Indemnification in Mergers and Acquisitions Contracts
Indemnification as a legal concept takes some getting used to for most business owners. But this word takes on a whole new meaning when Buyers and Sellers get into discussions regarding “Indemnification” in the stock or asset purchase agreement (the “Purchase Agreement”) for a merger and acquisition (“M&A”) transaction.
Simply put, Indemnification is one of the most important, but least understood, parts of an M&A transaction. The posts in this series will talk about the different parts of the Indemnification Section of the Purchase Agreement including:
- Indemnification Definition & Procedures
- Indemnification “Claims”
- Time Periods for Indemnification (aka. The Survival Periods)
- Caps, Deductibles, and Baskets
- Materiality Scrapes
This first post will cover (a) What is Indemnification? And (b) Indemnification Procedures. Readers of this series should note that each transaction is different and generalizations herein may not apply to every transaction.
What is Indemnification?
“To indemnify” means to compensate someone for his/her/its harm or loss. In most contracts, an indemnification clause serves to compensate a party for harm or loss arising in connection with the other party’s actions or omissions. However, indemnification goes further than merely paying another party for damages caused. Indemnification also generally means that the other party (“Indemnifying Party”) will step into the shoes of the party being protected (the “Indemnified Party”) and may have the right or obligation to directly handle the issue, whether by hiring a lawyer to defend a claim, settling a lawsuit or audit, or otherwise resolving the issue.
Indemnification is also known as a “hold harmless” clause, because one party will hold harmless the other for certain events. The justification for indemnification usually arises from the idea that certain events (and damages) result from factors under control of the Indemnifying Party. In the M&A context, these events usually include the pre-Closing period, where the Seller or selling owners controlled the target company that was sold.
The Indemnification Section of the Purchase Agreement for an M&A transaction will typically set out a detailed process for Indemnification under the agreement. Typically, the Purchase Agreement will cover the following:
- Written notification by the Indemnified Party to the Indemnifying Party regarding the claim
- Which party will be allowed to control the litigation/arbitration/claim process? Most often this will be the Indemnifying Party, but the Indemnified Party may want to control the process for certain types of claims, such as income taxes.
- Whether the Indemnified Party may participant in the litigation/arbitration/claim process, and whether the Indemnified Party must approve the settlement of a claim
Stay tuned for Part II of this indemnification series about which “claims” indemnification covers.