Reps, warranties & indemnification — the contract architecture that decides post-close exposure.

Indemnification is the financial enforcement of the seller's representations. The seller makes promises about the business. If a promise turns out to be false, the buyer can claim indemnification — reimbursement for losses. The Cap, Basket, and Survival Period are the three levers that turn this from open-ended exposure into bounded risk. This piece covers the legal-agreement framing; the deeper mechanics live in the R&W framework.

§ 01 · Representations and warrantiesWhat the seller is actually promising.

Representations are factual statements the seller makes about the business, assets, and transaction. Examples: organization and authority, financial-statement accuracy, no undisclosed liabilities, tax compliance, employee matters, insurance and E&O claims history, carrier appointments in good standing, producer agreements, real property and IP ownership, absence of material adverse change.

Each rep is a potential breach point. If a representation proves false post-closing, the buyer can sue for indemnification — the seller must reimburse the buyer for losses arising from the breach.

§ 02 · Materiality qualifiersThe narrow vs. broad battle.

Representations often contain "Materiality" or "Material Adverse Effect" qualifiers that narrow scope. "We have disclosed all material contracts" vs. "we have disclosed all contracts." The materiality version is narrower and gives the seller more protection.

Buyer strategy: push for representations without materiality qualifiers (broader scope, easier to claim breach). Seller strategy: insist on materiality qualifiers; for non-critical reps, define "Material" as exceeding a dollar threshold (e.g., $25,000). The qualifiers determine which small issues can become large indemnification claims.

§ 03 · The three indemnification leversCap, Basket, Survival Period.

Cap — the ceiling of liability. General R&W: typically 10–15% of purchase price (10% acceptable; 15% borderline; 20%+ unfavorable). Fundamental R&W (taxes, ownership, authority): often uncapped or 100% of purchase price. Fraud: always uncapped — never agree to a cap on fraud.

Basket — the deductible. Deductible basket (seller-friendly): seller pays only excess above the threshold. Tipping basket (buyer-friendly): once losses exceed the threshold, seller pays from dollar one. On a $5M deal with a $50K basket, $100K of damages costs the seller $50K under deductible (only the excess) or $100K under tipping (everything back to dollar one). Fight aggressively for deductible. Standard range: 0.5–1.0% of deal value ($25K–$100K for general R&W; smaller or zero for fundamental).

Survival Period — the clock. General R&W: 12–24 months (12 acceptable; 18 borderline). Fundamental R&W: 3–7 years or indefinite for fraud. Tax-related R&W: 3–7 years (must align with IRS statute of limitations). After the survival period expires, no new claims can be filed.

§ 04 · Disclosure SchedulesThe seller's primary shield.

Sellers rarely sign clean representations. Instead, they list exceptions in Disclosure Schedules attached to the APA. Anything disclosed is accepted risk that cannot form the basis of an indemnification claim. The schedules effectively transfer risk to the buyer.

The seller's posture: prepare comprehensive, detailed Disclosure Schedules. List all exceptions, all known issues, all pending matters. A lapsed license in Schedule 3.4 is no longer an indemnifiable surprise — it's a documented condition the buyer accepted. A vague reference ("see attached list") won't suffice; the schedule must be granular and specific.

§ 05 · SandbaggingThe Delaware default and the knowledge waiver.

Sandbagging is when a buyer closes the deal knowing the seller has breached a representation, stays silent, and then sues for indemnification post-close. Most M&A agreements are governed by Delaware law, and Delaware is a pro-sandbagging jurisdiction — unless the contract explicitly states otherwise, a buyer can legally sue for breaches they knew about pre-closing.

The seller's defense is the anti-sandbagging clause: a knowledge waiver requiring the buyer to waive indemnification claims for breaches they (or their agents) had actual knowledge of prior to closing. Negotiations typically focus on the definition of "knowledge." Sellers prefer "constructive knowledge" (what the buyer should have known from diligence). Buyers prefer "actual knowledge" (what they explicitly knew).

§ 06 · Holdback and escrowWhere the indemnification actually gets paid from.

Because indemnification obligations can persist for 12–24 months, buyers demand security. A Holdback (typically 10–15% of purchase price) is retained at closing in a third-party escrow account for the survival period. If no claims are filed, the escrow releases to the seller. If claims are filed, the escrow funds the indemnification.

Holdback impact on seller's net proceeds is real. A 12% holdback on a $5M deal means the seller receives $4.4M at closing, with $600K held for 18 months. Best practices: negotiate lower percentage (10% vs. 12%), shorter duration (12 months vs. 18), partial release mechanisms, and an Exclusive Remedy clause limiting buyer recovery for general-rep breaches to the holdback alone (creating a firewall protecting the seller's other assets).

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