Take care with indemnities

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A potential buyer of a business or company usually carries out an investigation into the target before buying. If the buyer’s due diligence reveals something unsatisfactory about the target, the buyer may insist on an indemnity from the seller to cover the relevant problem. Under the indemnity, the seller will agree to pay to the buyer all costs that arise in connection with the problem. The purpose of the indemnity is to ensure that as between the buyer and the seller ultimate financial responsibility for the issue stays with the seller.

A recent case shows the importance of precise drafting of such an indemnity. In Wood v Sureterm Direct Ltd & Capita Insurance Services Ltd, the Court of Appeal considered a dispute arising from the following outline facts. The buyer bought all the shares in Sureterm Direct Ltd (the target). The target was an insurance broker selling insurance policies. In the contract for the purchase of the shares (the SPA) the sellers agreed to give an indemnity to the buyer to cover claims or complaints relating to any mis-selling of insurance products before the buyer became the owner.

After the sale, the target itself identified some potential mis-selling. It was obliged to report this to the Financial Services Authority (FSA) and did so. The FSA decided that customers had not been treated fairly. Eventually, this led to the payment of compensation by the target. The cost of this exercise was well over £1 million. The buyer tried to recover these costs under the indemnity.

The Court of Appeal held that the indemnity did not cover the relevant costs. The indemnity referred to payments made following claims or complaints registered with the FSA. On a precise reading of the indemnity, this did not cover the payments made by the target because no claims had been made against the target – the losses arose out of the self-reported facts identified by the target itself.

The Court’s decision depended, of course, upon the specific words used in the SPA. Nevertheless, as a general point it is clear that when a buyer is negotiating the terms of an indemnity in a share purchase agreement, it is vitally important that the buyer checks that the wording clearly covers all the potential problems that need to be covered by the indemnity.

Clare Richards is a solicitor in the Business Services team

If you need advice, the friendly and experienced solicitors at Barker Gotelee are on hand to help. Call the team on 01473 611211 or email bg@barkergotelee.co.uk