What is an indemnification clause in a business sale?

An indemnification clause is the part of a purchase agreement that says who pays if something goes wrong after closing. BDC describes the section as where the parties agree the ground rules for the compensation the vendor will have to pay if disclosures about the business turn out to be inaccurate, or if covenants are not respected. BDC calls it an important and hotly negotiated section.

What it covers

BDC gives an example. If the vendor discloses two outstanding lawsuits and it turns out there are five, what compensation or indemnity does the vendor have to pay to the buyer? BDC also describes an indemnity agreement as the seller promising to be responsible for unforeseen liability that could arise for a period after the sale. For the buyer, the clause is the route to compensation when the seller’s disclosures prove inaccurate or its covenants are not respected.

What limits it

BDC notes the seller of a business is not liable for misrepresentations forever, and that liability is typically capped at a certain percentage of the purchase price. So read two things in any draft. First, the amount the seller can be required to pay. Second, the length of time in which you can make a claim. Ask whether any category of claim is treated differently from the rest.

How it differs from a warranty

BDC describes the representations section as the vendor telling you things like there is no litigation, no environmental issues and no labour issues. The indemnity section sets the compensation the vendor pays if those disclosures turn out to be inaccurate. BDC says market norms on indemnity have changed substantially in Canada in recent years and recommends advisors who are up to date. Compare representations and warranties against indemnities before you negotiate.