Updated November 26, 2020:

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.

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.

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.

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.