M&A Vocabulary – Understanding Experts: “Hold Harmless Clause”

The basis of virtually every M&A transaction is the execution of a due diligence review of the target company to identify any existing risks.

While operational or economic risks are typically covered by purchase price adjustments (e.g., via a purchase price reduction or an earn-out), the general existence of a condition of the target company that complies with applicable legal and tax requirements is secured by the seller’s Reps & Warranties.

However, these declarations by the seller are usually limited by the buyer’s knowledge and disclosures, meaning they do not apply to facts that were reasonably disclosed by the seller during the due diligence review (fair disclosure). If, during the buyer’s review of the target company and examination of any disclosure letter from the seller, facts are identified that indicate a violation of applicable norms or at least suggest that the risk of non-compliance by the target company cannot be ruled out, the seller’s liability based on their guarantees for these facts is excluded.

To avoid the buyer being “stuck” with the actually identified risks, and to ensure the seller is not released from liability in this regard, a Hold Harmless Clause is necessary. This contractual agreement (also referred to as an Indemnity Clause) obliges the seller to indemnify the buyer against all disadvantages arising from the respective facts. The formulation common in German, to hold the entitled party “schad- und klaglos” (harmless and blameless), is not used in English terminology.

When agreeing on a Hold Harmless Clause, however, care must be taken not to make it too general or broad. In addition to the seller’s understandable interest in limiting their liability specifically to the risk identified by the buyer, an overly general clause can also raise questions regarding its effectiveness.

Finally, a Hold Harmless Clause is also conceivable in the reverse case: Should the seller disclose a circumstance that generally poses a risk, but which the seller can no longer change or minimize, the seller can demand a Hold Harmless Clause from the buyer if a limitation of their liability solely based on the disclosure rules does not seem sufficient.

In practice, this particularly applies to risks that are significant in terms of potential consequences but are rather theoretical in nature or highly unlikely to occur. Examples include ambiguities related to the formation of the target company, which may date back years, cannot be remedied due to their formal nature, and could potentially lead to the invalidity or dissolution of the company in the event of an official or judicial review. If there are no indications that such an official or judicial review is imminent, but the parties have an interest in implementing the transaction, a seller may insist on the buyer agreeing to a Hold Harmless Clause in this regard to avoid any risk concerning the respective material liability, effectively waiving any claims against the seller. Whether such an explanation of the facts covered by the waiver, regarding significant but previously unknown risks, should be explicitly included in the purchase agreement due to potential disclosure obligations, remains subject to the parties’ negotiations.

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