indemnities

What are Indemnities?

What are Indemnities in M&A?

Indemnities are contractual protections used in mergers and acquisitions (M&A) to allocate specific risks between the buyer and seller. They are designed to ensure that one party compensates the other if a defined liability or loss arises after the deal completes.

In practice, indemnities help buyers avoid inheriting unexpected costs linked to known risks identified during due diligence. They are commonly included in share purchase agreements (SPAs) and asset purchase agreements (APAs).

How do indemnities work?

An indemnity is a promise by one party, usually the seller, to reimburse the buyer if a particular issue causes financial loss after completion.

For example, if the target company is under investigation by a tax authority before the sale and the buyer later receives a tax demand relating to that period, a tax indemnity may require the seller to cover the cost.

Unlike broader contractual protections, indemnities are usually linked to clearly identified risks rather than general business conditions.

Why are indemnities important?

M&A transactions often involve uncertainty. Buyers may uncover issues during due diligence that cannot be fully resolved before signing or completion.

Indemnities help deals move forward by clearly defining who carries responsibility for those risks.

They are particularly useful when dealing with:

  • Ongoing litigation
  • Tax disputes
  • Environmental liabilities
  • Regulatory investigations
  • Pension obligations
  • Data protection breaches

Without indemnities, buyers may seek to reduce the purchase price significantly or delay the transaction entirely.

Common types of indemnities

Type of indemnity

What it covers

Tax indemnity

Historic tax liabilities or ongoing tax investigations

Litigation indemnity

Existing or threatened legal claims

Environmental indemnity

Contamination or remediation costs

Regulatory indemnity

Fines or compliance breaches

Employment indemnity

Employee claims, pensions or redundancy liabilities

Data protection indemnity

GDPR breaches or cybersecurity incidents

These clauses are usually negotiated carefully because they can create significant financial exposure for the seller.

Indemnities vs warranties

Indemnities are often confused with warranties, but they serve different purposes.

Indemnities

Warranties

Cover specific identified risks

Cover broader statements about the business

Usually provide direct reimbursement

Often require proof of loss

Focus on known issues

Focus on the overall condition of the company

More targeted and specific

Broader disclosure mechanism

For example, a warranty may state that the company complies with all applicable laws. An indemnity, however, may specifically cover an identified regulatory investigation already known to the parties.

How due diligence affects indemnities

Due diligence plays a major role in indemnity negotiations. Risks identified during financial, legal or operational reviews often become the subject of indemnity clauses.

  • For buyers, this helps reduce exposure to issues discovered before completion
  • For sellers, it creates an opportunity to disclose problems openly and negotiate limits on liability.

This is why maintaining accurate records throughout the due diligence process is important. A virtual data room (VDR) helps companies organise disclosures and collate evidence of what information was shared during negotiations.

The audit trail inside a VDR can become important later if disputes arise over whether a buyer was aware of a risk before the transaction was completed.

What sellers try to limit

Sellers usually seek to narrow the scope of indemnities because they can create long-term liability after the deal closes.

Common negotiation points include:

  • Financial caps on liability
  • Time limits for claims
  • Narrow definitions of covered risks
  • Restrictions on double recovery
  • Specific claim notification procedures

The balance of negotiating power often determines how broad or restrictive indemnities become.

Risks of poorly drafted indemnities

Unclear indemnity clauses can create disputes after completion. If the wording is vague, the parties may disagree about:

  • Whether a loss is covered
  • How losses should be calculated
  • When claims can be made
  • Which party is responsible