When one company — or other type of business entity — buys the assets of another, the companies negotiate and execute a detailed Asset Purchase Agreement. Among many other sets of provisions, there is a series of clauses called “indemnification” or “hold harmless” clauses. The purpose of an indemnification clause is to shift the risk of some loss, injury, or damage from one party to the other. In an asset purchase transaction, almost always, the buyer is seeking to shift risk to the seller. The buyer is already accepting a high level of risk by paying a lot of money for the assets. Thus, the buyer wants to reduce those risks even further by insisting on significant indemnifications.
Further, in asset purchase agreements, there is also another section in the agreement involving “representations and warranties” (or “reps and warranties”). This is another area in the asset purchase agreement where the buyer seeks to reduce risk. Thus, the seller often agrees to significantly more reps and warranties than does the buyer.
Although indemnification clauses are independent, there is often a connection between the indemnification clauses and the reps and warranties. A short sample indemnification clause might read like this:
“Buyer Indemnification. Buyer agrees to indemnify Seller and its officers, directors, employees, agents, representatives, Affiliates, successors, and assigns (collectively, the “Seller Parties”) and to hold the Seller Parties harmless against any Loss that any of the Seller Parties may suffer, sustain or become subject to, as the result of (i) any breach of any covenant or agreement of Buyer herein; (ii) the inaccuracy or breach of any representation or warranty made by Buyer in this Agreement; or (iii) the use of the Assets purchased herein on and after the Closing Date.”
Real-world indemnification clauses are often much longer. Generally, indemnification includes two aspects: paying any cost of defending a claim (such as paying attorneys’ fees and litigation costs) and paying any resulting settlement or judgment. That is the idea of “hold harmless.”
Let’s look at an example: in many asset purchase agreements, inventory, equipment, and machinery are being sold. In the asset purchase agreement, the seller will sign a rep and warranty that the seller owns the inventory, equipment, and machinery and that the seller owns such free and clear from all liens and encumbrances. Among other things, these reps and warranties mean that the inventory, equipment, and machinery are not stolen and have not been used as collateral for a loan or a line of credit. As in our example above, the indemnification provisions will reference these reps and warranties in a manner that allows the buyer to sue the seller if it turns out that the inventory, equipment, and machinery were, in fact, stolen or used as collateral for a loan.
As noted, an indemnification clause does not JUST allow the buyer to recover the value of the inventory, equipment, and machinery that was stolen or not free and clearly owned, but also ANY harm, damage, or injury that might flow from the fact that the inventory, equipment, and machinery was not owned free and clear by the seller. Let’s say, in our example, that the inventory, equipment, and machinery were used as collateral for a loan. Let’s further say that the loan is not paid off, goes into default, and the bank seizes the inventory, equipment, and machinery several months after the asset sale is finalized. Well, the buyer will have damages and losses not only from the seized assets but from defending the legal proceedings and from other possible eventualities. Maybe the buyer is unable to complete a project for a client because certain equipment was seized. Any damages or losses flowing from those consequences can be recovered under an indemnification clause.
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