Indemnification (M&A)
Indemnification in M&A is the contractual obligation of one party — typically the seller — to compensate the buyer for losses, damages, or liabilities arising from breaches of representations and warranties, covenant violations, or specific identified risks that were known at closing.
Indemnification is the primary remedy mechanism in M&A transactions. While reps and warranties define what the seller is affirming about the business, the indemnification provisions define what happens financially when those affirmations prove incorrect.
Indemnification obligations are bounded by several negotiated limitations. The basket (or deductible) is a threshold below which no indemnification is owed — a seller will not indemnify for small claims that collectively do not exceed, say, 0.5% of deal value. Baskets come in two varieties: a tipping basket means all losses become indemnifiable once the threshold is crossed (including the first dollar), while a true deductible means only losses in excess of the threshold are recoverable. The cap is the maximum aggregate amount the seller must pay in indemnification, typically ranging from 10% to 100% of the purchase price depending on deal type.
Fundamental representations — covering the seller's authority to do the deal, ownership of shares, and capitalization — typically have higher or uncapped indemnification limits and longer survival periods because they go to the core of what the buyer is purchasing. Fraud is also typically excluded from caps.
Specific indemnities are negotiated for known risks that do not fit neatly into the rep and warranty framework: ongoing litigation, environmental liabilities, pre-closing tax periods, or regulatory proceedings. These dollar-for-dollar indemnities often have their own caps and time limits separately negotiated.
In practice, the rise of representations and warranties insurance has shifted how indemnification works. In RWI-backed deals, the insurance policy sits behind a retention (the amount the insured must absorb before the policy pays), and the seller's direct indemnification obligation may be limited to the retention amount or even eliminated for general rep breaches. This structure allows sellers in private equity deals to distribute proceeds to fund investors at closing without holding back reserves for post-closing claims.