Carscallen Blog

Why you need a well-drafted indemnity clause in your M&A agreement

Posted by Carscallen LLP on Oct 8, 2020 9:24:36 AM

Written by Aron R. Balakrishnan and Nicholas M. Ramessar

An indemnity is a form of contractual protection routinely offered in a transaction respecting the purchase and sale of a business (“M&A Transaction”), usually given from a seller to a purchaser, that will compensate or reimburse the purchaser for certain losses, damage or injury that may arise against the business subsequent to the closing date of the transaction.

A well-drafted contractual indemnity is essential to an M&A Transaction, as it provides the purchaser with protection for a number of potential costs and/or damages that may arise in relation to mergers and acquisitions ("M&A"), including:

  • Compensation or reimbursement to the purchaser for liability in the form of loss, damage, and/or injury;
  • Compensation or reimbursement to the purchaser for legal costs associated with dealing with loss, damage, and/or injury;
  • Compensation or reimbursement to the purchaser for loss of expected profit;
  • Compensation or reimbursement to the purchaser for breach of contract; and
  • Protection to the purchaser from some forms of liability resulting from negligence of the seller.

Indemnities are most often included in an M&A Transaction in the form of a stand-alone Indemnity Agreement, or as an indemnity clause in the operative purchase and sale agreement.

what difference does a well-drafted indemnity make in a Mergers and Acquisitions Transaction?

The importance of a well-drafted indemnity cannot be overstated. At a minimum, an indemnity should expressly address:

  • every type of loss, damage and injury that can be claimed under the indemnity by the purchaser against the seller; and
  • to specify any limitations to, or exclusions for the indemnity, which are often referred to as the “carve-outs”.

Without a well-drafted indemnity, the purchaser is generally at risk for potential liability, additional costs and unforeseen expenses. If an indemnity clause or agreement is not part of your M&A Transaction, or if the language providing for such an indemnity has not been drafted appropriately, the purchaser can face expensive and time-consuming litigation after the M&A Transaction has concluded.  

Even if the operative purchase and sale contract includes representations from the seller respecting the nature and condition of the shares or assets acquired, without the benefit of a well-drafted indemnity the purchaser may not be entitled to indemnification for certain types of damages or losses, such as legal fees and disbursements on a full indemnity basis.

A well-drafted indemnity not only benefits the purchaser - an indemnity which does not adequately define carve-outs, limitations and exclusions with the requisite detail can lead to unlimited liability for the seller and an unfair apportionment of risk between the parties.

Having an experienced M&A transaction team on both sides of an M&A Transaction, who will draft and review the indemnity, will ultimately benefit both sellers and purchasers.

Indemnity vs. the duty to defend

Most contractual indemnities include the obligation “to indemnify and hold harmless” (or “save harmless”) the indemnified party. Although this clause is often treated as being part of the indemnity, the “hold harmless” or “save harmless” obligation is usually treated by the courts as a separate legal obligation.

An obligation to hold harmless usually requires the reimbursement of or compensation for paid costs, expenses and losses that are covered under the terms of the obligation. However, sometimes this obligation requires advance payment for covered costs and losses (although judicial interpretation in Canada on the issue of advance payment for covered costs varies). For certainty, contracting parties that intend to require advance payment of an indemnified party’s covered costs should specify as such under the indemnity or hold harmless provision.

The scope of a hold harmless obligation can also be much broader than a basic indemnity, and can apply to any costs and expenses that are covered under the definition, including a risk of loss, regardless of whether an actual loss is suffered by the indemnified party.

How do I ensure my M&A Transaction includes the appropriate indemnity?

An indemnity and its exclusions and limitations should always be drafted with the specificity necessary to convey exactly what situations are covered under the clause, and those that are excluded. An experienced M&A lawyer with a thorough understanding of the indemnities necessary in an M&A Transaction is invaluable to both purchasers and sellers so that they may comfortably negotiate and understand their rights and obligations.

Carscallen LLP’s M&A Experience

Carscallen’s team of experienced M&A lawyers can assist both buyers and sellers in an M&A transaction. We have extensive experience in advising on different purchase and sale transactions for both private and public companies and can help you understand your options, identify potential issues and how to overcome them, and to negotiate the most beneficial terms for your position.

Please contact any member of our Mergers, Acquisitions & Divestitures team with any M&A questions you may have, or any other business-related legal issues.

Contact Mergers, Acquisitions & Divestitures

 

*This update is intended for general information only on the subject matter and is not to be taken as legal advice.

 

 

Topics: Mergers, Acquisitions & Divestitures

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