A press release dated 15 February, 2012 (Press Release) issued by Telenor Group (Telenor) seeking indemnification from their Indian counterparts, Unitech Limited (Unitech) regarding the cancellation of the telecommunication licenses (Licenses) by the Supreme Court of their joint-venture, Uninor Limited (Uninor) drew my attention to a seemingly boilerplate provision used/ written in a typical merger/ share purchase/ share subscription agreement (Merger Agreement)- Indemnification. This note is not about the 'Telenor- Unitech deal-what went wrong?' or the implications of Supreme Court's order but is an attempt to understand (a) how a typical indemnification clause is drafted in a Merger Agreement and (b) how to negotiate an indemnification clause in a Merger Agreement from the perspective of the buyer (Buyer) and the seller (Seller).
According to the Press Release:
“The legality and validity of the licenses was a fundamental term of the share subscription agreement between Telenor Group and Unitech Limited. We believe that the Supreme Court’s cancellation of the Unified Access Service Licenses (UASL) conclusively demonstrates a clear breach of Unitech’s warranties,” said Pål Wien Espen, Group General Counsel, Telenor Group.
In the share subscription agreement between the partners, Unitech Ltd. has irrevocably and unconditionally agreed to indemnify and hold harmless the Telenor Group from all damages which may be suffered as a result of breach of any of the agreed warranties.
“The fact is that Uninor as a consequence of the judgment will no longer hold any UASLs. Telenor will therefore exercise its entitled right under the share subscription agreement to hold Unitech Ltd. liable to indemnify and compensate Telenor Group for its investment in India,” said Pål Wien Espen. [Underlines and italics are mine and Emphasis implied]
Undoubtedly, its an inter-play of word and phraseology used in the share subscription agreement (SSA) mainly the conditions precedents clause, representations and warranties clause (Reps & Warranties) and indemnity clause (Indemnity or Indemnity Clause), which would determine whether the claims of Telenor would be successful.
Drafting Indemnity Clause
Indemnity Clause needs to be drafted carefully and cannot be a mere boilerplate provision copied and pasted from the earlier precedents of the Merger Agreements available to a law firm. Typically an Indemnity Clause may be of two types- (a) General Indemnity Clause- concerning with the general breach of Reps & Warranties or any other covenants under the Merger Agreement, and (b) Special Indemnity Clause- concerning with certain special/ certain circumstances regardless of the breach on the part of Seller or Buyer e.g. certain pending litigation, tax issues, environmental issues etc). Some of the issues encountered during the drafting of Indemnity Clause are discussed below:
(A) Who is indemnifying whom – a Merger Agreement should in clear terms specify who is an indemnifying party and who is an indemnified party.
(B) “..hereby agree to jointly and severally indemnify, defend and hold harmless”- This language is typically used in the first paragraph of an Indemnity clause. It should be kept in mind that words- indemnify, defend and hold harmless all have different meanings under varied circumstances. A party may have duty to defend (for e.g. in law suits) but may not indemnify the other party. To cover this a broad array of situations may be inserted (whichmay be left open ended (beneficial for Buyers)) defined as 'Loses' to cover the harm done to the indemnified party.
(C) “...directly arise out of, result from or may be payable by virtue of any breach”- A Merger Agreement may use words 'due to' the conduct of indemnifying party (this may be good for the Sellers!), however more general y the language 'directly arising' is used when Buyer is in a strong position.
(D) To provide significant clarity in the Merger Agreement, the parties may resolve to negotiate and define words like 'Claim', 'Indemnifying Party Conduct', 'Damages'.
(E) “The liability of Seller in respect of any Claim shall be equal to...”- A Merger Agreement may specify the monetary limits of the Seller under a Basket, Ceiling or threshold clause. Buyers may like this to be open-ended or as large as possible.
(F) Failure to give notice clause – In a typical Merger Agreement, certain procedures are described for claiming the damages from the indemnifying party. However, in some case inadvertently, Buyer may miss some steps to claim damages, to cure this a language is generally inserted to waive any of the failure on the part of Buyer.
(G) Jointly or Severally- Often there may be situations, when Sellers are accompanied by scores of its affiliates, which may range from promoter of the Seller to the holding company of the Seller who may make good the losses for damages incurred to the Buyer.
(H) Time Limitations/ Survival clause: The parties will need to agree upon the length of time during which indemnification claims must be raised. The length of time may be different for different items. For example, the time for raising an indemnification claim for breaches of representations and warranties may be two years while claims for fraud may be unlimited as to time. By not specifying a time limitation, the length of time for raising claims will be controlled by the applicable statute of limitations.
Negotiating Indemnity Clause
Some of important and common issues involved in an Indemnity Clause are discussed below:
(A) Seller's indemnification of Buyer for breaches of Reps & Warranties
- By far the most common matter with respect to which indemnities are given by the Sellers to the Buyers.
- From Buyer's perspective it would be helpful to state clearly from when does the duty to indemnify arises- signing or closing under the Merger Agreement, in my view the earlier the better.
- From the Seller's perspective, it would be better to fully disclose its liabilities and potential liabilities/ risk factors to the Buyer during the due-diligence process so that a milder Reps & Warranties clause may be drafted in Seller's favor. Typically, an anti-sandbagging provision is inserted in such cases, limiting the liabilities of a Seller.
(B) Buyer's indemnification of Seller for breaches of Reps & Warranties
- This is largely used as a matter of reciprocity.
- In a typical Merger Agreement, Buyer may be liable to indemnify/ make good the losses incurred by the Seller acting on the representations of the Buyer.
(C) Buyer's post-closing activities
- In a Merger Agreement, indemnification is generally drafted as a post-closing matter, with the parties tacitly agreeing to leave the resolution of pre-closing breach of contract claims in the event the deal does not close, and the appropriate measure of the damages, to a court of competent jurisdiction.
- From Buyer's perspective it is important to draft this provision carefully, as Buyers would not like to the burdened by Seller's activities pre-signing or pre-closing.
(D) Third Party Claims
- From the Buyer's perspective, it would be prudent to ask for Seller's indemnity for third-party claims in cases where the root cause of the third-party rights/ claims arises from factor existing pre-closing of the Merger Agreement.
- Depending on whats the importance of this clause of the Seller, Seller's counsel may draft for no liability for Seller's in a case of third-party claims.
(E) Escrow
- Along side of a Merger Agreement, typically an escrow agreement (Escrow Agreement) is also executed between a Buyer and a Seller.
- Under the terms of Escrow Agreement, typically an amount of upto 10-15% of the deal size is deposited with a third-party, which is typically a financial institution who keeps the money for the benefit of Buyer is case liability for any breach by Sellers arises.
- Time period of such an escrow is generally 12 or 18 months depending upon how the Escrow Agreement and Merger Agreement is negotiated by the parties.
(F) Non-reliance clause
- A typical ‘non-reliance’ clause is intended to limit a Buyer's ability to make a Rule 10b-5 claim by prohibiting the buyer's reliance on information not explicitly included or incorporated in the purchase agreement itself.
- Seller should consider requesting non-reliance clause under the Merger Agreement.
(G) Illegality committed by the indemnifying party
In most of the jurisdictions there are strict anti-bribery laws, however, they are not strictly followed. Often these days some of the private equity investors insist on inserting a provision as to indemnification if any bribery is committed or proved.
(H) Payment on Indemnification
Many times, the question of when an actual indemnification will occur is not clearly addressed in the Merger Agreement. Not addressing this issue may not be a bad idea for the Seller. However, the Buyer should require that indemnification occur within some established time period, such as within 30 days of notice to the Seller of any claim, expense or obligation incurred by the buyer.
In addition to above, subject to negotiations between the parties certain specific Indemnity Clauses like Director's liability, insurance claims, third-party environmental damages claims, materiality qualifiers, major litigation crossing certain threshold amount may be inserted in a Merger Agreement.
