Beware: Buyer in an Acquisition may be caught by the indemnity provided by the Seller and target company
In share purchase agreements, it is not uncommon that both the seller and the target company would provide an indemnity to the buyer for the target company’s liabilities incurred prior to the acquisition, often on a joint and several basis. The seller and the target company would be treated as co-indemnitors but there is seldom any express term in the share purchase agreement dealing with allocation of liabilities between co-indemnitors after completion.
A typical indemnity clause may read as follows:
“The Warrantors (defined as the seller and the target company) shall indemnify, defend and hold harmless the Indemnified Parties (defined as the buyer and its related parties) against any and all losses arising out of or in connection with [a list of events such as litigation and complaints]”.
Civil Liability (Contribution) Ordinance
Under Hong Kong law, the Civil Liability (Contribution) Ordinance (Cap. 377) (“CLCO”) provides for a legal basis enabling a person who has suffered damage from any tort, breach of contract, breach of trust, statutory liability or otherwise to seek a contribution or indemnity from any other person who is also liable in respect of the same damage. Section 3(1) of the CLCO reads:
“…… any person liable in respect of any damage suffered by another person may recover contribution from any other person liable in respect of the same damage (whether jointly with him or otherwise).”
In the context of a share purchase agreement, if the seller is liable to indemnify the buyer pursuant to an indemnity clause, the seller could potentially seek a contribution from the target company (as the co-indemnitor) for the same indemnity or part of that. That would mean that the buyer who has already completed the acquisition of the target company could end up bearing part of the ultimate liabilities as a result of the indemnity clause and the operation of the CLCO.
To be able to invoke the CLCO, the indemnitor (the seller in this situation) would have to show that the person injured (the buyer) has a cause of action against both the person claiming for contribution per the CLCO (the seller) and the person against whom such claim is sought (the target company) in respect of the same damage. The amount of contribution an indemnitor can recover from a co-indemnitor would depend on what the court considers “to be just and equitable having regard to the extent of that person’s responsibility for the damage in question” (Section 4, CLCO). When assessing the extent of liability, the court would take into account two main elements, namely blameworthiness and causative potency. The court may also consider the likely financial consequences of any contribution order that may be made. The court may also exempt any person from liability to make contribution.
Section 9 of the CLCO also states that nothing in the CLCO shall affect “any express or implied contractual or other right to indemnity; or any express contractual provision regulating or excluding contribution”. As such, if the buyer wants to eliminate the potential risk of the target company being sued by the seller for contribution under the CLCO, the indemnity clause can be structured in one of the following ways:-
The seller and the target company provide the indemnity severally such that each of the warranties is separate and independent;
The agreement may specify the exact scope and extent of liability of the seller and the target company in different situations; hence certain indemnity would not attribute to the target company;
The agreement may include a provision to exclude or limit the target company’s liability under the indemnity clauses post-acquisition.
Arbitration between co-indemnitors
There have been instances where there is a written agreement between co-indemnitors which provides for disputes between them to be resolved through arbitration. An arbitration clause typically encompasses “rights and obligations under the contract”. In Lo Pui Fan v Hongkong United Dockyards Ltd  HKEC 1721, the contract provided that “Any dispute arising under or by virtue of this Contract or any differences of opinion between the parties hereto concerning their rights and obligations under this Contract shall be resolved by arbitration.” The clause made no mention of the statutory claims which were brought under Hong Kong laws. It was held that statutory claims such as those brought under the CLCO were not matters relating to the contract and hence not covered by the relevant arbitration clause.
In the absence of express contractual provisions, an indemnitor may have a claim for contribution from other co-indemnitors under the CLCO if the former can prove that the co-indemnitor would also be liable for the same damage. In the context of a share purchase agreement, there could be a situation under which, post-completion, the buyer may become ultimately responsible for liabilities under the indemnity clauses as a result of the target company also providing an indemnity to the buyer together with the seller in the agreement.
To avoid such unintended situation, it is important that there be an express term under the agreement to segregate and allocate the indemnity liability between the seller and the target company. If the agreement contains an arbitration clause, such clause should cover both contractual and non-contractual (including statutory) obligations, so that the right to seek contribution arisen by operation of law would also be subject to arbitration.