LIABILITY AND INDEMNITY UNDER SHARE PURCHASE AGREEMENT

   Acquisition of business can be by way of purchase of shares or assets. After agreeing on Term Sheet and completion of due diligence process, parties agree in principal to enter into a definitive agreement to document the transaction. While negotiating the numerous provision, most difficult is finalsing Seller warranties and indemnities. Both Seller and purchasers larger interest is involved as Purchaser need a strong seller indemnity to protect it against damages suffered due to breaches of the seller’s representations, warranties and covenants. Seller shall try to limits its liability under indemnity.  A number of Representations and Warranties (R & W) are made by the sellers depends upon the nature of the company is being purchased and accordingly indemnity clause is framed to protect purchasers against breach of R&W.

Warranty

A share purchase agreement (for share sales) or a business purchase agreement (for asset sales) usually contain a series of warranties. A warranty is a contractual statement of fact that the seller is standing behind as true and accurate as at exchange and/or completion

Indemnity

Indemnity means allocating the risks & liabilities. An indemnity clause is basically accepting the risk and liability which may arise due to sellers own R&W breaches. Indemnity can be for specific breaches or a general clause for breaches can be included in the SPA

The standard clause can be as below for Indemnity

-       The Seller agrees to indemnify and save harmless the Purchaser from any and all liabilities, claims and demands whatsoever suffered or incurred by the Purchaser as a result of or arising directly or indirectly out of or in connection with:

(a) any breach by the Seller of or any inaccuracy of any representation or warranty of the Seller contained in this Agreement or in any agreement or other document delivered pursuant hereto; and

(b) any breach or non-performance by the Seller of any covenant to be performed by it that is contained in this Agreement or in any agreement  or other document delivered pursuant hereto.

From Purchase point of view it must be kept in mind that an indemnity is only as strong as the financial strength of the party that is giving it. It would be advisable a purchaser should consider requiring the shareholders of the seller to also provide an indemnity in favour of the purchaser. 

Limitation of Liability

From Seller perspective, limiting the liability should be paramount. Seller can chose to determine specific breaches that would give rise to indemnification claims rather a general breach & indemnification clause. However it all depends how the negotiations happens.  Few principle of limiting of the liability is given below.

A.  Time Limitation

Time limitation means till when the respective R&W will survive and purchaser can claim against sellers. This typically depend upon the type of R&W.  This basically governs the length of time that purchaser may bring a claim against the seller for breach of representation, warranty or covenant. 

·       for breach of general representations and warranties, normally 12 months to 36 months are provided in SPA

·       For Tax related matter, six months/1 years following the expiration of the applicable limitation period for tax matters. From purchaser perspective, It is always better to have this indemnity at least till the limitation period of tax matters.

Purchaser should not accept any time limit with respect to claims relating to the authority and organization of the seller, the seller’s ownership to and validity of the shares.

The other time limits generally put in the contract is time period within which seller should be notified of the matter when purchase become aware of the fact or circumstances which may give rise to claim. There must be defined time period for this.

After expiry of time period as described above, sellers shall not be liable for any claim

B.   Monetary Limitations

1.    Maximum limit

It is common to limit the liability of the seller to a certain maximum amount. Generally it is fixed as a percentage of purchase price. Different percentage is agreed on different R&W. In complex transactions, the limit on indemnification might be specific to certain types of breaches

From Purchaser point of view, it need to be ensured that monetary caps are not cumulative, i.e. claims under one representation and warranty would reduce the cap for the claims made under another representation and warranty. Further in case of breaches of fundamental matters such as authority and organization of the seller, the seller’s ownership to the shares or assets there should not a limit less than the purchase price or no limit for damages at all.

2.    Minimum limit

Generally this called as “Basket” or “deminimis”. Under this, claims for indemnification is subject to “de minimis or basket” limit as agreed between the parties.

Under this provision, a minimum amount is fixed and the seller will not be responsible to the purchaser for any indemnification payment unless damages reach a certain amount. Sellers shall only be liable in respect of claim when aggregate amount of such claim exceed “basket”. It depends on the negotiation between parties that the seller would be  liable for amount in excess of the basket amount, or  it shall be liable for the whole amount instead of only the exceeding part of basket. Below standard language just for example

(a)           unless the amount of the liability pursuant to that single Claim (and, for these purposes, a number of Claims arising out of the same or similar subject matter, facts, events or circumstances may be aggregated and form a single Claim) exceeds USD ……. in which case the purchaser shall be able to claim the whole amount of such Claim and not merely the excess; and

(b)           unless the aggregate amount of the liability of the Investors for all Claims not prohibited by paragraph (a) above exceeds USD ………. (in which case the purchasers shall be entitled to claim the whole amount of such Claims and not merely the excess).

The purpose of a basket is to protect seller from nonmaterial matter after closing. The other purpose can be that few liability has been factored in purchase price. In these case, risk of these items is taken by purchaser till the basket amount is reached.

C.  Knowledge or Materiality Qualifiers

Representations clause are generally qualified by  seller to limit its liability  such as qualifying a representation by using words like “to the best of its knowledge” or qualify certain representations with “materiality” language. For example:

(a) To the knowledge of the seller, ……………………………………………………….

(b) The seller has complied, in all material respects, with……………...

Reasonability of such qualifiers must be examine because it shifts associated risk to the purchaser.  

However purchaser can include following to safeguard

Where any Warranty is qualified by the expression "so far as the Warrantors are aware", "to the best knowledge of the Warrantors" or words having similar effect, such Warranty shall be deemed to include a statement that such awareness means both the actual knowledge of the Warrantors and also such knowledge which the Warrantors would have had if they had made reasonable enquiry of all relevant persons.

D.   Disclosure letter

A disclosure letter is very important purpose in minimising the seller’s liability. It purpose is to limit any warranties of seller. Accordingly, the disclosure letter should set out any information about the sale asset that is inconsistent with warranties in the sale agreement. Generally if This means that if a seller’s warranty is incorrect or untrue, the purchaser is eligible to make a claim to recover its losses. However if proper disclosure has been provided against such warranties, buyer will not be succeed in claim and claim will fail

A full and proper disclosure protect seller  against a breach of warranty claim or at least may provide a successful defence to such a claim. For the buyer, it supplements the due diligence exercise in giving the buyer the fullest picture of the target company or business.

Other liability under SPA

Third Party Claims

In the cases of third party claims, purchaser must notify seller within a determined time period to allow seller to take due care of the issue. SPA may have provision to allow seller to assume legal proceedings and defend third party claims at its own cost. In such cases purchaser should provide the seller with all necessary information, documents and assistance.

In certain circumstance sellers shall not be entitled to undertake defence of the Third Party Claim such as, if such Third Party Claim: (i) imposes injunctive or other equitable relief against the Investors; or (ii) the Third Party Claim relates to or arises in connection with any criminal proceeding, action, indictment or allegation. SPA should have provision that Purchaser should not admit any liability without prior consent of seller.

Remediable Breaches

The Breaches which may have the nature of remedial, opportunity to remedy the same must be given to seller to remedy the breach in define timeline at its own cost. If seller has not been able to remedy breach, then only purchaser shall be entitle to claim breach. SPA should have this provision.

Double Recovery

Purchaser should not be allowed to recover claim more than once in respect of the same matter. If seller indemnified purchaser and purchaser has also recovered the amount from any other person in respect of relevant claim, purchaser must return such amount to seller.

Exclusion from Limitation

Limitation of liability of the seller shall not be applicable in certain cases, such as claim arises due to consequence of fraud, dishonesty, wilful concealment or wilful misrepresentation by or on behalf of the sellers; a claim for reimbursement of any criminal or statutory fine or penalty is related to an event or circumstance that occurred prior to the closing.

Exclusion from Liability

SPA also contain provision about the circumstances which exempt seller from liability. Below are some circumstances where seller should be exempted from liability

(a)          if such breach occurs by reason of any matter because of change any legislation not in force at the Completion Date, including but not limited to any retrospective change in law;

(b)          to the extent that specific allowance, provision or reserve has been made in the Accounts at the Accounts Date in respect of the matter to which such liability relates; or

(c)          to the extent that such breach or claim arises as a result of any change in the generally accepted accounting bases or policies in accordance with which the Group values its assets or calculates its liabilities or any other change in accounting practice from the treatment or application of the same used in preparing the Accounts (save to the extent that such changes are required to correct errors or because relevant generally accepted accounting principles have not been complied with).

(d)          an act or omission of the seller made at the request of the purchaser;

(e)          the matters, facts or circumstances that have been disclosed to the purchaser during due diligence or disclosure statement.

Conduct of Claims

How to make the claim under indemnity must be duly described under SPA to avoid any ambiguity. Some times SPA contain the provision for payment of indemnity on demand. From Seller perspective, it should not be accepted and due process of finalization of indemnified amount be mentioned under SPA.