Indemnification provisions are among the most highly negotiated provisions in private M&A transactions. These provisions set out the terms and conditions under which one party will be required to indemnify the other party for any losses the other party may suffer post-closing. In other words, indemnification provisions set forth the "rules of the road" and allocate the risks involved in a transaction.

While risk allocation may seem conceptually simple, structuring indemnification provisions may become quite complicated. As the size, complexity and economics of a transaction increase, it can sometimes be very difficult to specify the scope of a party's indemnification obligations in a manner appropriate to the value (actual or perceived) inherent in the deal. However, and to add certainty to their bargain, parties usually arrange their affairs to limit the amounts for which an indemnifying party may be responsible and prevent a party from bringing immaterial claims.

The following terms are typical in indemnification arrangements:

  1. De Minimis Amount: The de minimis amount specifies the minimum threshold a single claim must exceed in order to become eligible for indemnification. Expressed differently, a party can only claim indemnification if a claim's value exceeds a minimum dollar amount, expressed either as a percentage of the purchase price or a specified amount.
  2. Tipping Basket: A tipping basket specifies the threshold which the aggregate amount of all claims must exceed before a party can bring any claim for indemnification. Once the threshold is exceeded, the indemnifying party will be liable for the entire amount of losses. Like the de minimis amount, baskets eliminate redress for relatively small claims.
  3. Deductible Basket: A deductible specifies the threshold which the aggregate amount of all claims must exceed before a party can bring any claim for indemnification. However, once the threshold is exceeded, the indemnifying party will only be liable for losses that exceed the threshold amount. For example, if there is $1 million deductible, and a party brings a claim for $3 million, the indemnifying party will only be responsible for portion of the claim exceeding the $1 million deductible; i.e., $2 million.
  4. Indemnity Cap: An indemnity cap limits the amount an indemnifying party may be required to pay. The cap amount is generally calculated as a percentage of the purchase price, but may also be a specified amount.

Indemnification provisions are extremely important to both buyers and sellers, and the law affords parties great flexibility to structure their indemnification arrangement. Many deals contain exceptions to the basket and cap limitations, including for claims involving a breach of certain representations or warranties, fraud, willful misconduct, and other matters specific to a transaction. In all cases, when attempting to structure indemnity provisions, it's important to carefully consider the scope, the duration and the dollar amount attached to an indemnification obligation. To restate the obvious, a small mistake could have a large dollar impact.

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