The Webinar Review

Warranties and Indemnities in M&A Transactions

Webinar – 4 July 2022 @ 1 pm IST
M&A Masters Series 2022

Background
Warranties and indemnities are essential aspects of all M&A transactions and are used as risk-allocation and
risk-mitigation tools. While a buyer conducts its due diligence prior to the transaction, diligence does not
provide the buyer with absolute certainty. Hence, the seller provides comfort to the buyer by providing certain
representations, warranties, and indemnity protections in relation to the transaction.

It is important to balance the varied interests of the parties during the negotiation of warranties and indemnities.
For this reason, the objective of the webinar was to provide an analysis of the underlying concepts behind
warranties and indemnities from both the sell-side and buy-side perspectives.

Definition
Representations and warranties are an assertion of facts and are used as risk allocation tools. Both these terms
are often used interchangeably. However, there is a thin line of difference between the two. Representations
are made to induce the parties to enter into the contract, and warranties are collateral to the main purpose of
the contract. The other significant difference is the type of remedy that can be claimed in case of breach. In
case of a misrepresentation, compensation can be claimed and the contract itself can be held void. However,
in case of a breach of warranty, the contract cannot be held void and only compensation can be claimed.

Types of Warranties
Fundamental Warranties

These warranties are fundamental to transaction and largely relate to authority and capacity of parties and title
to relevant assets. They are are seen in almost all types of transactions and are usually structured similarly for
both the buyer and the seller.

Business Warranties

These warranties are specific to the business of the seller / company, and include warranties in relation to the
financial statements (assets, liabilities, & profits), contracts, employees, insurance, property, regulatory and
other aspects of the business.

Tax Warranties

These warranties are specific to the present or past tax liabilities of the seller / company, or tax liabilities relating
to the transaction.

Warranty on sufficiency of funds

This warranty is provided by the buyer to give assurance to the seller that it has sufficient available funds to
pay the requisite consideration.

Limitations to Warranties
While buyers try and keep the warranties broad, sellers commonly use the following techniques to limit the
scope of their warranties:
 Time limitations: To provide a look-back period for the warranties;

 Materiality thresholds: To narrow the scope of the warranties and avoid giving any warranty for
insignificant aspects;

 ‘Material adverse change’: To provide objectivity to the materiality threshold. This typically includes a
decrease in the revenue of the company by a certain percentage as compared to the previous year;

 Knowledge qualifiers: To limit the warranties to the extent of the knowledge of the seller / specific
individuals or designations as identified by the seller; and

 Exception of ‘ordinary course of business’: To exclude warranties in relation to events that are
consistent with the past practice of the seller / company.

Disclosures
Warranties generally have corresponding disclosures, which serve as exceptions to the warranties. Disclosures
can be generally provided against all warranties; for example, disclosure of accounts of the company; charter
documents of the company; and documents / information contained in the data room.

Disclosures can also be provided specifically against particular warranties; for example, if a warranty states
that ‘there is no pending litigation against the seller / company’, the warrantor can make a corresponding
disclosure against this warranty providing specific details of all the pending litigation against the seller /
company.

The timing of disclosures directly corresponds to the time the warranties are given. Typically, warranties and
disclosures are provided at the time of signing of the definitive documents and at the time of closing of the
transaction. The disclosures provided at the time of closing of the transaction are termed as ‘updated
disclosures’ and generally relate to events that occur between the date of signing of the definitive documents
and the date of closing of the transaction.

Indemnity
Key Aspects

Indemnity is a contractual commitment by a party to save the other party from specific losses relating to the
transaction. Key aspects of indemnity provisions are:

 Indemnifying party: Typically, in a sale agreement, the sellers are the indemnifying parties and in a
subscription agreement, the company and/or the promoters are the indemnifying parties. If there are two
or more indemnifying parties, the buyer would prefer to get a ‘joint and several’ indemnity obligation, such
that it can pick and choose which party to bring a claim against. On the other hand, a seller would prefer
to keep liability several and limit the liability to its own obligation.

 Indemnified party: A seller generally endeavours to limit the obligation to indemnify to the buyer only .
However, the buyer will prefer to broaden the scope and cover the buyer, its affiliates, directors,
employees, officers and agents.

 Loss: Typically, the underlying agreement provides for an exhaustive definition of ‘loss’. The indemnified
party endeavours to include all types of losses, damages, liabilities, costs, and expenses. On the other
hand, the indemnifying party seeks to limit the scope of indemnity by excluding inter alia indirect,
consequential, or remote losses.

 Trigger event: Generally, indemnity events include breach of representations and warranties, breach of
covenants, fraud, and specific indemnity events.

Limitation of liability

The indemnifying party generally restricts its indemnity obligations by including certain limitations,
qualifications, and exceptions, including the following:

 Monetary limits: A de-minimis threshold is used to specify the minimum amount of loss that is required to
be suffered for such loss to qualify for indemnity. Further, an indemnity basket concept can be used to
pool together all losses which cross the de-minimis threshold. Once such losses meet the basket threshold,
 an indemnity claim can be made. An overall indemnity cap can also be put in place to ensure that no
indemnity payment is required to be made for any amount exceeding such cap.

 Time limits: Indemnity provisions can be limited by restricting the time during which a claim can be made.
Different time limitations are generally negotiated for different indemnity triggers depending on the risk
perception of the parties.

 Other limitations: There are certain other types of limitations and qualifications to indemnity obligations,
such as: no double recovery for the same loss and the duty of the indemnified party to mitigate loss or
prevent incremental loss due to actions or omissions attributable to such indemnified party.

Credit Risk Mitigation Tools

The indemnified party commonly uses credit risk mitigation tools to ensure that at the time of raising the
indemnity claim, the indemnifying party has the capacity to fulfil its indemnity obligation. These tools include
the following:

Tranched structure

The acquisition of a consolidated stake can be executed in multiple tranches. If an indemnity claim arises, it
can be adjusted against the amount payable for the next tranche.

Deferred consideration

In this structure, the stake is bought in one transaction and a part of the consideration is held back as deferred
consideration. Any indemnity claim can be adjusted against this heldback amount.

Escrow

In this structure, a part of the consideration is held in an escrow account. Any indemnity claim can be adjusted
against the amount in the escrow account.

Warranty and indemnity (W&I) insurance

While this is a relatively new concept, it is gaining significance and is used to reduce reliance on the sellers for
indemnity pay-outs. We have delved deep into this concept in another webinar, available at
https://www.youtube.com/watch?v=KGnOyEGz7J4.

Key Takeaways
 Representations and warranties provide assurance on the status of a party’s affairs; and indemnity provides
protection to the buyer from certain losses.

 For a buyer, it becomes important to have a robust set of warranties and adequate indemnity protection. On
the other hand, for the seller it is equally important to qualify the warranties and limit the indemnity obligations.
Disclosures, limitations, and exceptions play a key role in limiting such obligations.

 In all these negotiations, corporate lawyers play a key balancing role and advise the clients on how to get the
M&A deal done most effectively and efficiently.

Contact Partners

Sameer Sah Vidushi Gupta

Khaitan & Co Khaitan & Co
T: +91 33 2248 7000 T: +91 22 6636 5000
E: sameer.sah@khaitanco.com E: vidushi.gupta@khaitanco.com