How Purchasers and Guarantors May Transfer Risk with an Indemnity Agreement

Kim Alexander, Counsel

As a purchaser or a loan guarantor, you may be faced with the challenge of how to protect yourself against real risks while achieving your ultimate goal of consummating a purchase or loan. One way to transfer some of those risks as a purchaser is to require your seller or the seller’s principals to enter into an indemnity agreement and another way to spread your exposure if you are guaranteeing a loan is to insist that the borrower’s other members indemnify you with respect to your loan obligations.

Keep in mind, however, that an indemnity agreement is only as strong as the party backing it. So, it may not have much weight if the indemnity is executed by an entity which now or in the future many not have any significant assets. It may be more comforting if, in addition to the entity involved in the transaction, an individual stands behind the indemnity. But, even with an individual, you must have done your diligence and be confident that the individual indemnitor currently has and in the future will maintain sufficient net worth to cover the risks.

Once you are comfortable with the indemnitor, then you must consider what the indemnity should cover. That really depends on the nature of the transaction and your specific areas of concern. A few scenarios are discussed below.

For example, if your entity is a borrower and you, as a member of that borrower, are personally guaranteeing a loan or are indemnifying your lender against environmental exposure, you may be concerned that you bear a disproportionate amount of the loan’s risks. As such, you should consider requiring the other members of the borrowing entity to personally indemnify you with respect to their pro rata share (based on their percentage of membership interest) of your losses. In the event your lender takes action again you, then you can seek reimbursement under the indemnity agreement from the individual indemnitors to reduce your losses.

If you are a purchaser, then another scenario may involve your acquisition of a property that is part of a larger parent parcel. If it is unclear whether certain obligations are to affect the parent parcel or the parcel that you are to acquire and you are unwilling to undertake those obligations, then you may want to consider requiring an indemnity from your seller. You may decrease your risks by requiring the seller and an individual member of the seller entity to not only perform all such obligations, but to also indemnify and hold you harmless from any and all liabilities, losses, costs, damages, judgments, claims and expenses (including, without limitation, reasonable attorneys’ fees and disbursements) that you may suffer or incur by reason of their failure to comply with those obligations.

Even if your seller is willing to agree to these terms, the seller may insist on being released upon a subsequent sale of the parent parcel. If acceptable to you, said release should be forward looking. In other words, your release of the seller should be limited to those obligations required to be observed by the seller from and after the date of such transfer (not with respect to obligations to be performed prior to the transfer). Also, the release should be conditioned upon the delivery to you of an original duly executed assignment and assumption agreement confirming that the subsequent owner of the parent parcel has assumed the obligations of the indemnity agreement in a form of which is acceptable to you. You may also want to go one step further and require that the deed conveying the parent parcel expressly refer to the indemnity obligations to the effect that the subsequent owner of the parent parcel is bound by the deed to comply with the terms of the indemnity agreement. Keep in mind, however, that you have no rights to vet the subsequent indemnitor or to require a personal indemnitor in this scenario.

If you believe that an indemnity agreement may be too formal of an approach, then, if you are a purchaser, think about incorporating the indemnity concept into the contract of sale. But, remember that any indemnity concept included in a contract of sale must survive the closing (ideally forever) and should be backstopped by an individual. Include a signature block for the individual indemnitor party at the end of the contract of sale so that you are not left with an indemnifying seller entity which may no longer have any assets after the sale.

Also, keep the following in mind when drafting your indemnity agreement:

It should include joint and several liability language if the indemnitor consists of more than one party and should also include a clause for prevailing party fees and expenses. In addition, if the indemnity relates to recorded documents, then make certain that the indemnity itself is in recordable form and require the indemnity to be recorded against the affected block and lots. And, don’t forget a basic notice provision so that there is no ambiguity as to how and to whom notices are to be sent.

Remember that the indemnity must also address what happens in the event of your indemnitors’ failure to perform. Provide yourself with self-help rights in such events and require indemnitors to pay you for any sums that are due and owing pursuant to the indemnity (including, but not limited to, any sums that are due and owing with respect to your exercise of self-help rights). If such sums are not paid within a short grace period, then said sums shall bear interest at a default rate (not to exceed the maximum amount permitted by applicable law) computed from the date of demand until the day that you receive payment.

While you are exposed to risks when acquiring property or obtaining a loan, one effective way for you to spread that exposure may be to require an indemnity agreement. Require other members of the borrower to indemnify you, as the guarantor, in the event your lender takes action against you and require your seller and an individual member of the seller entity to indemnify you, as purchaser, with respect to any obligations that you are unwilling to assume.

The opinions expressed in this blog are not intended to create an attorney-client relationship and do not constitute legal advice. Neither the transmission of the information contained within this blog nor the use of the information or communication with A.Y. Strauss LLC creates an attorney-client relationship with A.Y. Strauss LLC.