Indemnification Carveouts for a Seller in a Business Transaction
When acting for a seller, in a business transaction, the indemnification clause in the asset or share purchase agreement will be broad and possibly far-reaching. While the indemnification clause will be mutual, it is principally designed to protect the purchaser. It is reasonable to expect that a purchaser or investor in a new business will want to be indemnified, for any loss or damage incurred due to a seller’s breach of a representation, warranty or covenant. That being said, there are carveouts that a seller’s counsel can negotiate – as expanded upon below – to manage the seller’s exposure.
(a) Survival Period
Most asset or share purchase agreements will contemplate that the representations and warranties provided by a seller in good faith will survive for a period of time post-close, which oftentimes is between 12 – 24 months, save and except for those that are considered fundamental or which speak to tax-related matters.
Typically, fundamental representations and warranties survive indefinitely and pertain to the seller (i) having authority to enter into the agreement without any conflict, and (ii) holding title to the assets or shares (as applicable). Tax-related representations and warranties are in reference to tax liabilities and their expiration will be connected to the latest date on which any taxing authority can make a determination on the amounts owing.
(b) Tipping Basket & Deductible
A tipping basket is a figure that must be reached before a party (typically the purchaser) can seek indemnification from the other (typically the seller). In the case of a tipping basket, once the figure is met, the party seeking indemnification can do so from the first dollar of its losses; in other words, it can seek indemnification for its total losses. This contrasts with a deductible, whereby the party seeking indemnification can only obtain its losses for anything over and above the deductible amount.
The figure, while negotiable, tends to hover at or below 1.0% of the purchase price. It effectively represents materiality, in that amounts at or above the threshold will be deemed material and subject to indemnification.
It would not be uncommon or unreasonable, however, for a purchaser to exempt the fundamental or tax-based representations and warranties from the tipping basket or deductible.
(c) Total Liability Cap
A seller may not be interested in selling all or part of its business if that would result in it being liable for an amount greater than the purchase price. To that extent, a seller will want the inclusion of a total liability cap in the asset or share purchase agreement, which would be the lesser of (i) the purchase price and (ii) the amount of the purchase price that has been paid (applicable if part of the purchase price is payable post-closing, such as an earnout). While a purchaser may be amenable to the foregoing, it may nevertheless want the total liability cap to exempt fundamental and tax-based representations and warranties.
(d) Anti-Sandbagging
Over the course of a transaction, the seller will provide a host of representations and warranties to the purchaser. This will include disclosure schedules that will be attached to the asset or share purchase agreement. To avoid the issue of a technical breach – such as an omission from the disclosure schedule that the Purchaser was nevertheless aware of – the seller will benefit from the inclusion of an anti-sandbagging clause, which will confirm that the seller will not be liable for a breach of a representation or warranty if the purchaser was aware of the inaccuracy or breach prior to the closing date.
(e) Further Mitigation Measures
To avoid a potential windfall, a seller will want to limit the loss or damage it is required to indemnify the purchaser from (i) the amount of any insurance or other reimbursement received by the purchaser in relation to the breach or other event giving rise to the matter, (ii) any tax benefit realized or reasonably expected to be realized by the applicable loss incurred by the purchaser, and (iii) any other recoveries obtained by the purchaser through its mitigation efforts.
This article was originally published in HLA Journal Vol. 35 – Issue 2 – April 2025.
