The remedies that are available to a party under an acquisition agreement are usually the following:
Only the first two of these, which are explicitly provided for in the agreement, will be discussed here.
[A] Termination
The remedy of termination is relatively straightforward: if one party breaches its representations or warranties, the other party may terminate the agreement. This remedy is available only before the closing of the acquisition, since its primary effect is to prevent the closing from occurring. This may raise a question as to the need for this remedy, given that the breach will also cause the failure of a closing condition. But most agreements provide for an outside date for the closing to occur, and without a termination provision a party would have to wait for that date before it could assert the other’s breach as a basis for ending the agreement. The termination provision allows the party to walk away immediately upon the discovery of a breach by the other party.
Indemnification is usually the sole remedy for breaches of an acquisition agreement that occur or are discovered after closing.25 Although the indemnification provisions are generally mutual, the vast majority of indemnity claims are by the buyer against the seller and relate to the breach by the seller of representations or covenants relating to the target. In other words, the typical indemnification claim is based on a buyer that has received, in its view, damaged goods. Other indemnification claims may seek compensation for out-of-pocket expenses incurred as a result of the other’s breach. Indemnification may also be provided for specific claims without regard to the existence of a breach. For example, a seller may agree to indemnify a buyer against all liability and attorneys’ fees in connection with a specified litigation to which the target is a party at the time of the closing.
Here is the basic indemnification provision by a seller in favor of a buyer:
The Seller shall indemnify and hold harmless the Buyer from and against all losses, damages, penalties, disbursements, costs and expenses (including without limitation attorneys’ fees and expenses) incurred by the Buyer as a result of any breach by the Seller of any of its representations or covenants under this Agreement.
What is the difference between a buyer asserting a claim for indemnification under this provision and asserting a claim for damages in an action for fraud or breach of contract? First, a party’s right to indemnification may be subject to negotiated limitations. Second, the type of damages provided for in an indemnification provision may be different from those available in a legal proceeding—for example, attorney’s fees might not be awarded to the plaintiff in a contract action. Having said this, the inclusion of indemnification provisions does not avoid the need for the indemnitee to prove the breach and its damages. Put a different way, indemnification is not self executing: in other words, if the indemnitor refuses to pay, the indemnitee must judicially enforce the promise.
There are a number of techniques to limit exposure under an indemnification provision. The first is a basket, which is similar to an insurance deductible. The indemnitee may not receive indemnity payments except to the extent its indemnity claims exceed a stated dollar amount. In addition, sometimes any claim beneath a specified dollar amount will neither give rise to an indemnity claim or count against the basket. Another negotiated approach in this context may be that indemnity claims are not paid until they aggregate a stated dollar amount, at which point they are all paid. Sometimes a buyer will agree to cap the maximum aggregate amount of indemnity payments that it is entitled to receive. These provisions often contain detailed procedures with respect to claims for indemnification for legal claims. The basic rule is that the indemnitor, being responsible for paying a judgment or settlement in respect of a claim against the indemnitee, is entitled to control the defense of such claim, including the selection of counsel.
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Indemnification is an agreement to pay or reimburse another party’s expenses, losses, damages and costs. Many transactions involve some form of indemnification. In most acquisition agreements, the indemnification provision is one of the primary battlegrounds. (See 9:4.4[B].) In credit agreements, on the other hand, indemnification provisions in favor of the lender are customary but seldom negotiated extensively.
The typical language of an indemnification provision is the following:
Party A indemnifies Party B for and against all liabilities, losses, damages, penalties, actions, judgments, costs, expenses or disbursements of any kind or nature that may be imposed on, incurred by, or asserted against Party B, in any way relating to or arising out of Party B’s execution, delivery or performance of this agreement or the consummation of the transactions contemplated hereby.
Let’s examine the description of the indemnified amounts: all "liabilities, losses, damages, penalties, actions, judgments, costs, expenses or disbursements." This litany is a classic example of the propensity of legal writers to use every available synonym. This type of list is traditional, however, so it would be inadvisable to shorten it. Exactly what does all of this mean? Let’s assume the quoted language appears in an agreement pursuant to which Party A operates a deep-sea drilling rig owned by Party B. The indemnification provision is as set forth above. There are a list of things that would potentially give rise to a claim for indemnification by Party B against Party A by this indemnification provision:
What if the oil spill described in the second point above was Party B’s fault? Should Party B be entitled to indemnification for this from Party A? Most indemnification provisions address this type of concern by excluding costs that result from the indemnitee’s bad behavior, such as its gross negligence or willful misconduct. See section 5:6.5 for a more thorough description of this exclusion.
An issue that comes up frequently in indemnification provisions is whether the indemnitee should be indemnified for the results of its own misbehavior. A common approach is to exclude costs that result from the indemnitee’s "gross negligence or willful misconduct." In other words, costs incurred by the indemnitee as a result of its own gross negligence or willful misconduct are not subject to indemnification.
An example of this is the following. A company has indemnified an investor for all damages incurred by the investor "arising in any manner as a result of the investor’s making the investment, except for damages arising from the investor’s gross negligence or willful misconduct." The investor and the company agree on a plan for the company to make an illegal payoff to a public official in order to win a government contract. The investor is fined for its participation in this scheme. It turns to the company for indemnification, on the basis that the payoff was made by the company with financing provided by the investor. The company is not responsible for making the indemnification payment under the "gross negligence and willful misconduct" carveout, because the investor’s damages were the result of its own misconduct.
What if, under the above facts, the exclusion was worded as follows: "arising in any manner as a result of the investor’s making the investment, except for damages arising solely from the investor’s gross negligence or willful misconduct"? The inclusion of the word "solely" is often a negotiated point in this provision, and the example shows why. If the indemnification provision had been written this way, the investor would have a persuasive argument that it is entitled to indemnification, since the bad act was one which both the investor and the company participated in.
As an alternative to the use of the term "solely," a middle ground on this issue can be achieved by the following insertion:
arising in any manner as a result of investor’s making the investment, except for damages arising to the extent of the investor’s gross negligence or willful misconduct.
This requires the comparative fault of the parties to be analyzed in determining the level of indemnification to be provided.
An issue that arises with respect to this provision is whether the proper standard should be gross negligence or merely negligence. Under the gross negligence standard, the indemnitee’s claim for indemnification can only be denied if its behavior is grossly negligent. Clearly, the indemnitee will push hard for this standard because it requires indemnification even where the damages are the result of its ordinary negligence.
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Spotlight on contractual indemnities
Indemnities are an essential part of any contract lawyer's toolkit, and are often a hotly contested aspect of a contract negotiation. The law around indemnities is complex and, in many cases, far from settled. Ensuring that you have a solid understanding of the principles, and knowing where the potential pitfalls lie, can help you to spot the contractual risks and, where possible, mitigate them from the outset.
Indemnities are commercially significant in many transactions and hotly negotiated.
It is by no means clear that a contractual indemnity excludes the common law rules of remoteness and mitigation that apply to damages claims: keep an eye on developing case law!
The extent of liability will ultimately depend on the terms of the contract of which it is a part: express drafting recommended!
If you give an indemnity, seek safeguards.
If you receive an indemnity, check for restrictions and carve-outs which may claw-back the benefits which you think your client has received.
An indemnity is a promise, usually made in a contract, to pay money on the happening of a specified event. Indemnities protect one party from a contract from suffering financial loss in relation to certain eventualities – usually those that would arise from the conduct of the other contracting party, or over which the other contracting party has control.
In other words, an indemnity is a contractual mechanism for allocating risk, in a similar way to a warranty in a typical M&A contract, or a guarantee in a finance contract.
An indemnity is a primary obligation; it does not depend on having to prove a breach of a contractual obligation. This offers a number of advantages over bringing a damages claim for a breach of contract:
Being creatures of contract, indemnities are highly flexible, according to how they are drafted. But this can also be a challenge. Compared to mechanisms like guarantees, indemnities are subject to few fixed rules. There is no settled "law of indemnities". As a result, the questions of whether concepts like causation and mitigation apply, and what is needed to prove the amount being claimed, are all dependent on how the indemnity is drafted.
It is crucial that there is absolute certainty in relation to the relevant factual event that triggers the indemnity. A prime example of this issue arose in the recent Supreme Court case of Wood v Capita Insurance Services. The case turned on the interpretation of an indemnity in a share purchase agreement, which read as follows:
"The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer against (1) all actions … losses, claims, damages … expenses and liabilities suffered or incurred, and (2) all fines, compensation or remedial action or payments imposed on … the Company (A) following and arising out of claims or complaints registered with the FSA … against the Company … (B) and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any … insurance related product ..."
The numbers and letters in bold were not included in the original text, but the court inserted them to help in the construction of the clause. The question was whether the indemnifying party (Mr Wood as the seller) was required to indemnify Capita (as the purchaser) where there had been a loss "pertaining to … mis-selling or suspected mis-selling of … insurance products" but the claim being made did not arise out of "claims or complaints registered with the FSA" but arose as the result of an internal investigation.
The critical distinction between the constructions presented by the two parties was whether:
The Supreme Court preferred the first interpretation: the words in (A) qualified both (1) and (2), and (1) could not be read as an independent trigger. Given that no claims or complaints had been registered with the FSA, the indemnity therefore did not apply.
Drafting point:
The action for those drafting indemnities is clear: we must check for any ambiguities in the drafting of indemnity clauses, particularly when that clause grows in the course of negotiations.
It is common that an issue arises during the course of negotiations that the original draft of the agreement did not contemplate: use sub-clauses and renumber clauses as appropriate so that the specific trigger or triggers can always be identified with ease.
One of the restrictions on the recovery of damages in a breach of contract claim is the rule on legal causation. The loss must have been caused by the breach (in the sense that the loss would not have been caused absent the breach), but a new intervening act will break that chain of causation.
But the causal connection required in relation to an indemnity depends on the wording of the indemnity itself and its interpretation. For indemnities that relate to the performance by one party of its obligations, it is therefore possible to draft a wider or a narrower causal link. Campbell v Conoco suggests that there is an escalating scale of connecting links. The indemnity in that case read as follows:
"The Contractor hereby agrees to indemnify and hold harmless the Operator against … all claims arising in respect of any injury, death, sickness or ill health caused to or suffered by the Contractor and any Personnel as a result of or arising out of or in connection with the performance or non-performance of the Contract ..."
The Court of Appeal found that the connecting links in this indemnity were of increasing breadth, ending with the words "in connection with", which are as wide a connecting link as one will commonly come across. The degree of causal connection required is therefore within our control and will be determined by the words used in the drafting of the indemnity.
In Capita v RFIB Group, the Court of Appeal held that using the causal words "directly or indirectly" within a contractual indemnity imported the Hadley v Baxendale test of remoteness into the clause. The indemnity was worded as follows:
"The Seller undertakes to indemnify … the Buyer … from any liabilities costs claims demands or expenses which [it] may suffer or incur arising directly or indirectly from … any services or products supplied … prior to the Transfer Date".
The court ruled that including the words "or indirectly" made it clear that the indemnity provided the widest link allowed by law in establishing liability for the relevant conduct. It held that the wording covered liability for losses within the second limb of Hadley v Baxendale, but that it could not cover liability for losses which are more remote than the second limb.
Drafting point
Avoiding using the words "directly or indirectly" but relying on causative words such as "arising out of or in connection with" will have a broader interpretation that may go beyond the two limbs of Hadley v Baxendale and include all losses suffered, without importing the principle of remoteness.
With both the level and instance of regulatory fines on the rise, a question of increasing importance is whether a party can be indemnified against such fines or penalties.
Our view is that, where it is commercially feasible to do so, a party that could have fines or penalties imposed on it as a result of the actions or inactions of its counterparty to a commercial contract should consider seeking an indemnity to cover those potential fines and penalties from that counterparty.
However, if you are seeking such an indemnity, be aware that it may not necessarily be enforceable. For example, a party will be precluded (under the doctrine of "ex turpi causa") from recovering for damage that is a consequence of its own illegal act. By extension, this would prevent a party from enforcing an indemnity for the penalties it has to pay as a result of that act.
Thus, an indemnity against criminal liability is generally unenforceable. Where the offence is one of strict liability and the party commits the offence innocently, however, it seems that an indemnity may be enforceable.
In relation to regulatory breaches, one of the key cases is called Safeway Stores v Twigger. Safeway was a chain of supermarkets; Twigger and others was a group of former directors and employees who engaged in repeated exchanges of commercially sensitive pricing information. Following an enquiry by the OFT (as it was then), Safeway admitted breaching the Competition Act 1998 and the OFT imposed a fine. Safeway then sought to be compensated by the wrongdoers under an indemnity, but Twigger argued that ex turpi causa applied and that any recovery under the indemnity would be contrary to that maxim.
The directors were successful, and the maxim defeated the indemnity. The Court considered that the contraventions of the Competition Act 1998 were sufficiently illegal or unlawful or serious to engage the maxim; and, additionally, that the Competition Act 1998 did not impose any liability on directors and employees, only on undertakings. Safeway was therefore not vicariously liable (i.e. liable because of the actions of another) but was personally liable. If a company is personally liable, the defence can apply, and the fine may not be recoverable under an indemnity. Conversely, if the company's liability can be vicarious, i.e. liability can be imposed on the company, its directors, (or its processors, in a data processing context), then the maxim may not apply and the fine may be recoverable under an indemnity. The ex turpi causa principle is one of law but it is worth noting that its application will vary with the circumstances.
The policy driver should also be considered. It is clear that if a party can transfer a penalty to a third party, there is less deterrent to commit that offence again. (This is why an insurance policy will not generally provide cover for a regulatory fine imposed on the insured – to do so would be against public policy – but may provide cover for a regulatory fine which is imposed on a counterparty of an insured (and which that counterparty seeks to recover from the insured under an indemnity) because that claim could be regarded as a compensatory claim.) But if the contractual indemnity transfers the penalty to the party which could have ensured compliance, public policy may not be defeated, and enforcing an indemnity may not offend such public policy.
In an industry where seeking an indemnity against a regulatory fine may not be market practice, it is worth remembering that it may still be possible to seek an indemnity in relation to the costs of dealing with the regulator action, and other related losses, if not for the fine itself.
There is surprisingly little case law on this point. There is an argument that including the wording may help to ensure that the indemnified party is not required to combine all claims it may have during the term of the relevant agreement into one single claim. There is a second argument that including the wording may help to ensure that the indemnity survives termination of the agreement. But if that is the intention, best practice must be to include reference to the indemnity in the survival clause of the agreement.
In most instances, the words are probably superfluous.
In Codemasters it was argued that including the word "defend" in an indemnity required the indemnified party to allow the indemnifying to run the defence. This was rejected. At best, it was held, the word may give the indemnified party the right to request the indemnifying party to take over the defence. The court also identified the challenging overlap between the word "defend" and the conduct of claims clause.
Best practice is to avoid using the word "defend" in indemnities and ensure all conduct of proceedings issues are dealt with in one place, namely in the "conduct of claims" clause.
The trigger for a claim under an indemnity will be the suffering of loss that is covered by the indemnity. It is for this reason that the limitation period for an indemnity claim will not start to run until the date that the indemnified loss is established.
There is very little consistent case law on this point. There is an argument that including the words "on demand" in an indemnity may lengthen the limitation period, in that the indemnified party may have a cause of action from when a demand is made by it, not from when the indemnifying party fails to prevent the indemnified party from suffering a loss.
Alternatively, inclusion of the words "on demand" may mean that the indemnified party can argue that its claim under the indemnity should be paid as soon as the claim has been made (or at least as soon as the amount has been agreed between the parties). However, this wording would not prevent a party from disputing whether a particular sum is covered by the indemnity. That ultimately can only be settled by litigation or other dispute resolution procedure in which case any payment will only be due and payable in accordance with any resulting court order or equivalent and not "on demand" from the indemnified party.
There are further arguments: perhaps including the words "on demand" is relevant where the agreement includes a "late payments" clause which states that interest is payable from the date of demand. Or alternatively, including such words may protect an indemnifying party from a claim being brought against it under the indemnity before being served by a demand. There is scant case law to provide a definitive view on the precise consequence that including "on demand" will have on an indemnity. We can only conclude that given the case-law is unclear on what the consequence are of adding the words "on demand" into an indemnity, the words are omitted and the parties draft expressly to provide for any of the above consequences, as required by the parties.
There is no general rule as to whether a clause limiting liability applies to indemnities contained within the agreement. It will therefore be a question of construction. It seems most likely that the wording "liability under this Agreement" would in fact cover indemnity claims. However, it could be argued, for example, that the indemnity claim is a claim in debt, and that a debt is a promise to pay, not a liability. Far better, therefore, to draft expressly and make it clear (either in the indemnity clause, or the limitation of liability clause) whether or not the agreement cap limits the indemnity.
You should also consider whether any sums paid under a specific indemnity count towards or "use up" the agreement liability cap. Considering the issue up-front and drafting expressly to deal with the concern will help avoid later disputes. Wording such as the following may be helpful: "no amounts awarded or agreed to be paid under the indemnity in clause X shall count towards the financial cap on liability in clause Y".
As mentioned below, consideration must also be given to whether or not any exclusion of indirect losses applies in the event of a claim being brought under any indemnity.
The meaning of the phrase "hold harmless" has been discussed in a number of cases notably in the Supreme Court in Farstad Supply v Enviroco, in a case between the same parties in a lower Scottish Court, and in Deepak Fertilisers v (1) Davy McKee and (2) ICI Chemicals.
The result of these cases is that, in some ordinary contexts, the words "indemnify" and "hold harmless" can have the same meaning. The likely consequence of this is that including only the words "hold harmless" in a contractual provision is that it could be deemed to be an indemnity provision.
However, it seems clear that including the words "hold harmless" in an express obligation to indemnify will add something, and takes the clause beyond an obligation to reimburse. In Deepak, the Court held that a promise to hold harmless is wholly incompatible with a right to sue. It held that "an agreement to indemnify and hold harmless contains within it by necessary implication an implied term not to sue".
Thus, if party A agrees to indemnify and hold harmless party B in respect of any loss or damage suffered by party B for the breach of a third party’s intellectual property rights, party A must indemnify party B for those losses, but, in addition to that, these cases also suggest that party A cannot bring an action against party B were party A to consider that party B had caused or contributed to the loss suffered (whether through its negligence or contractual breach). Party B would have a defence to party A’s claim because its liability to party A is excluded by the words "hold harmless".
Without the words "and hold harmless", an indemnity may not protect an indemnified party against claims by the indemnifying party. However, in most circumstances, an indemnifying party is likely to resist the inclusion of these words as it would not want to rule out the possibility of bringing an action against the indemnified party where that party is partly responsible for the loss.
In Durley House v Firmdale Hotels, in considering whether the requirement of prior payment was a condition precedent to the right to be indemnified, the judge explained that one view is that where the clause requires the indemnifying party to "hold harmless" the indemnified party, the true obligation of the indemnifying party is to prevent the indemnified party from sustaining any loss or expense in the first place, rather than merely to reimburse the indemnified party only once the latter has paid or lost. However, it was not necessary to resolve this particular debate on the facts of the case, so this point remains unsettled.
It is quite common to see a long list of indemnified parties in a contractual indemnity. You may be familiar with wording such as the following: "The Supplier shall at all times during and after the term of this Agreement indemnify and keep indemnified the Customer, its Group Companies, the Service Recipients and their respective contractors, employees and suppliers".
As the indemnifying party, you should seek to expressly limit any indemnity to the other contracting party only, not its subsidiaries, agents, sub-contractors, directors, etc. Adopting this position will oblige the indemnified entity under the agreement to seek to put in place a contractual mechanism for recovery by it of the losses suffered by and on behalf of those other entities. You will also need to consider the "rights of third parties" clause. Commonly, the indemnifying party will want to seek to avoid a direct right of enforcement of rights by third parties.
It is quite common to see the phrase "costs (including reasonable legal costs)" within the list of losses that can be recovered in an indemnity clause. Following the recent case of Euro-Asian Oil v Credit Suisse, it seems that the wording "reasonable legal costs" will have a specific meaning in the context of any ensuing litigation.
In Euro-Asian Oil, after judgment was given in Euro-Asian's favour, it sought to rely on an indemnity as entitling it to a more favourable recovery of its litigation costs. The indemnity read as follows: "To protect, indemnify and to hold you [Euro-Asian Oil] harmless from and against any and all damages, costs and expenses (including reasonable attorney fees) which you [Euro-Asian Oil] may suffer".
Euro-Asian Oil argued that the words "any and all … costs" meant that the legal fees should be assessed on an indemnity basis, which is the basis that generally provides for a higher recovery, given that the costs don't have to be proportionate to the sums in issue, or to the complexity of the litigation, and any doubt is resolved in favour of the receiving party. Credit Suisse disagreed and argued that the costs should be recoverable on a standard basis.
The court found in favour of Credit Suisse, that the costs were to be awarded on the standard basis. This meant that the costs recovered had to be proportionate (for example, proportionate to the sums in issue), and if there was any doubt as to whether the costs were incurred reasonably, that doubt would be resolved in favour of the indemnifying party, not the indemnified party.
A conduct of claims clause offers significant and practical protection to an indemnified party. There are many permutations of such a clause, and the practical requirements of each particular clause will need to be considered carefully. Such a clause may require the indemnified party to:
The clause may also require that the indemnifying party conducts the claim so as not to bring the reputation of indemnified party into disrepute. If litigation is conducted in the name of the indemnified party, it may want a right to appoint a co-counsel.
As a drafting point, seek to make compliance with the claims procedure a condition of making a claim. In the recent case of Heritage Oil v Tullow Uganda the indemnifying party argued that there was a condition precedent of giving notice before a certain indemnity kicked in, which had not been complied with. But it lost its argument on the basis that elsewhere in the contract was a condition precedent for an indemnity that had been clearly drafted as such. (It stated that that indemnity "shall not apply unless...".) In comparison to such clear drafting, the court did not accept that the clause in question was intended to operate as a condition precedent.
If you intend compliance with the claims procedure to be a condition of making a claim, it could deprive the indemnified party of the benefit of the indemnity even if it commits a trivial breach of the claims procedure (which may in fact cause no loss or have no prejudicial effect). As such, you need to ensure that the effect of the clause is clearly drafted (particularly if there are any conditions precedent elsewhere in the contract).
If you are the indemnifying party
Where you are giving an indemnity, the concern is that any resulting claim would give rise to a claim in debt (such that the principles of mitigation and remoteness would not apply) and therefore you should seek to draft expressly such that mitigation and remoteness do apply!
First, you should consider providing for an express duty to mitigate. This could be achieved by way of a boilerplate clause in the agreement which applies on a mutual basis to all indemnities in the relevant agreement. For example: "Each party shall use reasonable endeavours to mitigate its losses under this agreement, including any losses under any indemnities set out in this agreement". Or it could be drafted to apply to a specific indemnity only: "The Indemnified Party shall not be entitled to an indemnity under clause [x] to the extent that it fails to take reasonable steps to mitigate its losses."
You should also consider the issue of remoteness. Consider any clause in the relevant agreement which excludes indirect losses, and the interplay between that clause and the indemnity clause in question. Can indirect losses be claimed under the indemnity? You can consider drafting expressly so that remoteness will in essence apply: "provided such losses are reasonably foreseeable". Including such wording might provoke the indemnified party to exclaim: "hey, this indemnity is now no more than a breach of warranty claim!". If that is the case, it is much better to have these discussions at the point of negotiation so that both parties can be clear on what they expect to be able to recover in the event that any claim is made.
If you are the indemnified party
Where you are receiving the benefit of an indemnity, your aim is likely to be ensure that the claim will be treated as a debt claim, or in the same way as a debt claim would be treated. We would therefore advise that you draft the indemnity narrowly so that the loss is quantified in the contract, or is easily quantifiable, or there is perhaps a mechanism within the contract which can be used to quantify the liquidated loss.
You should consider drafting expressly so that remoteness will not apply to any resulting claim. You could include wording such as "whether or not foreseeable" in the relevant clause.
You should also consider drafting expressly so that a duty to mitigate does not apply. Mutual wording could be included in a boilerplate provision, such as: "Neither party's recovery under any indemnity set out in this Agreement shall be subject to a duty to mitigate the losses suffered." Or perhaps you could include wording in the specific indemnity clause itself: "…shall indemnify party B (which shall have no duty to mitigate its losses)…".
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Limitations of liability (and exclusions of liability) are almost invariably found in contracts. In addition to limitations on the warranty period to claim under the warranties, a supplier will normally limit its risks and exposure to liability in various other respects:
Providing for a ‘cap’. Many contracts contain a monetary limitation of liability (a ‘cap‘). For M&A-agreements, such a cap is typically defined as a percentage of the (preliminary or adjusted) purchase price or simply a fixed amount (agreed by the same token). Normally, a cap should not apply to matters relating to ownership or entitlement to sell because it affects the entire sales transaction (and more). For operational contracts, such reference is not always readily determinable or the parties may have reasons to vary.
Any cap established in accordance with one of the above referenced amounts, will nevertheless be subject to further discussions. Solutions to overcome such discussions is to further distinguish for the risks involved (and not apply the standard one-size-fits-all clause). An example of such distinction was proposed by D.C. Toedt III:
A damages cap distinguishing the types of risk involved could be, for example:
In this example, the factor X could be:
In many operational contracts in which intellectual property rights are at stake, the limitation of liability clause contains a carve-out or exception for breach of the confidentiality provision and for IP infringement claims. A very common (and between equal parties, often accepted) reference is:
…the amounts actually received by Seller under this Agreement during the twelve months period preceding the event or circumstances giving rise to a claim.
Note that in case of a claim, the customer will typically cease payment of its invoices (and in many industries, a seller will nevertheless continue its supplies, at least for a certain period of time), which makes twelve months preceding the claim relevant. Arguments to come to a higher amount (beyond one purchase order or the scope of the contract) are often established by reference to the amount that the parties order annually: in a good commercial relationship, a purchaser expects that for determining a cap on liability other supplies between the parties are also taken into account (i.e. no limitation merely to amounts paid under the agreement, let alone under a purchase order).
Many contracts include a provision on indemnification. It entitles one party (the indemnified party) to be indemnified by its supplier (the indemnifying party) against damages resulting from a claim made by a third party and caused by the product or service delivered by that supplier. Two indemnities are commonly provided. First, the indemnity can relate to infringement of third party intellectual property rights resulting from the use of rights or technology licenced from the supplier. Secondly, an indemnity can relate to claims by customers of the indemnified party resulting from the use of contaminated raw materials or incorporation of defective half-products in the end-products supplied by the indemnified party; the indemnity is in fact the extension of a warranty that comes to life later in the supply chain.
Procedural law aspects. The scope and nature of such indemnification varies considerably from jurisdiction to jurisdiction. In some countries, the indemnity can be invoked in court proceedings by such third party claimant, following which, the party providing the indemnity would step into the position of the party with the benefit of the indemnity. In other countries, civil procedural law does not provide for such right (or obligation) of substitution but requires the indemnified party to continue the court proceedings notwithstanding its right to take recourse against the indemnifying party.
Indemnity aspects. The indemnification provision should address the key elements:
A purchaser-friendly indemnity for infringement of intellectual property rights could for example be as follows:
8.1 Supplier shall defend and indemnify Customer against all losses, damages and expenses incurred by Customer which arise out of or in connection with a claim or proceeding alleging that the manufacture, sale, importation, use or disposition by Customer or any of its customers of a Product or any part thereof, or of equipment incorporating such Product, directly or indirectly infringes Intellectual Property Rights, trade marks or trade secrets of a third party (a “Claim“).
8.2 In the event of a Claim, Customer shall:
(a) notify Supplier of the Claim;
(b)
grant Supplier the authority to either settle or defend such Claim with counsel of its choice, provided that any
settlement does not impose liability on Customer; and
(c) cooperate and provide reasonable
assistance in the defense of the Claim, at Supplier’s expense.
8.3 In connection with a Claim, Supplier may, at its expense, procure for Customer and its customers the right to continue all acts in relation to the Product, or if a procurement of such right is not a reasonable or viable option, (a) replace existing Products or parts thereof and (b) replace any future Products or parts required to be supplied under this Agreement with a non-infringing alternative product with at least equivalent performance (and price, as to (c)), all in compliance with Customer’s requirements and specifications, as approved in writing by Customer.
8.4 If a Product is held to infringe and its manufacture, sale, importation, use or disposition is enjoined, Supplier shall, at its discretion and expense, either procure for Customer and its customers (i) the right to continue all acts in relation to the Product, or (ii) replace the Product or part thereof and replace any future Products or parts required to be supplied under this Agreement with a non-infringing alternative product with at least equivalent performance (and price, as to (ii)), all in compliance with Customer’s requirements and specifications, as approved in writing by Customer.
A supplier (or licensor) geared indemnification will likely exclude various aspects. Although this may well be self-evident, being explicit in case of an overlap or division of responsibilities between the contracting parties is recommended. For example, the above section 8.2 can be continued as follows:
Supplier has no obligation or liability to Customer in connection with any Claim:
(a) to the extent that
such Claim is attributable to specifications, designs or instructions provided by Customer; or
(b) to the
extent that the Claim is based on any prototypes, risk production units, or disabled parts of the Product, the
use of which has not been expressly permitted; or
(c) for any unauthorised use or disposition of the
Product beyond the Specifications; or
(d) to the extent that the Claim arises from (i) a modification of
the Product and the infringement would have been avoided without such modification, or (ii) the combination of
the Product with any other product, service or technology, or (iii) the use of the Product or any part thereof
in the practice of a process if Customer does not incorporate the Product into a device of which the end-user is
a consumer; or
(e) to the extent a Claim arises from Customer’s continued manufacture, use, sale,
offer for sale or other disposition or promotion after Supplier’s notice to Customer that Customer must
cease such activity, provided such notice shall only be given if the Product is, or is likely to become, the
subject of such a claim of infringement; or
(f) for any costs or expenses incurred by Customer without
Supplier’s prior written consent.
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Indemnification Claims – Follow the Letter of the Contract-Kirkland M&A
Purchase agreements typically include fairly elaborate provisions addressing the step-by-step process of how a buyer can pursue an indemnification claim against a seller for breaches of the terms of the sale. A number of recent Delaware decisions highlight how courts expect parties — both buyers and sellers — to strictly adhere to those terms in the event of a dispute over an indemnification claim or risk losing their right to pursue or defend the claim.
In the most recent decision, the court, in what itself noted “may seem like a harsh result”, granted summary judg- ment to the buyer on an indemnification claim based on the failure of the seller to object to the buyer’s claim notice within the mandated 10-day objection period. is outcome could be viewed as particularly unforgiving being that the seller did in fact deliver the objection a few days after the deadline and had previously objected in a timely fashion to an earlier claim notice that related to the same underlying claims. However, the second notice contained additional details and certain new claims, effectively restarting the clock for a timely objection notice. In addition, the court refused to even entertain the seller’s counterclaim that the buyer’s indemnification notice itself missed the contractual 10-business day deadline for the buyer to deliver a notice of claim, finding that the seller’s failure to deliver a timely objection notice served as a full waiver of this assertion by the seller.
Similar themes underlie a 2015 decision in a long-running dispute between Al Gore and Al Jazeera over the sale of Current TV. In this case, the court held that certain of the buyer’s indemnification claims were “facially invalid” because the words chosen by the buyer in the claim notice were that it “may incur Damages” from the seller’s breaches, while the language of the merger agreement required the notice to state that that the buyer “rea- sonably believes it will incur or pay Damages”. Similarly, in the context of an indemnification claim by buyer for expected third-party claims against the acquired business, the court strictly construed the requirement that the buyer’s claim notice describe “the maximum amount reasonably believed by [Buyer] to be demanded by a third party”. Because the merger agreement did not limit this requirement to state the maximum claim to what was then known or knowable by the buyer, the buyer’s failure to predict and then state what was then likely unknowable — the maximum amount an independent third party would ultimately claim against the acquired business — made the claim notice defective and therefore invalid.
If an indemnification claim or dispute does arise, parties should pay careful attention to the procedural require- ments such as timing and wording to maximize the chances that their claims will be evaluated on the merits rather than being disqualified on a technicality or foot-fault, even if otherwise massaging the language of the notice would preserve more optionality on the ultimate trajectory of the claim.
In his recent decision, VC Slights captured Delaware’s “contractarian” approach to these issues that favors strict construction over perceived fairness by reiterating that “Delaware courts enforce bad deals the same as good deals…and cannot ignore the plain
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A lot of contracts contain mutual indemnities (so each party is obliged to compensate the other party for loss suffered by that other party). However, with loan agreements, it is usual for only the borrower to agree to indemnify the lender. The lender will not agree to indemnify the borrower. This is due to the strength of the lender’s bargaining position compared to the borrower’s.
The indemnity clause will state when the borrower must indemnify the lender (e.g. on demand by the lender or
within [X] Business Days of demand by the lender).
It must also set out clearly what the borrower must
indemnify the lender against. For example:
Any loss, liability, cost or expense caused or contributed to by:
Contract terms in a director’s guarantee and indemnity place obligations on the director, as guarantor for the business loan. Generally, the terms in a guarantee and indemnity tend to be standard across the market. Nevertheless, it is essential to understand the nature of the guarantee and indemnity before signing.
The typical terms you will find in the guarantee will include that the guarantor:
Likewise, there may be a term that states the guarantee and indemnity must remain in place despite:
Additionally, most terms of a director’s guarantee and indemnity are standard in the market and tend to be lender friendly. Nevertheless, you should see if you can negotiate the terms of the guarantee and indemnity. Ultimately, your ability to negotiate the terms will ultimately depend on how important building a relationship with you and your business is to the lender.
Further, two points you may consider negotiating are:
Often, the amount that a director is liable for is unlimited. This is to capture all amounts the business is liable for under the loan agreement and any money the lender incurs in providing the loan. However, you may consider negotiating with the lender to limit the guaranteed amount to a specific amount. This will provide clarity on how much you could be liable for if your business is unable to repay the debt.
Placing a limit on the guarantee period
Standard terms in a director’s guarantee and indemnity will often state that the guarantee will remain until the lender is satisfied that the business owes no liabilities. You may consider putting provisions in the deed so that the guarantee is only valid while you are a director of the business.