Indemnities in Acquisition Agreements

What are indemnities?

Indemnities are promises by one party (usually the seller) to be responsible for and reimburse the loss of the other party (usually the buyer).  The principle is that it should be used in situations where it is unfair for the buyer to bear this loss.

The purpose of an indemnity is to move the risk of a specific matter from the buyer to the seller and provide the buyer with pound for pound compensation in respect of this loss.

What do indemnity clauses look like?

There are two types of indemnity clauses you may see in an acquisition agreement:

1. Specific Indemnities clauses – these are more common and are sometimes included to cover specific risks identified in the buyer’s due diligence on the target company and which are of particular concern. They generally cover historic tax issues and can cover issues such as litigation, employee claims, environmental risks and product liability matters
2. Indemnity basis of claim clauses – these are harder to identify for the untrained eye and are rarely justified in an acquisition.  These seek to allow the buyer to recover for any breach of warranties on an indemnity basis, rather than the usual breach of contract claim.

What are the advantages of using indemnities for a buyer?

• Recovery is easier, as a debt claim, rather than a claim for breach of contract (depending upon how the clause is drafted) and effectively give the buyer a £ for £ recovery for the loss
• All losses are recoverable, regardless of the foreseeability or remoteness of such loss
• There is no obligation on the buyer to mitigate the loss
• They can be used in circumstances where a breach of warranty may not necessarily give rise to a claim in damages
• Liability under the indemnity is often unlimited, so there is no cap in value and they are usually not subject to the other limitations on the liability of the seller included in the acquisition agreement
• They are not subject to disclosures made by the seller
• In addition to the loss, it will usually cover all costs and expenses incurred

What are the issues of using indemnities in Acquisition Agreements?

A typical indemnity clause will detail the specific issue/event/liability triggering the indemnity and describe the loss the seller should be responsible for.  The details of the issue triggering the indemnity is usually uncomplicated but the loss to be paid by the seller is less straightforward and will depend upon how the clause is drafted. 

Indemnities may be drafted too broadly, trying to cover any breach of contract, even those that would be unlikely to give rise to any material loss or claim.  In most acquisitions or sales, only specific indemnities should be considered and the extent of these negotiated.

You have to consider the allocation of risk between the parties.  There is often a presumption that, where an indemnity has been given by a seller to a buyer, the buyer is blameless and should be fully recompensed if an indemnified risk occurs, even though the buyer may have contributed to the risk materialising.

An indemnity is not the only means for a buyer to recover its loss.  A buyer will always have the right to bring a claim for damages resulting from the seller’s breach of warranty/contract, subject to any limitations on liability agreed between them in the agreement.  Courts will consider the claim based on the facts, whether the loss was reasonably foreseeable and if the buyer took steps to mitigate the claim and reduce the impact of the loss.

The key points to take away are:

• In most cases, indemnities should only be used to cover specific, identified risks or liabilities of particular concern to the buyer
• Consider the fair allocation of risk between the parties
• Consider the extent to which the seller is insured against the risk they are being ask to indemnify
• Ensure that scope of the indemnity given is clear and not too broadly drafted

Please see our previous blog on Warranties and Indemnities in Acquisition Agreements for information about the differences between warranties and indemnities.

If you have any questions on any of the above, please get in touch with a member of the Corporate team by emailing corporate@mlplaw.co.uk or calling 0161 926 9969 and we will be able to talk through your specific needs and our various flexible pricing options.