Publications: Corporate Update

A recent Delaware chancery court case, Sage Software, Inc. v. CA, Inc., highlights the need for careful negotiation of the indemnification rights of a buyer. The buyer sought to obtain a declaration that the seller must provide indemnification in a situation where a foreign taxing authority required the buyer to pay a tax assessment, even while the final amount of the assessment was still in dispute.

The purchase agreement contained a standard indemnification provision with respect to “tax losses” relating to the pre-closing activities of the target. After the closing, the Canadian tax authority (the CRA) demanded that the target deposit 50% of a contested tax amount relating to pre-closing activities, pending final adjudication of the amount owed. The buyer attempted to force the seller to indemnify it for the deposit amount. The seller objected on the grounds that there had been no final adjudication of the amount owed and therefore no “loss.”

The parties disagreed over the application of the following language:

Any amounts owed by [seller] to [buyer] under this Article X shall be paid within ten (10) business days notice from [buyer] following the final resolution (which is final in the sense that it is no longer subject to appeal or other review) of any dispute related to such amounts; provided that in the case of indemnity payments for a Tax Loss, [seller] shall not be required to make the portion of such payment, if any, that is not yet due and payable to a Tax Authority[,] until ten (10) days before it is so due and payable.

The buyer contended that indemnification losses existed because the deposit was “due and payable” and that the proviso introduced an independent right to indemnification for “Tax Losses” not subject to the finality requirement of the first clause. The seller replied that the proviso did not eliminate the finality requirement, and that the deposit was not an indemnifable “Tax Loss” because it was not “final” in the sense that it was “no longer subject to appeal or other review.”

The court sided with the seller, essentially holding that the finality requirement applied to “Tax Losses” and that if the buyer had wanted advancement of amounts such as the CRA tax deposit, it should have negotiated specific language to that effect, given the well-known distinction between indemnification for adjudicated losses and related costs versus advancement of costs pending adjudication.

This is a good reminder to buyers that they should be cautious in agreeing to provisions that require a final determination of a third party claim (like the tax claim that was at issue in this case) before indemnification can be obtained.

For a seller, care should be taken to ensure that interim damages are not available to the buyer and that it is required to provide indemnification only upon a final determination of liability.