M&A Vocabulary – Experts explain: Hold Harmless Clause

Practically every M&A transaction is based on a due diligence examination of the target company in order to identify any potentially existing risks.  

Whilst operational or economic risks are usually secured via purchase price clauses (e.g. via a purchase price reduction or an earnout mechanism), the general situation of a target company in terms of its compliance with relevant legal and tax requirements is secured by reps & warranties made by the seller.

However, the protection derived from these declarations of the seller is usually limited by the buyer’s knowledge of certain facts and by disclosures, i.e. the warranties do not apply to any facts disclosed by the seller to a reasonable extent during a due diligence examination (fair disclosure). If the buyer as part of his examination of the target company or possibly from a disclosure letter provided by the seller learns of any facts that are indicative of any violation of applicable regulations or, at least, based on which a risk of non-compliance by the target company cannot be excluded, the seller’s liability based on his warranties will be excluded in respect of these facts. 

So, for the buyer to avoid “getting stuck” with these actually identified risks and not to discharge the seller from liability also in respect of these facts it is necessary to include a hold harmless clause in the contract. This contractual arrangement (also called indemnity clause) obliges the seller to hold the buyer harmless in respect of any and all detriments that might arise from the respective set of facts. There is no equivalent to the commonly used German phrase “schad- und klaglos halten“ in English terminology. 

When a hold harmless clause is agreed on, care should be taken not to draft it too generally or too broadly. Apart from the seller’s reasonable interest in limiting its liability specifically to the risk identified by the buyer, a clause drafted too broadly may rise doubts as to its validity. 

Last but not least, a hold harmless clause may be applied also in the opposite case: If the seller discloses a fact that involves a risk but nothing can be done to change or minimise this risk, the seller might request the buyer to agree on a hold harmless clause – if he deems the limitation of his liability only on the basis of fair disclosures as not sufficient.  

In practice, this refers in particular to risks that may be significant as regards their potential consequences, but are rather of a theoretical nature or very unlikely to materialize. They include e.g. uncertainties surrounding the establishment of the target company, which may have happened years ago and which can no longer be cured due to their formal nature but, if verified by an administrative organ or by court, may possibly result in the invalidation of the company formation or lead to a deregistration of the company. If there is no indication for any imminent or pending official or court verification, but the parties wish to implement the transaction, the seller, so as to avoid any significant liability risk regarding that specific issue, may insist on the buyer practically waiving any claims against the seller by agreeing on a hold harmless clause in this respect. 

 

 Given the disclosure obligations or publication requirements in regard to the transaction documentation that the seller might possibly be subject to, it is up to the parties whether they want to explicitly include in the purchase agreement any facts or information concerning such significant yet so far unknown risks with respect to which the buyer waived his potential claims.