It’s Time to Play the Blame Game
Indemnification, limitations on liability and reps and warranties. What are these concepts and why are they important? If you have been through a transaction in the past or negotiated a complex agreement, you know that these provisions can sometimes be the most negotiated points. It’s almost like you are playing the blame game before something actually happens.
Below are quick descriptions of each and why they are important:
Indemnification Clause – Put simply, this clause transfers or assigns risks between parties to an agreement. A good example of this would be when you rent a car. Let’s say you rent the car, decide to play demolition derby and you end up hurting someone else or causing damage to another person’s property. When that person sues you and the rental car company, the rental car company points to the indemnification clause and says the defense is on you not them. I know this is overly simple, but it is a way for both parties to define what risks they are willing to take on and not take on in the use of a product or service. In the transaction space, it is typically used to set a timeframe as to when and who is liable for actions against the buyer and seller of acquired assets or company.
Limitation of Liability – This clause defines the amount of liability the parties to an agreement are exposed to in the event of a legal action related to the contract. So, if a dispute arises between the parties because of a key term of the agreement, then the limitation of liability will set a good financial starting point for settling the dispute.
Reps and Warranties – Representations are statements of fact by one or the other party in an agreement. Warranties are promises by one or the other party that the representations are in fact true. So, for example, if you buy a business, you will typically ask that the seller actually owns it (seems silly, but you would be surprised how often it is not the case). The Seller would state this in the Agreement. The Seller would also promise that it is true. If you close on the transaction and then another party provides proof that they in fact owned the business, the Seller has violated its reps and warranties and the Buyer can move into a legal action to enforce their rights against the Seller. Again, this is overly simplistic, but it gives you the basic gist of the importance of this clause.
Bottom Line – These clauses are important because they help to define who is really at fault in a contract dispute prior to an actual dispute and how you will handle its resolution. That way you at least have set the rules for the blame game if something happens.
As always, be sure you are consulting with your professional business advisors before you agree to the terms of these vital agreement clauses.
Helpful Resource Pages
- Knowledge Center (eisneramper.com)
- Trout CPA Blog | Tax & Business-Related Topics
- News & Analysis | Littler Mendelson P.C.
- Insights, Analysis & Perspectives for Your Business | RKL LLP (rklcpa.com)
- NFIB Research: Data and Trends Affecting Small Business Owners | NFIB
- The Tax Warrior Chronicles (taxwarriors.com)
As always, please don’t hesitate to email myself (firstname.lastname@example.org), Andy Miller (email@example.com), Christian Miller (firstname.lastname@example.org), Erik Spurlin (email@example.com) or anyone in our office with questions or comments.