Indemnification in a Business Sale: What Is Actually at Risk

When you sell a company you make a long list of statements about it, and the indemnification article of
the purchase agreement is what happens if one of them turns out to be wrong. Four numbers decide how
much of your price is genuinely at risk: the cap, the basket, the survival period, and
whether the escrow is the buyer's exclusive remedy. Most founders negotiate the price for weeks and
these four for an afternoon.

Indemnification means compensating someone for a loss. In a purchase agreement it means: if a
representation was inaccurate, or a specified liability surfaces, the seller makes the buyer whole.

A purchase-agreement indemnity allocates specified losses — most often losses caused by a
representation turning out to be inaccurate. It is worth knowing what this provision is not. Texas
imposes heightened fair notice requirements on a different kind of clause: one that shifts
responsibility for a party's own future negligence. There, the agreement must express that intent
within its four corners (the express negligence rule) and the provision must be conspicuous
(Dresser Industries, Inc. v. Page Petroleum, Inc., 853 S.W.2d 505, 508–11 (Tex. 1993)). A related
express-intent requirement applies to indemnity against strict liability (Houston Lighting &
Power Co. v. Atchison, Topeka & Santa Fe Ry. Co., 890 S.W.2d 455, 458–59 (Tex. 1994)).

Those requirements do not attach to every clause called an indemnity. The Supreme Court confined
Dresser to its prospective-negligence context and declined to extend it to a provision addressing
contractual economic loss (Green International, Inc. v. Solis, 951 S.W.2d 384, 386–87 (Tex. 1997)).
What the clause actually transfers decides which rules apply — and a purchase agreement can
contain provisions that implicate the negligence or strict-liability rules alongside the ordinary
warranty indemnity.

The cap. The maximum the buyer can recover for a breach of general representations. Frequently
expressed as a percentage of the purchase price, and frequently equal to the escrow. Fundamental
representations — title to the equity, due organisation, authority, sometimes tax — are usually
carved out of the cap and survive longer, occasionally up to the full purchase price. Which
representations count as fundamental is a negotiation, and it is one worth having, because moving a
representation out of the fundamental list moves it under the cap.

The basket. The threshold before the buyer can claim at all. Two flavours, and the difference is
real money:

• A deductible basket: the buyer recovers only the amount above the threshold. A $200,000 claim against a $150,000 deductible recovers $50,000.
• A tipping basket: once the threshold is crossed, the buyer recovers from the first dollar. The same $200,000 claim recovers $200,000.

A tipping basket is not a small drafting variant. Sellers should expect to argue for a deductible,
and should notice which one the draft contains.

The survival period. How long each representation stays claimable after closing. General
representations often run twelve to twenty-four months — long enough to cover one full audit cycle.
Fundamental representations run longer. Tax and certain statutory items may run to the statutory period.
When survival ends, the exposure ends, which is why the release of the escrow tail and the survival
date are usually aligned.

The exclusive remedy. Whether the buyer's only route is the indemnity — capped, basketed, and
escrowed — or whether it can also sue outside the agreement. This is the provision that decides
whether the cap is a real cap. A cap with a fraud carve-out is normal; a cap with a broad carve-out
for any misrepresentation is not a cap at all.

A pro-sandbagging clause lets the buyer recover on a breach it already knew about before closing.
An anti-sandbagging clause prevents it. Many agreements say nothing, and the consequence of silence
is jurisdiction-specific and litigated.

For a seller the practical point is simpler: whatever the clause says, the disclosure schedules are
the protection. A disclosed problem is generally not a breach. An undisclosed one is, whether or not
the buyer would have discovered it.

The escrow is where the indemnity is usually funded — a slice of the price held back and released on
the survival schedule. What matters is the amount, the release timing, and whether the buyer can offset
unrelated claims against it.

Representation and warranty insurance shifts the exposure to an insurer. On deals large enough to
support the premium and the underwriting, it can materially reduce the escrow and sometimes the cap,
which is worth real money to a seller who wants clean proceeds at closing. Whether it is available
and worth it is a function of deal size, and it is a question worth asking early rather than
assuming either way.

When diligence finds a specific problem, the buyer will usually not accept it inside the general
indemnity. Instead it becomes a special indemnity — a standalone obligation for that identified
issue, and it typically comes with no cap, no basket, and a longer survival period than anything else in
the agreement.

This is where the diligence findings turn into money, and it is why a problem found in diligence is
so much more expensive than the same problem fixed a year earlier. A contractor IP gap, an unresolved
worker classification, a pending tax question: each is a candidate for its own uncapped indemnity, and
each is negotiated on its own.

Three things are worth pushing on when one appears. Scope — the indemnity should be drawn to the
identified issue rather than to a category that could swallow other claims. A cap of its own, even a
high one, because "uncapped" and "capped at the purchase price" are different sentences. And a
sunset, tied to the point at which the exposure realistically expires rather than left open.

The alternative a seller should raise is a price reduction instead of an indemnity. Buyers often
prefer it: a known number today beats an open obligation, and it takes the item off the escrow schedule
entirely.

Get the fundamental representations list right, because everything else is downstream of it.

Populate the disclosure schedules properly. They take longer than anyone plans for, you are the
only person who can do it, and they are worth more than any drafting point in this article. A disclosed
problem is almost always cheaper than an undisclosed one.

Model the worst case. Cap plus any uncapped items plus the escrow tail, against the proceeds you
were planning around.

Check the exclusive remedy clause last, because it can undo the first three.

This is one of two provisions that decide what a seller actually receives — the other is
the working capital adjustment — and both are
downstream of the letter of intent. The
diligence work that keeps the representations true in the first place is
getting a business ready to sell, and this is
sell-side counsel for Texas founders.

Disclaimer. This publication is provided by Amini & Conant, LLP for educational and informational purposes only and is not intended and should not be construed as legal advice. Should the reader seek further analysis of the subject matter or answers to specific questions about the subject matter, please contact the author at neema@aminiconant.com. This publication is considered advertising under applicable state laws.

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