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CHAPTER 14 Indemnities

Indemnities in M&A Negotiations

Overview of indemnities

An indemnity shifts liabilities to the seller that would otherwise fall upon the buyer. Once the transaction closes, the buyer owns the target business and, by default, has economic responsibility for the target’s obligations (in that the target’s liabilities reduce the value of the target for the buyer). An indemnity is one mechanism for the buyer to shift liabilities back to the seller.

An indemnity is frequently used where the liability at issue is uncertain. If the amount of a liability is fixed, such as $100 million in debt or a $50 million fine that cannot be appealed, then it is easy enough for the parties to simply adjust the purchase price. By doing so, the shift in value occurs on the closing date. The buyer does not have to take any credit risk with respect to the sellers—that is, no risk that the sellers fail to pay the indemnity when due.

Where a liability is contingent and uncertain, however—such as outstanding litigation—there are two choices. If the buyer is willing to take the risk, the parties could adjust the purchase price by the expected value of the liability (plus a risk premium for the buyer). In that case, the buyer would forgo indemnity protection. If the buyer is not willing to bear the risk, the seller could instead provide an indemnity to the buyer.

Whether the buyer or the seller will want to take the risk of a contingent liability depends on a number of deal-specific ...