Share to Social Media:

Facebooklinkedintwittermail

Limiting Indemnification in Stock Purchase Deals

Some of the basics of stock purchase agreements were introduced in previous posts that mentioned principal clauses such as indemnification provisions, which impose obligations on stockholders of a target company. The obligations are usually subject to a threshold, deductible, or cap. A threshold forces the buyer to withhold indemnification claims until accruing actual indemnifiable losses equal to or above the threshold amount, after which it receives full compensation for all losses incurred. A deductible is more favorable to target stockholders, forcing the buyer to absorb a stated floor of indemnifiable losses, only receiving compensation for those indemnifiable losses exceeding that amount. Imposing thresholds or deductibles can substantially affect the deal value, making the decision a focal point of heavy bargaining in any M&A transaction. The negotiations may touch other value changing terms beyond the stated threshold and deductible amounts, which can vary substantially depending on the size of the deal. A target company might try to impose a “noise level” that stipulates that any individual claim for indemnity must have losses exceeding a stated amount in order to be recovered by the buyer—in other words, it must stand out among the noise.  Clauses such as these have manifest downstream effects on the ability of a buyer to reach deductible or threshold amounts through aggregation of multiple claims. To reduce risk further, the total possible indemnification liability of the target stockholders will usually be capped at an amount negotiated with the buyer. That amount may be as high as the entire value of the deal, or much smaller, depending on several factors and market conditions. Transaction terms may even include separate caps for individual stockholders of the target company, limiting that stockholder’s indemnification obligations to the amount of transaction proceeds the stockholder receives in connection with the deal. These individual caps are a sort of safety valve for stockholders to assuage fears that indemnity might lead to a net loss on the deal. Businesses hoping to circumscribe their potential indemnification liability with even greater precision may resort to other, more creative methods. One such method is limiting a buyer’s remedy for indemnification to funds placed in escrow, effectively limiting the total potential liability of target stockholders. Any imposed caps are then usually subjected to carve-outs for certain losses arising from breaches of fundamental representations and warranties, or fraud and willful misconduct by the target and target stockholders; these carve-outs are of course heavily negotiated as well, which should not be surprising to anyone with previous deal making experience.

Facebooktwitterlinkedinmail

Copyright 2020 - R. D. Adair, PLLC, business transactions, M&A and real estate attorneys.
All rights reserved.

This website contains general information about R. D. Adair, PLLC and legal information in the form of blogs, etc. However, nothing in this website is intended to offer legal advice and does not constitute legal advice. The most effective way to obtain legal advice on your specific issue is to contact an attorney. Please contact us at your earliest convenience so that we may sit down and discuss your legal issues.