In share purchase agreements (SPAs), it is common for buyers and sellers to face risks or contingencies revealed during the legal due diligence process. A key legal tool to manage such risks is the so-called specific indemnity.
What are specific indemnities?
Specific indemnities are commitments by the seller to indemnify the buyer against particular risks identified before signing the SPA. Unlike general representations and warranties, generally included in an SPA, specific indemnities aim to cover pre-identified situations that could cause financial losses to the buyer in the future.
For instance, if due diligence reveals an ongoing tax inspection or a potential lawsuit arising from a labour claim, the seller may agree to cover any financial consequences if these risks manifest after the closing.
Why are specific indemnities important?
Specific indemnities protect the buyer against identified risks, preventing the need to renegotiate the purchase price or, in the worst case, walk away from the deal. For the seller, it may be preferable to accept a future indemnity obligation — only if the risk materialises — rather than losing value upfront in the purchase price.
Moreover, unlike the general liability regime for breaches of warranties, usually subject to time and monetary limits, specific indemnities are often not restricted by such limitations, thereby granting the buyer greater protection.
Properly negotiating a specific indemnity is key to avoiding future disputes. The buyer should ensure that:
- The risk is clearly identified: The covered contingency must be precisely defined (e.g., Tax audit file no. XXX).
- Indemnifiable damages are defined: The SPA should clarify how to calculate damages if the risk materialises. This approach proves particularly useful when the contingency has not yet triggered actual expenses, but its economic impact is already quantifiable.
- Claims may be made without prior payment: In some cases, the buyer can claim indemnification once the damage is quantifiable, even if not yet paid.
The seller, on the other hand, will try to limit the scope of these clauses by excluding some consequences, restricting their duration, or setting an indemnity cap.
What risks are usually covered by specific indemnities?
These clauses typically address contingencies identified during the due diligence process that parties cannot easily transfer to a W&I insurance policy or that the policy excludes from its coverage. Common examples include:
- Ongoing tax audits
- Pending or threatened litigation
- Identified environmental issues
- Known labour or union conflicts
What happens if the parties do not agree on specific indemnities?
If the SPA does not include a specific indemnity for a known contingency, the buyer may face challenges when claiming damages. This situation becomes more complicated if the SPA includes an anti-sandbagging clause that prevents the buyer from making claims about issues already known before the signature.
By contrast, if a specific indemnity is in place, it is sufficient to prove the damage and its connection to the covered risk, without having to prove a breach by the seller.
Conclusion
Specific indemnities are crucial to protecting buyers from known risks, ensuring the successful closing of M&A deals. Properly negotiating these clauses, with the support of experienced legal advisors, can make the difference between a safe transaction and a post-closing dispute.
If you are thinking about buying or selling a company, seeking legal advice for drafting and negotiating the SPA is essential to protect your interests. At Mariscal Abogados, we help you identify relevant risks and reflect them correctly in the contract to avoid unpleasant surprises in the future.
