Meaning
Contractual provisions specify the conditions under which one party compensate another for losses arising from breaches of representations or specific liabilities. Within an acquisition agreement, indemnification covenants function as a recovery mechanism for a buyer when a seller’s previous disclosures prove inaccurate. These clauses establish the financial limit and the timeframe for making a claim.
The scope typically excludes matters known at the time of signing unless specifically carved out as a special indemnity.
Risk Allocation
Liability limits define the maximum exposure of a founder or selling entity. These limits, often termed caps, represent a percentage of the total transaction value. Deductibles or baskets ensure that minor discrepancies do not trigger a formal claim until a specific dollar threshold is reached.
A tipping basket allows recovery from the first dollar once the threshold is met, while a non-tipping basket only allows recovery for the excess.
Survival Period
Time limits restrict the window during which a claim may be filed after a transaction closes. General representations might expire after twelve to twenty four months, whereas fundamental representations like title to shares or tax compliance often last for the full statute of limitations. This temporal boundary provides a date after which a former owner no longer carries the weight of past corporate actions.
Recovery Source
Funding for potential claims often resides in an escrow account managed by a third party. When a buyer identifies a breach, they submit a formal notice detailing the loss and the specific covenant violated. If the seller does not contest the notice, the escrow agent releases the funds.
This system replaces the need for litigation by providing a pre-funded pool of capital for dispute resolution.
