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M&A Contracts: 4 Indemnity Questions to Ask in Every Deal
Understanding indemnity in M&A contracts
Indemnity is how the parties in the M&A agreements assign responsibility for liabilities both known and unknown. If one of the companies involved fails to meet its obligations—for example, not fully disclosing debt or some other significant issue—the indemnification clauses stipulate how the other company will be compensated.
There are countless nuances that come into play with indemnity clauses, which typically cover financial, operational, and legal risks. However, some basic high-level indemnification questions should be addressed in every M&A deal. Let’s look at four of them.
1. What is the scope of the indemnification?
Indemnification agreements are like basic contracts and everything in them is negotiable.
Buyers may seek broader protections, while sellers might try to negotiate narrower terms that are more advantageous. In addition to the representations and warranties made by the company being acquired, other covered issues might include taxes, employee benefits, ongoing litigation, and data security.
2. What is the recourse and how will it be enforced?
Once indemnification terms are agreed upon, the parties must negotiate what happens when indemnity is triggered. There could be an escrow account from which any claims would be paid, future payments from the buyer to the seller could be reduced or eliminated, etc. Some agreements stipulate that no indemnification will be sought until claims reach a certain threshold, commonly referred to as a hurdle. It is also possible to negotiate a cap on the total dollar amount of indemnification claims, limiting the seller’s overall exposure.
Enforcement must be addressed as well. Agreements should spell out the venue and jurisdiction in which claims will be managed:
- Will they be litigated in court?
- Go through arbitration?
- Do the parties want to add a pre-litigation mediation requirement?
Finally, it’s important to note that indemnity provisions must be examined within the context of other language in an M&A agreement. For instance, there might be exclusive remedy provisions, clauses that limit liability, or warranty insurance.
3. How long does the indemnity last?
For issues that are non-fundamental (not representative of the very core of the deal) there typically will be an end date to the indemnification. These clauses might expire 12-24 months after the deal closes.
However, the “survival period” of an indemnity clause could be much longer—or even indefinite—for issues so significant that they would have prevented the buyer from agreeing to the deal in the first place, or that would have a severe adverse impact on the buyer post-close.
Long survival periods favor buyers, while sellers naturally prefer shorter ones.
4. Who are the indemnitors and indemnitees?
Who is responsible for breaches of the indemnification clauses, and who benefits from the indemnity? Typically, the parties can include directors and officers of both companies, subsidiaries, employees, even stockholders—even though they all won’t necessarily sign the agreement or even know the full detail of it. Just like every other part of the indemnity process, these inclusions and exclusions can be negotiated.
Things can get a lot more complicated when it comes to the non-signatory parties, those who are not intimately involved in the agreement.
In one case several years ago, an indemnification obligation imposed on the stockholders of a company was ruled unenforceable. Because there was no cap on damages in the agreement the court ruled that stockholders were unaware of the exact exposure they faced.
Meanwhile, in another more recent deal, a court held that the provisions involving stockholders were binding because there was a cap. So, while identifying indemnitors and indemnitees might seem simple, there are numerous gray areas.
Vital protections for both buyers and sellers
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