What is an indemnity?Once the transaction completes, who bears the burden if an unexpected liability arises? The seller will want to walk away from the sale with minimal future liabilities relating to the business. The buyer will want assurance that any losses which arose under the control of (or were caused by) the previous owners will be compensated for by the seller.
How is an indemnity different from a warranty?A warranty is a contractual statement made by the seller regarding the health of their business. An indemnity is a promise by the seller to compensate the buyer for a specific liability if the need to do so ever arises. Essentially, the main difference is that under a warranty you are promising that something is true whereas an indemnity is a promise to pay.
If the buyer requests an indemnity, the seller should ensure that the indemnity is specific to an identified issue or risk. General or broad indemnities covering any potential liability that could possibly arise should be avoided at all cost. For example, if the buyer spots something untoward during the due diligence process they may want an indemnity to cover that specific issue. This could be, for example, evidence of a dispute with a key supplier which is uncovered during due diligence or disclosed by the seller in the disclosure process. The buyer may request an indemnity which requires the seller to reimburse the buyer if the key contract with the supplier is terminated as a result of the dispute causing a significant loss to the business.
- An indemnity for any tax liability incurred during the seller’s operation of the business prior to completion.
- An indemnity for any claims relating to litigation brought against the company arising from the period of ownership by the seller.
- An indemnity for any claims brought against the company in relation to any pension schemes arising from the period of ownership by the seller, for example where the business has not complied with its legal obligations to offer its employees the opportunity to enrol into a pension scheme.
- An indemnity in the event that the seller was not the legal owner of the shares to be transferred to the buyer.
- An indemnity for any claims by the sellers in respect of their employment with the company during the period of ownership by the seller.
Dos and don’ts for the seller:DON’T give an indemnity which relates to something that will no longer be in your control.
For example, if a loan agreement contains an early repayment charge and the buyer requests an indemnity should that charge arise, the decision to make early repayment will be out of the seller’s control post-sale and so they should not be liable for the charge.
DO ensure certain indemnities are limited to pre-completion.
For example, the seller should not be expected to indemnify the buyer for any loss suffered as a result of a complaint arising in respect of the period post-completion.
DO ensure the loss is quantifiable and avoid wherever possible, consequential loss claims
DO consider whether the buyer could pursue other means or reimbursement.
For example, if the business is subject to a litigation dispute and there is an insurance policy in place to cover any potential damages, request that the buyer pursues reimbursement under the insurance policy first. If the indemnity is given, the seller could of course be liable for any excess amount or the full amount if the policy will not pay out.
Need more help?If you would like any help and advice on your proposed sale or defining your indemnities, please contact our specialist corporate team on 0151 305 9650 or email email@example.com
This article is not intended to be interpreted as advice.