In private acquisition agreements, the provisions for indemnification are frequently among the most heavily negotiated issues in the entire transaction. The main function of indemnification provisions is to allocate risk among the parties to an agreement. They detail the rights of the parties following:

Indemnification clauses often reflect the relative negotiating power between the buyer and the seller as well as the nature of the business, industry, financial condition and operation of the target company.

As most post-closing indemnification claims are made by the buyer against the seller, the seller negotiates to limit its indemnification obligations. These limits are made possible by using several customary tools, including:

The majority of private M&A deals provide for an indemnification basket of some form. The following discussion of indemnification baskets is taken from Practical Law Corporate & Securities' newest resource, Practice Note, Indemnification Clauses in Private M&A Agreements.

A basket limits indemnification obligations so that an indemnifying party is not liable for inaccuracies in or breaches of certain representations until losses exceed a specified minimum amount. Baskets usually only limit indemnification for breaches of representations and warranties, and do not cover breaches of covenants, agreements and obligations, excluded assets or excluded liabilities. In addition, certain fundamental representations and warranties are often carved out, such as representations of title, authority or capitalization. Baskets are particularly useful when dealing with losses that can be easily calculated.

Baskets can be structured as either:

Baskets may also contain mini-baskets to increase their limiting effect. These require the losses from a particular claim to exceed a certain amount (typically small) before those losses can be counted toward the basket. The purpose is to prevent the buyer from searching for any minor breach in order to reach the basket amount. A mini-basket is generally subject to the same carve-outs as the basket in which it is included.

Baskets and mini-baskets carry the risk of the seller "double-dipping" if the representations also contain materiality qualifiers, because the buyer would need to show that both the breach and the loss met their respective materiality thresholds before the loss counts towards the basket. To prevent this double-dipping effect, the buyer should try to "read out" the materiality qualifiers from the agreement for purposes of indemnification (for further discussion of the "materiality scrape," see Practice Note, Indemnification Clauses in Private M&A Agreements: Limits on Seller's Indemnification Obligation: Materiality).

The seller can also try to expand the limitation so that the basket applies to indemnification claims for breaches of pre-closing covenants, agreements and obligations. However, standard practice is to allow the buyer to recover on those claims from the first dollar with no limit.

Counsel for buyers and sellers frequently settle contentious issues by appealing to a market standard. Practical Law has several Practice Notes that it updates on a quarterly basis to provide ongoing awareness and analysis of market trends. Practice Note, What's Market: Indemnification Provisions in Acquisition Agreements gathers recent summaries of publicly filed private acquisition agreements from the What's Market database and displays some of their key indemnification terms, including survival periods, caps and baskets, exclusive-remedy provisions and escrow provisions.

Beyond the Practice Note snapshot, subscribers can use the What's Market database to determine how parties have come out on indemnification baskets in hundreds of private acquisition agreements across a dozen different industries. Simply visit the private acquisition agreement database and take the following steps:

This will produce a customized report analyzing the provisions for baskets and mini-baskets in the selected deals. The What's Market database can run these comparisons for several other indemnification provisions, including caps, materiality scrapes, rights of set-off, mitigation obligations and other issues.

For an example of a basket provision drafted as a tipping basket (which favors the buyer), see Standard Document, Stock Purchase Agreement (Pro-Buyer Long Form): Section 8.04. For an example of a basket provision drafted as a deductible with mini-baskets (which favors the seller), see Standard Document, Stock Purchase Agreement (Auction Form): Section 7.04(a).