December 20, 2019

M&A Indemnity: Does Your Clause Cover Direct Claims?

Does a clause that purports to indemnify a party for losses sustained due to the other party’s breach of reps, warranties or covenants in the agreement cover direct claims as well as those brought by a third party?  According to this recent Weil blog, it might not:

The dictionary definition of “indemnify” includes both “secur[ing] against hurt, loss, or damages,” as well as “compensat[ing] for incurred hurt, loss, or damage.” Nonetheless, cases across the country have suggested that there is a presumption that the term “indemnify” only applies to losses arising from third party claims, not losses incurred directly by a party as a result of a counterparty’s default under a contract. While most of these cases do not involve the indemnification provisions contained in private company acquisition agreements, and are focused on whether the indemnification provision allows recovery for attorneys’ fees related to direct claims between the parties, it is not clear that they can be completely discounted on that basis.

To overcome the general presumption that an indemnification provision only covers third party claims, it is important to state in clear and unequivocal terms that the indemnification provision applies to both direct and third party claims. Language that simply provides that the breaching party shall indemnify the non-breaching party for losses sustained by the non-breaching party, as a result of the breaching party’s breach of representations, warranties or covenants set forth in the agreement, may be deemed insufficient to clearly cover first party (or direct) claims, as opposed to be presumed to only apply to third party claims.

The blog then reviews a number of Delaware cases addressing whether indemnification provisions apply to claims brought directly by the party with the right to indemnity against its counterparty. Some of those cases aren’t very reassuring.  The blog goes on to note that most private company acquisition agreements address direct claims specifically and make it clear both direct and third party claims are intended to be covered by the indemnification regime, and use terms concerning the scope of the indemnity obligation that go beyond the “indemnify, defend and hold harmless” formulation that is more traditionally related to third party claims.

However, it ends with a note of caution – the wording of many ancillary agreements isn’t as explicit when it comes to the inclusion of direct actions within the scope of the indemnification provisions, so this remains a live issue in private company M&A.

John Jenkins