A collection of resources addressing indemnification in private M&A deals.
In a perfect world, every M&A transaction would be an unqualified success. In the real world, however, M&A transactions sometimes do not work out as expected. While this does not have to be anyone's fault, the failure of the target company to perform to the buyer's expectations may be due to misrepresentations or omissions made by the seller about the business. To remedy this failure, the buyer in a private M&A transaction typically has a right to indemnification from the seller for losses it incurs as a result of the seller's breach of its representations and warranties in the purchase agreement.
Indemnification provisions are among the more heavily negotiated provisions in the agreement. Practical Law has several resources that aid practitioners in several phases of the negotiation, including the negotiation and drafting of the indemnification provisions themselves, the purchase of representations and warranties insurance, and the process for making an indemnification claim.
The Negotiation and Drafting
As most post-closing indemnification claims are made by the buyer against the seller, the seller negotiates to limit its indemnification obligations. These limits are made possible through several customary tools, including:
Requirements for materiality of the breach or claim amount.
Caps on the indemnification amount.
Baskets, which can take the form of:
a deductible;
a threshold (also known as dollar-one or tipping baskets); or
a hybrid of the two.
Set-off for insurance proceeds or tax benefits.
Practice Note, Indemnification Clauses in Private M&A Agreements highlights the main issues covered by indemnification provisions. The Practice Note also discusses ways to both limit the indemnifying party's indemnification obligations and ensure payment of an indemnification obligation, and considers the interplay between the indemnification clause and the other clauses in the agreement.
The survival period(s) for the agreement's representations, warranties, and covenants.
The basket(s) and mini-basket(s) for indemnification claims.
The cap(s) on recovery for indemnification.
Whether the agreement provides that indemnification is the exclusive remedy.
Whether a portion of the purchase price must be placed into escrow for potential indemnification claims.
This resource is updated on a quarterly basis. For ongoing summaries of publicly filed private acquisition transactions, see the What's Market private acquisitions database.
The purchase agreement's indemnification provisions cannot be considered in isolation from the disclosure schedules. If a seller makes inadequate disclosures, it may find itself on the receiving end of an indemnification claim it could have avoided. If a buyer fails to adequately review the disclosure schedules, it may be stuck with liabilities it did not account for. For an introduction to disclosure schedules, including a discussion of their key drafting and reviewing considerations, see Practice Note, Disclosure Schedules: Mergers and Acquisitions.
Representations and Warranties Insurance
The conflicting motives of buyers and sellers and the specter of post-closing payments for indemnification can make negotiating the acquisition agreement contentious. Representation and warranty insurance can help resolve risk-allocation differences and ultimately help the parties reach their mutual goal of closing the deal. For a general overview of representation and warranty insurance, including types of policies, policy terms, and advice for insurer selection and the underwriting process, see Practice Note, Representation and Warranty Insurance for M&A Transactions.
The Indemnification Claim Process
Practical Law's newest resource on the issue of indemnification in private M&A deals provides an overview of the indemnification claim process in M&A transactions. The resource discusses:
How indemnification claims are initially identified.
Potential limits on indemnification claims set out in the purchase agreement.
Preparing and delivering the indemnification claim notice.
The process for resolving indemnification claims.
Satisfying amounts owed under indemnification claims.