As a follow-up to last month’s blog on seller representations and warranties, this blog will touch on seller indemnities in business sale and merger transactions. There is probably no part of the agreement that is less popular for clients to wade through than the subject of indemnities. However, the subject is vitally important for both buyer and seller, and both parties are normally required to provide indemnifications. But normally the indemnifications extracted from sellers are subject to more negotiations, particularly in a transaction involving the sale of stock or the LLC ownership interests. And as one would expect, the interests of the parties are diametrically opposed. Buyers want to extend the time, scope and amount of seller indemnities while sellers wish to do just the opposite. And this usually results in a wide range of provisions in purchase and merger agreements as there probably is no “boiler plate” language for this area.
This blog will focus on dollar limitations. It is not infrequent to see both a floor limitation and a ceiling limitation in the purchase agreement. Depending on the size of the deal, the floor is intended as a negotiated amount beneath which the seller is not responsible. And these floor limitations can be of two types—either a responsibility for payment by seller only for amounts above the floor amount or once the floor is exceeded, then the liability to indemnify by the seller reverts back to dollar one. This can be illustrated as follows. If the purchase agreement provides a floor of $75,000, then the seller’s obligation to indemnify will not kick in until that number is exceeded. However the revert back provision would require the seller to go back and indemnify buyer from dollar one once the $75,000 floor is exceeded. With respect to the ceiling limitation, this is the negotiated amount over which the seller will not be responsible. It is not uncommon for buyers to try to have that ceiling set at the purchase price amount if not more. But many, many deals are done where the ceiling is far less than the purchase price amount.
Normally, the seller will insist that buyer’s consequential damages (like lost or anticipated earnings) are not included. The wise seller will also require that there be an offset for any insurance and for any income tax benefits to the buyer.
Next time, I will touch on indemnity time limitations.
Michael W. Margrave