1) M&A Indemnification: Who Should Control 3rd-Party Claims? —By Brandon Vongsawad, Kirkland & Ellis LLP Indemnification. The devil is in the details, capability to defend a claim and fulfill its to defend against the injunction, and the and it is all about control. When a third-party indemnification obligations. In extreme indemnitee cannot rely on the indemnitor to claim arises following the sale of a private situations, the indemnitee may even require adequately protect its interests. company, indemnification may cover the the posting of a bond or escrow of funds related economic losses, but the party for additional comfort. Similarly, indemnitor In consideration of these concerns, the controlling its defense may influence the control provisions often include other ABA Model Stock Purchase Agreement, claim’s ultimate effect on the noncontrolling conditions without which the indemnitor may Second Edition, includes an exception from not assume control (or must relinquish the indemnitor’s right to assume control if party, both economically and otherwise. Some indemnitors may want a contractual control). The conditions for an indemnitor to an indemnitee “determines in good faith right to assume control over the defense of assume and maintain control may include that there is a reasonable probability that a third-party claims, but certain situations (1) confirming that no conflict of interest Third-Party Claim may adversely affect it or may call for an alternative regime in which exists, (2) agreeing to use satisfactory any Related Party other than as a result of the indemnitee maintains control. counsel, (3) providing evidence of financial monetary damages for which it would be capability, and (4) agreeing to provide entitled to relief under this Agreement.” The standard reasoning provides that the indemnification for all resultant losses party paying for the losses should have the (including beyond any indemnification cap). This broad exception gives an indemnitee great flexibility to maintain control over right to control the defense, because it has the greater incentive to be efficient and Even if an indemnitor satisfies the conditions third-party claims. However, many parties financially judicious with the defense. above, conflicting incentives may naturally have moved away from general exceptions Therefore, a commonly agreed-upon arise between indemnitors and indemnitees. in favor of specific, enumerated exceptions indemnification procedure following the sale Indemnitors have the incentive to resolve in which the indemnitor may not assume of a private company allows the indemnitor third-party claims quickly and inexpensively control. Determining an exhaustive list may the right to assume control of the defense. until the liabilities reach the applicable prove challenging, because the exceptions Certain conditions and exceptions typically indemnification cap. This generally aligns will depend on the business, the industry, apply. For example, the indemnitee may with the indemnitee’s incentive to preserve and a variety of other circumstance-specific require evidence of the indemnitor’s financial the maximum indemnitor’s indemnification factors, but may include: (1) conflicts of obligation available for future claims. interest, (2) claims involving criminal charges, THE AUTHOR However, the indemnitee may have additional trade secrets, confidential information or incentives as well. For example, an material intellectual property, (3) claims from indemnitee may want to defend a beachhead Brandon Vongsawad Partner Los Angeles key customers or suppliers, governmental claim vigorously, with limited regard for cost, bodies, regulators, financing sources, or to discourage future claims. partners, or (4) claims seeking injunctive or noneconomic relief, admissions, waivers or The indemnitee may not want the indemnitor nonindemnifiable losses. to control the defense of third-party claims Attorney Advertising when the parties have misaligned interests. Even if the preceding conditions are satisfied For example, if a claim seeks injunctive and no exceptions apply, the manner in relief, the indemnitor may have no incentive brandon.vongsawad@kirkland.com +1 213-680-8319 which the indemnitor defends a claim may 

2) still adversely affect the indemnitee. Admissions, exceeding the monetary damages under the In reality, even in an indemnitor control regime, waivers, missed deadlines or certain positions settlement offer and the defense costs an indemnitee will likely have the right to control taken by the indemnitor may undermine other incurred through that point. the defense of some subset of third-party claims. other options that the indemnitee has available Even with all of the conditions, exceptions, a gray area, and the right to assume control in future claims. To mitigate these risks, the monitoring rights and settlement limitations, can shift from one party to another, inefficiencies indemnitee may want to monitor the defense of third-party claims may adversely affect an will exist. By moving to a bright-line rule, the the claim to ensure that the indemnitor manages indemnitee in unforeseeable ways. The mere parties will have clear expectations and may However, as long as this balancing act creates ongoing claims or limit the defenses, positions or the defense diligently and responsibly. Receiving existence of a third-party claim may include adjust other contractual levers to align prompt updates and copies of all filings, notices, intrinsic or unquantifiable harm, such as incentives, such as those used by insurers. communications and other material information reputational harm, that an indemnitor may not will allow the indemnitee to stay abreast of the internalize. In addition, if midway through the An indemnitee control regime may also status of the defense. In addition to information defense of a claim the indemnitor becomes introduce new contractual levers. For example, rights, the indemnitee may require participation financially unstable or fails to satisfy any other the indemnitor may require that the indemnitee rights, including an opportunity to review or condition to control, the indemnitee may want invite settlement offers. Or, if a settlement offer approve the indemnitor’s strategies, filings, to reassume control. However, shifting control is received and rejected by the indemnitee, the communications and positions before its back to the indemnitee may raise additional indemnitor may argue that it should not be counsel implements or delivers them. Due to circumstance-specific issues, concerns and responsible for indemnification in excess of the importance of this monitoring, the inefficiencies. the monetary damages set forth in the rejected Upon considering the issues described above, control regime does not take into account the settlement offer. Because the indemnitee indemnitee may require that the indemnitor pay the fees and expenses of the indemnitee’s some circumstances may dictate a departure indemnitor’s interest in minimizing losses below from the traditional mindset altogether. Under an separate counsel to assist in the monitoring. an indemnification cap, such a regime may put Monitoring also extends to settlement indemnitee control regime, an indemnitee would downward pressure on indemnification caps. discussions. The indemnitor controlling the maintain control of the defense of all third-party Alternatively, an indemnitee control regime defense of a third-party claim may want to claims, and the indemnitor may only assume may lead to a shared defense costs scheme, settle the claim if the expected cost of defense control with the consent of the indemnitee. where the indemnitee controlling the defense exceeds the cost of settlement. However, the From the perspective of the indemnitee, even of a third-party claim must pay a percentage indemnitee has additional interests. In a typical the strongest indemnitee-favorable safeguards of all resultant losses or defense costs. indemnitor control regime, the indemnitor may in an indemnitor control regime do not give the settle controlled claims if and only if (1) the indemnitee the same protection as direct When third-party claims arise, control can sole relief under the settlement is monetary control. This proposition may seem extreme at make all the difference. An understanding of damages, (2) the indemnitor indemnifies the first, but it is not that extraordinary. the interests of the parties involved, their respective businesses and the dynamics indemnitee for the full amount of the settlement, (3) the settlement involves no Under the example described above, from the expected from potential third-party claims is admission by the indemnitee or finding of guilt, ABA Model Stock Purchase Agreement, critical to negotiating appropriate third-party and (4) the indemnitee receives a full release Second Edition, the indemnitee would merely claim control provisions for each situation. from the claimant. need to determine that there is a reasonable probability that a claim may adversely affect it But for the industry to be able to maintain its However, even if a settlement meets these beyond monetary damages. Modern insurance current rate of growth, insurers are going to requirements, an indemnitee may nevertheless provides another helpful data point (after all, need to be able to keep up. want to reject the settlement and continue to indemnitors act like insurers for third-party vigorously defend the claim. For example, the claims). In common representations and What the industry needs now is more overall indemnitee may want to make an example out warranties insurance policies, the insured capacity to write greater aggregate limits of of a patent troll, relating to a frivolous claim, in party controls the defense of all third-party liability, and more manpower to keep up with order to deter future claims. If the claimant claims, and the insurer does not have a right the need to write more policies, experts agree. makes a settlement offer that satisfies the to assume control. Instead, insurers rely on requirements described above, and the familiar protections: consent rights on counsel, indemnitee rejects the settlement offer, the consent rights on settlements, information parties may agree that the indemnitor need not rights and participation rights. The insurer may indemnify the indemnitee for any losses also require the insured to mitigate its losses. REPRINTED WITH PERMISSION FROM THE MARCH 28, 2016 EDITION OF LAW360 © 2016 PORTFOLIO MEDIA INC. ALL RIGHTS RESERVED. FURTHER DUPLICATION WITHOUT PERMISSION IS PROHIBITED