By Erwin G. Krasnow, Esq., Garvey Schubert Barer
Hidden away at the back of most broadcast purchase agreements will be a provision labeled “Indemnification” requiring the seller and the buyer to “indemnify” and hold each other “harmless” from all or some part of the expenses and damages sustained after the closing. As my brother-in-the-law John Pelkey observed: “The placement of the indemnification provision toward the end of the agreement belies its importance, however. If a purchase agreement does not include an indemnification provision, a party seeking damages because of a post-closing breach by the other party to the agreement might find that it has no alternative but to file suit and argue its entitlement to damages under general legal principles that may be ill-suited to the transaction.” See John M. Pelkey, “Indemnification: A Useful Tool,” RBR/TVBR, January 12, 2012. John wisely suggests that the better approach for both the seller and the buyer is to include in the purchase agreement an indemnification provision that sets forth the rights and the liabilities in the event of a breach by one of the parties.
The indemnification section of a purchase agreement is particularly important to the buyer of a broadcast station because of the extensive nature of the seller’s representations, warranties and covenants. An indemnification provision typically requires the seller (and sometimes, its shareholders and principals) to indemnify the buyer not only for breaches of warranties, representations and covenants but also for other kinds of claims (such as tax or environmental liabilities) that may occur after the closing but were not assumed by the buyer. Also, the indemnification section creates liability for the seller after the date of the closing even for matters that the seller had no knowledge of before the closing. For example, a typical indemnification clause may require the seller to indemnify the buyer from any post-closing claim resulting from a pre-closing “act, omission or event.”
While the phrase “indemnification” usually elicits an eyes-glazed-over response, buyers and sellers of broadcast stations would be well-advised to be familiar with the legal jargon used in indemnification and hold harmless provisions as well as some of the nuances of the ways that both sides attempt to transfer the risk of post-closing damages to the other party. The old adage “ignorance is bliss” does not apply here. The goal of this article is to provide a checklist and overview of the noteworthy issues that buyers and sellers should consider in negotiating indemnification provisions that serve to keep them out of harm’s way after the closing.
Deductibles and Caps. Purchase agreements typically contain dollar limitations on the amounts each party is legally entitled to collect. In negotiating indemnification provisions, the seller will try to get a “cap” or maximum amount that it may have to pay to indemnify the buyer. That amount is often heavily negotiable. It is not unusual, however, for the cap to be an amount equal to the total purchase price. See Erwin G. Krasnow, “Damage Control for Post-Closing Damages,” RBR/TVBR, November 23, 2010.
Sellers often negotiate for a safety net, or “basket,” which is a minimum amount of loss that the indemnified party must exceed before the obligation of the “indemnitor” (the party who is obligated to indemnify the other party against the loss or damage) becomes effective – it is, in effect, a deductible. One of the purposes of such a threshold deductible is to avoid disputes over insignificant amounts of money. The amount of the basket usually depends on the size of the transaction – the larger the purchase price, the more likely the basket will be greater.
The basket is sometimes structured as a threshold so that once the agreed-upon amount is reached, the indemnifying party is liable for the total amount of losses. Once the “threshold” deductible is crossed, the indemnifying party is entitled to cover all damages rather than just the losses that exceed the amount of the basket. Sellers prefer a true deductible — once the agreed-upon amount is reached, the indemnifying party is only liable for the amount of the losses in excess of the agreed amount.
Survivability of the Indemnity. Most broadcast station purchase documents provide that representations and warranties, and the rights to indemnification for breaches thereof, remain in effect (or “survive”) only for some specified period of time. Survival in the context of acquisition agreements may be viewed as a matter of life and death, namely, the life and death of the obligations of the parties once the transaction is closed. In theory, the time specified should be intended to give sufficient time, post-closing, to determine the veracity of the representations and warranties. There is a tension between buyers and sellers on the length of time within which the buyer must advise the seller of any potential claims it may assert. The seller, of course, wants the obligation to expire as soon as possible. Indeed, where sellers have very substantial leverage, sellers try to negotiate for a sales agreement which provides that the representations and warranties do not survive the closing or survive for a period of three months. In advocating a short survival period, sellers will contend that a buyer should be able to discover any problems within a limited time. By contrast, given their druthers, buyers want the representations and warranties to survive forever. The usual survival period specified in broadcast station contracts is one year. Buyers, however, often negotiate to expand the survival period for certain representations and warranties, such as tax, employee benefits, title to property and environmental matters. See Erwin G. Krasnow, “Post-Survival Strategies,” RBR/TVBR. November 8, 2011.
Cashing In on the Indemnity. An indemnification is worth only as much as the indemnitor. A major concern of the buyer is how to collect monies from the seller for post-closing breaches. See Erwin G. Krasnow, “A Guaranteed Way to Collect Post-Closing Damages,” RBR/TVBR, January 17, 2011.This concern takes on increasing importance where the seller plans to dissolve its business entity at, or shortly after, the closing. If the seller plan to dissolve or disband after the closing, the buyer will usually insist on special arrangements concerning who shall be responsible for indemnification (e.g., the major stockholders or the principals of the seller).
Also, the buyer often tries to secure the seller’s indemnification obligations by requiring the seller to place in an escrow account a portion of the purchase price. Of course, sellers are reluctant to agree to any arrangement which would deprive it of the immediate use of the sale proceeds. Other sources of monies to fund post-closing damages are the accounts receivable collected by the buyers on the seller’s behalf and payments made pursuant to the terms of a promissory note or a covenant not to compete. With respect to the foregoing sources of funds, buyers often negotiate for the inclusion of a provision in the purchase agreement that entitles them to set-off rights or a “right of an offset.” If the buyer has the right of set-off and believes that it has a claim for indemnification, it can withhold payment until the matter is settled. Such a mechanism gives the buyer much more leverage in the event of potential indemnity claims. It would behoove the seller to makes sure that the purchase agreement clarifies and limits the boundaries to any right to set-off.
Other approaches to making sure that funds are available for the payment of post-closing damages require the seller to retain a pool of money to fund its post-closing indemnification obligations or to maintain a minimum amount of assets net of liabilities.
Erwin G. Krasnow, the co-chair of the Communications Group of Garvey Schubert Barer, is a former General Counsel of the National Association of Broadcasters, Washington counsel to the Media Financial Management Association, and a coauthor of Profitably Buying and Selling Broadcast Stations and Washington counsel to the Media Financial Management Association. He concentrates on transactional matters and has represented sellers and buyers of broadcasting, cable, tower and telecommunications properties in transactions totaling in excess of $21 billion. He can be reached at [email protected] and (202) 298-2161.
