United States: Indemnification In An Acquisition

In an ideal world, after the deal has closed, the acquisition agreement is filed away, and its existence is forgotten by all parties. Unfortunately, effects of the agreement are often felt long after the deal has closed. There are some key concerns to consider when drafting the indemnification section in an acquisition agreement.

Holding the Purchaser Harmless

The indemnification section will mandate the seller to cover any losses or expenses suffered because of a misrepresentation made by the seller in the agreement or because of the seller's breach of the agreement. There are also several categories of items that are often forgotten but may be appropriate within the section:

(1) Post-balance sheet adjustments
(2) Matters relating to the transaction itself
(3) Remaining responsibilities of the seller such as a disclosed claim or litigation

The Seller Strikes Back

There are a few provisions that sellers often fight to get added to the indemnification section. First, sellers are usually entitled to a "basket" provision. This is a clause that limits the buyer's ability to collect indemnification to damages exceeding a certain amount. Like statutes of limitations, it is also common for sellers to seek a time cut-off whereby buyers cannot assert a claim beyond a certain date. The seller will also attempt to cap the impact of indemnification with an upper limit on its liability.

Additionally, a seller should insist on a provision that gives it the right to defend claims made by third parties at its own expense and with counsel of its own choosing since ultimately the seller will pay the expenses of litigation. Finally, typically a seller will agree that its shareholders are jointly and severally liable for indemnification claims. However, some small shareholders of the seller may be uncomfortable with this and may request to be dropped from the indemnification.

Escrows and Other Collection Devices

Even if the buyer has a right to indemnification, it often can be difficult to collect what is due from the seller. To combat this problem, buyers can hold back part of the purchase price via an escrow, a deferred payment or an earn-out provision. Then, when the seller does not pay up in an indemnification situation, the alleged indemnity amount can just be offset from the amount due.