Step into negotiation of any acquisition deal, as soon as indemnity clause comes for discussion, the negotiation becomes stressed. Indemnity clause, customarily, is most negotiated clause of any acquisition deal. It is this clause that determines who will endure the weight of any liability/losses that occurs, in future, due to action of the indemnifying party or any third party. So much is the significance of an indemnity clause in an agreement that the deals go cold for days, if not weeks, when indemnity clauses are negotiated.
However, when the Contract Act, 1872, (“Act”) provides a right to seek damages in the event of a breach of contract, why is there still a need for having a well drafted and negotiated indemnity clause in an agreement? Seeking damages under the Act is a statutory right; however, it comes with certain limitations. For example, if the aggrieved party had any opportunity to mitigate the loss or if lossis arising out of action of a third party, the aggrieved party may not be able to seek damages for such loss. Further, the aggrieved party cannot seek damages for any consequential or indirect loss. On the other hand indemnity is a special contract i.e. the parties have to specifically agree to an indemnity clause in the agreement. But, while claiming indemnity, the aggrieved party is not expected, under the Act, to mitigate the loss. Not only can an indemnity be claimed for a third party loss but it can also be claimed for consequential or indirect loss and can be claimed even before incurring any actual damage or loss. Thus, the right to get indemnified has better monetary advantages then right to seek damages. While negotiating an indemnity clause, the person seeking indemnification (“Indemnified Party”) will negotiate for a wider scope of losses while the party indemnifying (“Indemnifying Party”) will try to limit the scope. Definition of loss/claim thus becomes pivotal to negotiating the indemnity clause. While the Indemnified Party will seek a broader and wider definition encompassing within it all damages associated with the acquisition, the Indemnifying Party, usually, negotiate to limit the scope, the amounts and the period of the indemnity.
Survival Period: The Indemnifying Party will avoid living with the sword of indemnity hanging over its head, and thus survival period becomes point of negotiation for the Indemnifying Party. The survival period is the duration during which the Indemnified Party may bring its claim for indemnity. The shorter the survival period, the better it is for the Indemnifying Party. However, for representations which are fundamental to business, the Indemnified Party insists for longer survival period or even indeterminate period.
De Minimis: This is the minimum amount that the indemnity claim must be of i.e the amount of claim shot be over the ‘de minimis’ amount. The Indemnifying Party require this to ensure that they are not dealing with immaterial claims after selling the business.
Baskets or bucket: Another important aspect for negotiation is the basket/bucket in terms of which a threshold amount is commercially agreed between the parties and only once the total amount of aggregate losses have reached the threshold amount, the Indemnifying Party becomes liable for the full amount of claims.
Caps on Liability: The Indemnifying Party will always negotiate to have a cap on the maximum aggregate amount payable due to its breaches. The cap is generally calculated as a percentage of the overall purchase price. However, the Indemnified Party will negotiate to avoid any cap with respect to fundamental representations with respect to the business (for example representations with respect to ownership of the business being sold etc).
Duty to Mitigate: As stated earlier, while claiming indemnity, the Indemnified Party is not expected, under the Act, to mitigate the loss. Thus, it is important for the Indemnifying Party to contractually provide for a duty to mitigate in the indemnity clause of an acquisition agreement.
Fraud Exception: The Indemnified Party will negotiate that the limitation of liability (such as survival period, caps on liability, de minimis and baskets) will not be available to the Indemnifying Party in the event of any fraud.
Funding of Indemnity: While parties may contractually agree to indemnity clause, the Indemnified Party is always concerned on how the Indemnified Party will fund the indemnity. Customarily, three options are negotiated (a) indemnity escrow account i.e. keeping some percentage of purchase consideration in an escrow account for a certain time period; (b) holdback consideration i.e. the buyers will holdback certain percentage of purchase consideration for a certain time period; and (c) set off against amount payable in future (this is applicable only if purchase consideration or a portion of it is payable in future).
Sole Recourse: This clause restricts the Indemnified Party from seeking recourse for covered claims beyond indemnification i.e. indemnification will be the only recourse available to the Indemnified Party.
Right to Defend: The Indemnifying Party will always seek to have right to defend the Indemnified Party as soon as a claim is raised by any third party, which may also include the right to settle the claim.
Drafting of an indemnity clause is to be done meticulously and the negotiations punctiliously. The Indemnifying Party will try to shift the burden, to the extent possible, on the Indemnified Party and the Indemnified Party will try to seek indemnification for everything. The indemnity clauses are thus spine of an agreement and the lawyers should understand the deal and the need of their clients accurately so as to ensure that the indemnity clause best serves the interest of their client.
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