A Guide to Acquisition Agreements - Remedies and Indemnification
As discussed in another post, the remedies for breaches of contract, and especially breaches of representations and warranties, tend to be limited. These provisions are often heavily negotiated. This is not an area where a certain set of provisions are just “customary,” so you can’t rely on your lawyer to get them right for you. You need to understand these provisions.
There are two typical kinds of limitations: time and amount.
Limitations on the Time to Make Claims
Statutes of limitations will limit how long one party can make claims against another, even if the contract is silent. Often, however, sellers want peace of mind earlier than that. A typical end-point is a few months after the end of the fiscal year in which the purchase occurs or the first full fiscal year after that. The idea is to give the buyer enough time to conclude a full audit. That said many variations are possible and there doesn’t have to be a single time limit. For example, tax claims often run through the end of the government’s statute of limitations and certain claims (e.g. that the seller didn’t have title) may have no time limitation.
Limitations on the Amount of Claims
Limitations on amount include both minimum or threshold amounts (often called a “basket”) and maximums (often called a “ceiling”). For threshold limitations, it’s important to understand the difference between a minimum that is purely a threshold and one that is effectively a deductible. The difference is that once aggregate claims exceed a threshold, all the claims have to be paid. By contrast, if a minimum is set up as a deductible only claims in excess of the deductible are paid. Occasionally, the parties also agree on the minimum size of an individual claim for which a party can seek indemnification. Sometimes that minimum applies to determining if the overall minimum has been reached and sometimes it doesn’t.
The amount limitations vary widely and, as with time limitations, the same amount doesn’t have to apply to all claims. That said, the most common limitation is the amount of the purchase price. It doesn’t necessarily make sense, but it’s an available number and makes for an easier negotiation.
In thinking about the time and amount limitations on claims, it’s worth remembering the point of representations and warranties. As discussed [above], the main point of most representations and warranties is to provide an incentive to disclose, not a source of insurance for the party receiving them. This is important, because for representations and warranties that have this purpose, it’s usually overkill and counterproductive to try and get unlimited liability entirely secured by funds in escrow. You’re as protected as you need to be if the party making the representations and warranties has enough at stake to incentivize good disclosure. Of course, some representations and warranties, such as the seller’s representation that it has good title to the property sold, are fundamental to the deal and generally should not be limited. The general rule of forcing disclosure also doesn’t apply if the parties are dealing with a specific risk, such as a known environmental problem or a pending tax dispute with the government. In those circumstances, the remedies will often be tailored to fully compensate for the risk.