Classification: Deal Driver
Negotiation Time: Moderate
Transaction Costs: Intermediate
Major Impact: Risk Management
Indemnification by Seller
What is This? Indemnification is used to enforce representations, warranties and covenants made in the Agreement. Here, the parties list out which breaches by the Seller are subject to the Buyer’s right to indemnification.
The Middle Ground: This provision requires the Seller to reimburse the Buyer, its Affiliates, and their Representatives for any Losses arising out of: (1) the inaccuracy or breach of any representation or warranty contained in the Agreement or other Transaction Documents, if the representation or warranty was inaccurate or breached when made or at the Closing; (2) non-fulfillment of any covenant, agreement, or obligation undertaken by the Seller pursuant to the transaction; (3) any of the Excluded Assets or Excluded Liabilities; and (4) any Third Party Claim resulting from the Seller’s (or its Affiliates) operation or handling of the Business or Assets prior to the Closing Date.
Purpose: The indemnification aspect of the Agreement is the most efficient tool available for motivating the parties to stand by their agreed-upon obligations. As such, it is the main way for the parties to enforce the risk allocation scheme created throughout the Agreement.
Buyer Preference: If the Buyer is particularly worried about exposure from certain liabilities, it can specifically include those liabilities in this section so there is no debate whether they fall under the Seller’s indemnification obligation. Examples of the liabilities the Buyer may want to specify include retained employee liabilities, product liability claims, environmental issues concerning any assets or property transferred as part of the deal, and noncompliance with any applicable bulk sales laws. The Buyer also wants to carefully evaluate the definitions of “Affiliates” and “Representatives” to ensure the terms cover all those who may have an indemnification claim against the Seller in the future.
Seller Preference: The Seller wants to limit the matters eligible for indemnification as much as possible. Particularly, the Seller will be looking out for issues it cannot control to avoid being held responsible for problems caused by third parties.
Differences in a Stock Sale Transaction Structure: In a stock sale, there are no Excluded Assets or Excluded Liabilities, so it is even more essential for the Buyer to specifically list the liabilities for which the Seller has indemnification obligations. An often-used alternative to including a specific list in this section is to address those concerns in the representations and warranties since they are incorporated here by reference.
We want The Middle Ground to be an ongoing dialogue for and resource to the lower middle market M&A community. The outline above is generally applicable, but there is always specific case law and nuance around certain industries that can be useful in helping buyers and sellers come together. If you are a lawyer or deal professional, we encourage you to add your perspective below.