The indemnification clause is one of the most critical—and often most negotiated—provisions in an acquisition agreement. Its principal purpose is to allocate risk between the parties of the acquisition agreement, typically by holding one party financially responsible for certain breaches or events. While these clauses often favor the buyer, mutual indemnification may be appropriate in some circumstances. When drafting or negotiating an indemnification clause, it is important to keep the following considerations in mind.
1. Scope of Indemnification
Clearly define the events, breaches, or liabilities that trigger indemnification. Common triggers include breaches of representations and warranties, violations of covenants, or specific liabilities. Common examples of specific liabilities include pending lawsuits or outstanding tax liabilities. It is most advantageous to the Buyer for the indemnification clause to include broad coverage. However, using precise, unambiguous language can streamline negotiations and build trust between the parties.
2. Survival Periods
Survival periods specify how long each party remains liable for indemnifiable matters post-closing. Survival periods for most representations and warranties typically range from one to two years. However, the survival period for fundamental representations and warranties can be significantly longer, even indefinitely. Examples of fundamental representations and warranties include a representation that a party’s has the requisite authority to enter into the transaction, a representation that the acquisition agreement is fully enforceable, a representation that the seller has good and marketable title to the purchased assets or stock (unless otherwise specified in the acquisition agreement), a representation that the transaction does not violate any outstanding contracts or laws, a representation that all necessary consents have been obtained, and a representation that there are no broker or finder fees other than those listed in the acquisition agreement. Liability for specified matters, which should include threatened lawsuits or tax obligations at minimum, often align with the relevant statutes of limitations.
3. Claim Limitations
While mostly advantageous to the seller, both parties should consider including financial limits to the indemnification clause, such as caps and baskets. A cap sets a maximum liability for a claim of indemnification. Many acquisition agreements will set a liability cap at a certain percentage of the purchase price for the purchased assets or shares. A basket establishes a minimum threshold of losses before claims can be made, functioning similarly to a deductible on an insurance policy. These tools define the scope of exposure and help manage expectations.
4. Exclusions and Carve-Outs
Indemnification clauses often exclude certain claims, such as liabilities known to the buyer before closing or claims arising from changes in law post-closing. They may also limit recovery for specific types of damages, like punitive or consequential damages. Carve-outs typically remove certain serious breaches (e.g., fraud or breaches of fundamental warranties) from caps or baskets, allowing full recovery of the claim regardless of the limits contained in the indemnification clause.
5. Claim Procedures
Establish a clear process for making indemnification claims. This should include requirements for written notice within a specified timeframe and detail the necessary information the notice must contain to be valid.
Take these 5 Considerations to an Attorney
Given the importance of indemnification clauses in managing post-closing risk, they should be carefully drafted with guidance from experienced legal counsel. While not exhaustive, these five considerations provide a strong foundation for informed discussion with your attorney.
This is part two of a three-part series introducing some key concepts in purchase transactions. This content is general information and should not be construed as legal advice.
More about Andrew Vining: Andrew is a Corporate Services Partner with Practus, LLP. Andrew advises businesses at every stage of the corporate lifecycle, from formation and capital raising to mergers and acquisitions, to day-to-day operations. He also represents clients in general litigation and real estate transactions.
