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.
Contact the Business Attorneys at Revision Legal For more information, contact the experienced Business Lawyers at Revision Legal. You can contact us through the form on this page or call (855) 473-8474.
Seller Indemnification Obligations: What Buyers Actually Negotiate
In most asset purchase agreements, the indemnification obligations are not balanced equally between buyer and seller. Buyers drive hard for broad seller indemnifications covering a wide range of pre-closing liabilities, while sellers attempt to narrow their exposure through baskets, caps, and survival period limitations. Understanding these negotiating points is essential for both sides of the transaction.
A deductible basket (sometimes called a “tipping basket”) requires that the buyer’s aggregate losses exceed a threshold amount before the buyer can make any indemnification claim. For example, if the basket is $50,000, the buyer absorbs the first $50,000 of losses and can only seek indemnification for amounts above that threshold. In a “tipping basket,” once the threshold is crossed, the indemnified party can recover from dollar one — the basket “tips.” In a “deductible basket,” the indemnified party can only recover losses above the deductible amount. These are fundamentally different economic arrangements and must be clearly specified in the agreement.
An indemnification cap limits the total amount that the indemnifying party can be required to pay. Common caps range from 10% to 100% of the purchase price, depending on the size of the deal and the risk profile of the assets. Most sellers push for caps at or below the purchase price, while buyers seek caps that exceed the purchase price for certain categories of claims — particularly for fraud, intentional misrepresentation, and fundamental reps like title and authority.
Survival Periods and Their Legal Significance
Indemnification obligations do not last forever. Asset purchase agreements specify a survival period — the time window after closing during which a party can bring an indemnification claim. Once the survival period expires, indemnification claims are generally barred even if the underlying breach is later discovered. Survival periods are heavily negotiated and vary by the type of representation or warranty at issue.
Standard commercial reps typically survive for 12 to 24 months post-closing — enough time for the buyer to discover most operational issues. Certain fundamental representations — such as reps about the seller’s authority to sell, ownership of assets, and absence of certain liabilities — often survive for the full statute of limitations period. Tax representations typically survive until the expiration of the relevant tax statute of limitations plus a buffer period. Fraud and intentional misrepresentation claims are almost always carved out from survival period limitations entirely; courts and statutes of limitations handle those claims independently.
Indemnification for Environmental and Regulatory Liabilities
In transactions involving physical assets — manufacturing equipment, commercial real estate, inventory stored in owned or leased facilities — environmental liabilities deserve special attention. Under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), 42 U.S.C. § 9601 et seq., buyers of contaminated property can be held liable as “current owners” even if the contamination predates their ownership and was caused entirely by the seller. Although CERCLA provides an “innocent landowner” defense for bona fide prospective purchasers who conduct appropriate due diligence, that defense has specific requirements and limitations.
An indemnification clause that expressly covers pre-closing environmental liabilities is critical in any transaction involving real property or environmentally sensitive operations. The seller should agree to indemnify the buyer for all costs, claims, and penalties arising from environmental conditions that existed as of the closing date, including the cost of remediation ordered by the EPA or state environmental agencies. These provisions are frequently paired with environmental representations and warranties by the seller and may be backed by environmental insurance or seller-funded escrows for higher-risk transactions.
Indemnification Escrows and Holdbacks
An indemnification obligation is only as valuable as the indemnifying party’s ability to pay it. If the seller receives the full purchase price at closing and then dissipates those funds, a buyer holding an indemnification claim may find itself with a valid legal right but no practical remedy. To address this risk, buyers routinely negotiate for a portion of the purchase price to be held in escrow — typically 5% to 15% of the deal value — for a period corresponding to the survival period for general commercial reps.
Escrow arrangements are governed by a separate escrow agreement among the buyer, seller, and an escrow agent (typically a bank or title company). The escrow agreement specifies the conditions under which funds can be released to the seller (expiration of the indemnification period with no pending claims) and the conditions under which funds can be released to the buyer (a valid indemnification claim presented with supporting documentation). Properly structured, an escrow provides the buyer with a funded, accessible source of recovery without requiring litigation to collect against the seller personally.
Contact the Business Attorneys at Revision Legal
Indemnification clauses are among the most financially significant provisions in any asset purchase agreement. Getting them wrong — whether by drafting them too broadly, too narrowly, or failing to match them to corresponding reps and warranties — can cost buyers and sellers significant sums. The business attorneys at Revision Legal negotiate and draft asset purchase agreements, including indemnification provisions, for buyers and sellers of businesses across a wide range of industries. Contact us through the form on this page or call (855) 473-8474.
