Definition:Reserving | reserve]] releases, [[Definition:Reinsurance recoverable | reinsurance recoverable]] collections, or changes to [[Definition:Investment portfolio | investment portfolios]] during the interim period could represent disguised leakage.

🎯 The concept exists because the locked box mechanism trades pricing certainty for the risk that the business's economic value shifts between the reference date and completion. Permitted leakage defines the narrow corridor of acceptable value movement, and getting the boundaries right is critical — too broad, and the buyer overpays for a depleted business; too narrow, and the seller cannot operate normally in the interim. In insurance deals, where cash flows are inherently lumpy due to [[Definition:Insurance claim | claims]] payments, [[Definition:Premium | premium]] collections, and reinsurance settlements, the calibration of permitted leakage is more complex than in many other sectors. Disputes over whether a particular payment was truly in the ordinary course have led to post-closing [[Definition:Warranty | warranty]] and indemnity claims, reinforcing the importance of precise drafting and a comprehensive [[Definition:Permitted leakage schedule | schedule]].

'''Related concepts:'''
{{Div col|colwidth=20em}}
* [[Definition:Locked box mechanism]]
* [[Definition:Permitted leakage schedule]]
* [[Definition:Completion accounts]]
* [[Definition:Share purchase agreement (SPA)]]
* [[Definition:Ordinary course covenant]]
* [[Definition:Indemnity]]
{{Div col end}}

Definition:Permitted leakage - Revision history

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