Time to Play the Blame Game!

Written by James Sanders

Indemnification, limitations on liability and representations 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 controversial 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 would be when you rent a car.  Let’s say you rent the car, decide to play demolition derby and 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 time frame 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 over a key term of the agreement, then the limitation of liability will set a financial starting point for settling the dispute. 

Representations 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, a buyer will typically ask that the seller makes representations and warranties about key aspects of the business (e.g., the seller has paid all of its taxes or its liabilities).  Post-closing, if it turns out these promises are not true, the buyer has an actionable claim to enforce their rights against the seller.  Again, this is overly simplistic, but it gives 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.  Essentially, the parties set the rules for the blame game if something happens.