Key Takeaways

  • An indemnification clause in a sale of business contract protects one party from liability for certain post-closing events.
  • These clauses often involve financial responsibility for lawsuits, debts, or misrepresentations.
  • In real estate transactions, indemnification clauses help allocate liability for property-related risks.
  • Indemnification provisions must be precisely drafted and negotiated, with attention to scope, duration, and legal limits.
  • Buyers and sellers must understand the difference between standard indemnification and fraud-related misrepresentation claims.

An indemnification clause sale of business is a contractual clause that is included in a contract regarding the sale of a business. Particularly, when you sell your business, you’ll want to include certain language in the actual contract that will identify the responsibility and obligations of the seller and buyer. For example, each party might agree to hold the other party not responsible; this is referred to as indemnification.

In regard to indemnifying another party, this means that the party being indemnified isn’t responsible for any issues that might arise during the sale of the business.

Post-Closing Liabilities

If one party indemnifies the other with respect to certain matters, and any one of those matters causes some sort of financial loss after the sale has been made and subsequently closed, the party who made the indemnification might be financially liable for the amount of the loss that was incurred. Therefore, it is important to include legal counsel in the drafting of the contract, particularly in such indemnification clauses, so that both parties fully understand the financial risk. While the party being indemnified has no financial risk due to the indemnification, the party offering the indemnification must understand that it could, in fact, become financially responsible if certain matters arise after the close of the sale has been made.

Indemnification Clause Real Estate Applications

In real estate transactions, indemnification clauses are commonly used to protect buyers or sellers from liabilities tied to property ownership or lease agreements. For example, in a commercial lease or sale, the buyer may demand indemnification for any unresolved environmental issues, tax assessments, or tenant claims that arose before the transfer date.

These clauses are especially critical in deals involving older properties, long-standing tenants, or uncertain zoning histories. In these cases, the indemnifying party agrees to cover legal fees, judgments, or settlement costs if problems tied to pre-closing conditions emerge.

In some states, courts enforce indemnification clauses strictly, particularly if the indemnifying party explicitly agrees to cover negligence or breach of duty. However, these clauses may be limited if found to contradict public policy or if they fail to clearly specify the scope of covered liabilities.

What Happens When the Sale is Made

When a business owner sells her business, she makes representations and warranties to the purchaser regarding the business itself. For example, she might represent that there are no pending or outstanding lawsuits against the company. But let’s assume that there is a pending lawsuit outstanding after the business is sold. The purchaser is aware of the pending legal suit but feels comfortable because the seller has included an indemnification clause in the sale contract indicating that the seller will be held financially responsible for the remaining litigation of the lawsuit, along with the financial responsibility that might come with the outcome of the suit. Another example might be if the seller represents that there are no pending lawsuits when in fact there are. Even so, the indemnification clause will protect the buyer in the event that the seller is making a misrepresentation as to the business and such issues.

However, note that if this does occur, the buyer can bring a contract claim against the seller for fraudulent misrepresentation in the contract. Therefore, the buyer will need to prove the elements of a fraudulent misrepresentation, which include:

  1. The seller made a fraudulent misrepresentation or omission.
  2. The statement was material.
  3. The buyer relied on the statement, and the reliance was justified.
  4. The buyer wouldn’t have gone through with the deal had he known the truth.

Therefore, even an indemnification clause will not suffice if the seller makes an actual misrepresentation. Therefore, after the deal closes, if the buyer is now left to defend the lawsuit, even though the seller will take care of the financial responsibilities, this could affect the buyer’s ability to retain clients and expand the business itself.

Limitations and Exceptions to Indemnification

While indemnification clauses offer significant protection, there are limits to their enforceability. Courts may refuse to uphold overly broad indemnity agreements, especially those that seek to indemnify a party for intentional misconduct or fraud.

Moreover, many indemnification clauses include exceptions for:

  • Gross negligence or willful misconduct
  • Claims resulting from the indemnitee’s breach of contract
  • Statutory liabilities that cannot be waived

To address these risks, agreements often include "carve-outs" that specify where indemnity does or does not apply. Additionally, time-based limitations (e.g., survival periods) may restrict how long a party can bring indemnity claims post-closing.

Negotiating the Indemnification Clause

As previously noted, when a business owner wishes to sell her business to a prospective buyer, they should both retain legal counsel to assist in the sale and drafting of the sale contract. When it comes to indemnification, there is generally a negotiation phase whereby both parties will sit down with one another, including their attorneys, and discuss the business’s outstanding debts, obligations, and other issues that the buyer might have to deal with after purchasing the business. This is how indemnification clauses are created.

When contingent liabilities exist, the buyer will expect indemnification clauses to protect him or her when purchasing the company outright from the business owner. Therefore, it is important that the seller indemnify the buyer for any outstanding loans, lawsuits, etc. that the business might be currently undergoing or involved in. A buyer should never sign an agreement unless he is fully aware of what he might be financially responsible for after purchasing the business. It is important to ensure that all indemnification clauses are understood by both parties to prevent potential legal issues down the line.

Key Components of a Strong Indemnification Clause

When drafting or reviewing an indemnification clause, it’s essential to consider the following components:

  • Scope of Indemnity: Clearly define the types of claims covered—e.g., third-party lawsuits, regulatory actions, tax liabilities.
  • Cap and Basket Provisions: Set financial limits (cap) on indemnity obligations and minimum claim thresholds (basket) before indemnification kicks in.
  • Notice and Defense Rights: Specify how quickly the indemnifying party must be notified of a claim and who controls the legal defense.
  • Time Limits: Establish a survival period—often 12–24 months—for making indemnity claims, excluding fraud claims, which may survive indefinitely.
  • Dispute Resolution Mechanism: Identify arbitration or court venues to resolve indemnity-related disagreements.

Including these terms enhances the enforceability and predictability of the indemnification provision for both parties.

Frequently Asked Questions

  1. 1. What is an indemnification clause in real estate transactions?
    It’s a contract provision that protects a party (typically the buyer or landlord) from liabilities arising before the transfer of ownership or lease, such as lawsuits, code violations, or hazardous conditions.
  2. 2. Who usually provides indemnification in a business sale?
    Typically, the seller indemnifies the buyer for known and unknown liabilities tied to the business's past operations.
  3. 3. Can indemnification cover fraud or misrepresentation?
    Indemnification clauses cannot shield a party from intentional fraud. If the seller lies or omits material facts, the buyer may sue for fraudulent misrepresentation, regardless of indemnity.
  4. 4. What are survival periods in indemnification clauses?
    A survival period is the timeframe post-closing during which a party can bring an indemnity claim. Some claims—like fraud—may be exempt from these limits.
  5. 5. Is legal advice necessary when drafting an indemnification clause?
    Yes. Given the financial and legal risks involved, both parties should retain legal counsel to draft, review, and negotiate indemnification terms.

If you need help learning more about an indemnification clause in relation to the sale of a business, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.