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Indemnities are common in all sorts of contracts, such as those covering property, supply of services, and insurance.
In this post, SeedLegals Senior Legal Associate Anna Sivula explains the indemnities typically included in a Share Purchase Agreement, and how they protect buyers when you sell your company.
If you’re getting ready to sell your business, you might have come across the term ‘indemnity’ in a Share Purchase Agreement. But what does it mean? And how does it work?
An indemnity is a promise that you – as the seller – make to protect a buyer against certain types of losses, by agreeing to reimburse the buyer for these losses, pound-for pound.
The losses we’re talking about could be to do with, for example:
… or something else. Each of these could have a significant impact on your company’s business and valuation.
Let’s say your company is being sued and the claim isn’t resolved before you complete the sale of your company. If the company loses the case and is required to pay damages to the other party, the buyer will usually expect to be reimbursed for the amount the company has to pay out.
This is where the indemnity comes in. In the Share Purchase Agreement, the buyer can include an indemnity which states that the seller agrees to reimburse the company and/or the buyer for any losses relating to the ongoing litigation.
If you’re familiar with warranties – for example, in your contracts with investors – you might be thinking indemnities sound similar to warranties. Here’s how they differ.
Warranties give the buyer protection against losses arising from misrepresentations made by the seller. If a warranty turns out to be inaccurate or untrue, the buyer can sue the seller for damages, usually the difference between the price the buyer paid (based on the assumption that the warranty is true) and the actual value of the shares.
Indemnities, on the other hand, give the buyer the right to recover the amount equal to the liability they incurred without having to prove the company is worth less as a result. An indemnity is a promise by the seller to reimburse the buyer pound-for-pound – so the buyer will be reimbursed for every penny they lose.
Let’s say your company is involved in a dispute that hasn’t been resolved when you complete the sale. The buyer might ask you to promise (indemnify) that you – the seller – will reimburse them for any losses that arise as a result of the dispute. If the dispute is resolved and the company has to pay the other party £50,000 as part of the settlement, then the indemnity means you’d have to reimburse the buyer for the £50,000 the company had to pay out.
Warranties offer some protection but indemnities can be a more effective way to recover losses if there are specific issues that a buyer is particularly concerned about.
Indemnities can cover a wide range of losses that might arise from issues that weren’t disclosed or couldn’t be identified during due diligence when you were negotiating with a buyer.
Tax issues are often dealt with in a separate tax indemnity covering the company’s potential tax liabilities before completion that might not come to light until afterwards. We explain this in more detail in our post: What is at tax indemnity?
Indemnities can also cover non-tax related issues such as unresolved litigation, employment disputes and/or infringement of intellectual property rights – each of which could be significantly detrimental to the company’s finances, reputation and valuation.
In a Share Purchase Agreement, it is typically the founders and/or directors of the target company who are asked to give indemnities. This is because they’re the people with the most knowledge of the company and its operations, and are therefore in the best position to identify and address any potential liabilities.
Investors (VCs in particular) are usually not willing to give indemnities because they’re typically not involved in the day-to-day management of the company.
Drafting indemnities in a Share Purchase Agreement can be complicated because it’s important to make sure the indemnity provisions are tailored to the specific risks of the transaction.
Typically, the buyer will carry out thorough due diligence on the target business, including investigating all possible claims and risks that the buyer might face after they close the deal. The indemnity provisions will be drafted to cover these risks and to provide the buyer with adequate protection.
Negotiating indemnities can involve a lot of back-and-forth between the buyer and seller. The seller will typically try to limit the scope of the indemnity, while the buyer will aim to broaden it to cover as much as possible.
The provisions of an indemnity include details on the scope, such as the types of claims that are covered, the limitations on the amount of indemnity payable, and the time limits for making a claim.
The language used in indemnity provisions should be carefully reviewed to make sure it’s clear, unambiguous and identifies the specific liability for which the sellers are providing the indemnity.
As a seller, you’ll need to understand the potential risks to the buyer, including the likely value of the losses the buyer could suffer as a result. This will help you determine what you’re willing to indemnify and what limitations to include to protect you from liability.
Selling your company with SeedLegals? If you have any questions about indemnities or the Key Terms, ask your dedicated SeedLegals Exit expert or tap the live chat button (bottom right of this screen) to ask us. We’re always happy to help.
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