Classification: Moderately Material
Negotiation Time: Moderate to Substantial
Transaction Costs: Intermediate
Major Impact: Risk Management
What is This? While previous indemnification-related sections focus on the circumstances under which a claim can be made, this section details the procedural rights and requirements of both sides once a claim is made. Essentially, it provides the rules that must be followed once the indemnification process has been initiated.
The Middle Ground: The Indemnifying Party’s rights typically include (but are not limited to) receiving prompt notice of the claim and its details, the right to assume and control the defense of the claim (except in a few limited circumstances), and the right to the Indemnified Party’s cooperation in investigating claims. The Indemnified Party’s rights usually include controlling legal proceedings when the Indemnified Party is the Buyer and the claim is brought by a customer or supplier of the Business or when an equitable remedy is sought, as well as participating in the defense of claims when such defense is controlled by the Indemnifying Party.
Purpose: Indemnification is an essential tool used to enforce the terms of the Agreement, and this section lays out the steps that must be taken and the rights of each party involved when an indemnification claim is made. It has a moderate impact on risk for both parties (more so for the Seller, who is typically the Indemnifying Party), yet its main purpose is to give effect to more substantive indemnification provisions. It is important for the parties to strike the right balance between implementing enough procedures and rules to allow the Indemnifying Party to mitigate its risk as much as possible, while not employing so many hurdles that they interfere with the Indemnified Party’s ability to actually receive indemnification.
Buyer Preference: The Buyer generally favors terms that benefit the Indemnified Party such as including a specific but generous notice period, allowing the Indemnified Party to control all claims against it once the Cap is met (if a Cap is included), and giving the Indemnified Party the option whether to control defense of all claims. The Indemnified Party may also want a say over who the Indemnifying Party enlists as counsel to defend against a claim and/or the ability to control the defense when the Indemnified Party has defenses available to it that are not available to the Indemnified Party.
Seller Preference: The Seller’s preferences will usually be those of the Indemnifying Party. Those preferences typically include the desire for a flexible notice standard (e.g. “reasonably prompt notice”) and the ability to control the defense of all third-party claims and settlements. The Seller may also want to insert an arbitration provision so that disputes over direct claims can be resolved quickly and less expensively than would be the case with litigation.
Differences in a Stock Sale Transaction Structure: If the Stock Purchase Agreement contains a tax-specific indemnification provision tax issues will need to be carved out of this section so there is no question they are governed solely by the tax indemnification provisions.
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.