Meaning
Financial reserves in transaction agreements allocate specific portions of an overall indemnity cap to distinct types of potential losses or claims. This structuring ensures that a single large claim in one category cannot exhaust the entire protection available for other risks. Setting up indemnity sub-pools is a common practice in complex mergers and acquisitions to manage diverse risks like tax liabilities, intellectual property disputes or environmental issues.
These sub-pools do not increase the total liability of the seller, which remains capped by the overall indemnity limit.
Fund Allocation
The parties agree on the size of each sub-pool during the negotiation of the purchase agreement based on the perceived risk level. For example, a transaction might allocate a larger portion of the funds to a tax sub-pool if the target company is undergoing an audit. The use of indemnity sub-pools allows the buyer to secure targeted protection for known high-risk areas without over-allocating the entire indemnity amount to a single category.
Claims Process
When a loss occurs, the buyer must submit a claim against the specific sub-pool designated for that type of risk. If that sub-pool is exhausted, the buyer cannot use funds from other sub-pools to cover the remaining loss. This restriction forces the buyer to carefully evaluate the risks and negotiate realistic sub-pool limits.
The claim must be supported by evidence of the loss and submitted within the specified survival period.
Liability Limit
These sub-pools often have different survival periods and deductibles depending on the nature of the underlying risk. Tax sub-pools usually last until the expiration of the relevant statute of limitations, while general sub-pools may expire after eighteen months. This differentiation ensures that the seller’s exposure is reduced over time as the risks diminish.
