Indemnification

Indemnification is the contractual mechanism by which one party to a deal compensates the other for defined losses — most often, the seller making the buyer whole for losses arising from breaches of the definitive agreement's representations, warranties and covenants, or from specified pre-closing liabilities. It is the heart of how M&A agreements allocate post-closing risk, and its terms are among the most negotiated in any deal.

What it covers

A buyer's typical indemnification claim flows from:

• a breach of a representation (the financials were misstated, a key contract was undisclosed, there was unpaid tax);
• a breach of a covenant (the seller failed to do something it promised pre- or post-closing); or
• a specifically indemnified matter (a named lawsuit, an environmental issue, pre-closing taxes).

The limitation toolkit

Sellers do not accept unlimited liability. A web of negotiated limits caps and channels indemnity exposure:

• Survival period. How long after closing a claim can be brought — commonly 12–24 months for general reps, and longer (often to the statute of limitations) for fundamental and tax reps.
• Cap. The maximum the seller can owe — frequently around 10% of purchase price for general reps, but typically up to the full purchase price for fundamental/tax reps.
• Basket (threshold). Losses must exceed a floor before any claim is paid, filtering out trivial claims. A deductible basket pays only the excess above the floor; a tipping basket pays from the first dollar once the floor is crossed.
• De minimis. Individual claims below a small amount don't count toward the basket at all.

Fundamental and special reps

Not all reps are equal. Fundamental representations (due organization, authority, capitalization/title to shares, and usually taxes) go to the core of what the buyer is buying. They get longer survival and higher (often uncapped) caps than ordinary "business" reps, because a failure of title or a hidden tax liability is more existential than, say, a minor contract issue.

Backing the promise

An indemnity is only as good as the seller's ability to pay. So buyers back it with funded security: an escrow or holdback reserves part of the price, and increasingly R&W insurance shifts the risk to an insurer. With R&W insurance in place, the seller's direct indemnity is often reduced to little more than the policy retention and excluded matters.

"Sandbagging" and the exclusive remedy

Two recurring fights round out the indemnity package:

• Sandbagging. Can a buyer claim for a breach it knew about before closing? A pro-sandbagging clause says yes (the rep was bargained for regardless of knowledge); an anti-sandbagging clause bars claims for known issues. The default varies by jurisdiction, so the deal usually addresses it expressly.
• Exclusive remedy. The agreement typically states that indemnification is the buyer's sole remedy for breaches (carving out fraud), so the negotiated caps and baskets actually hold rather than being bypassed by common-law claims.