Where there is a R&W (see previous post), there is Indemnity.
First a few quick definitions:
Party giving indemnity = Indemnifying Party (using interchangeably with founders / company)
Party getting indemnity = Indemnified Party (using interchangeably with Investor)
Indemnity event = Breach of agreement + R&W being untrue / incorrect + (other items subject to negotiation)
A. What is Indemnity?
- Indemnity is a “financial” liability on the Founder
- Investor can make a claim (i.e. recover a loss if any) on Founder/ Company for any direct “loss” due to Indemnity Events
B. When does Indemnity crystallize?
- The liability crystallizes on founder/company when the Investor can prove they have suffered a loss
- TIP: Onus of proving loss is on Investor
C. Do you always need to pay in an Indemnity Event?
- No, there are elaborate dispute resolution mechanisms in def docs which you can resort to if such a situation arises
- TIP: choose jurisdiction carefully (hint: cost of dispute resolution)
D. Is there any monetary cap on this liability?
- Yes & No
- In most cases, fundamental warranties (e.g. title) are uncapped and business R&Ws are capped at 30–50% of consideration / investment amount
- TIP: negotiate fundamental warranties carefully
E. Are you exposed to this liability forever?
- Well, it depends on your negotiation
- Typically, a time limitation of 3–5 years is negotiated between the parties
- TIP: you could keep Tax-related indemnity limited to statutory period (typically 7 years in India)
F. What if you’ve disclosed certain event already to Investor?
- You can negotiate for “no” indemnity against disclosed items / diligence findings
- However, Investor may ask for “Specific Indemnity” for known events also where they perceive high risk (in the end, it will ultimately test your negotiation skills)
- TIP: Spend time to prepare a detailed disclosure letter
G. If you have co-founders, what is our respective liability?
- “Joint” v/s “Several” vs “Joint & Several” — This article explains it really well — https://www.lexology.com/library/detail.aspx?g=06dd2d6e-710b-43ca-9ec4-19a132a411af
H. How can you preempt any issues in future, when you’re just starting up?
- Be serious about compliances from Day 1. Get a strong support for compliances
- Do annual audit of compliances and continue to clean-up non-compliances on an ongoing basis
Simple enough to read / re-read your def docs? Feel free to connect for any questions. Happy negotiating.
