Due diligence has found a pending lawsuit no one knows how will end. Should the deal fall through because of it? Not necessarily — the solution is often an indemnity.
Short answer: An indemnity is a specific promise from the seller to cover a concrete, often already-known problem — unlike a warranty, which is a general assurance that the affairs of the business are as described.
Warranty or indemnity — what's the actual difference?
Where a breach of warranty requires the buyer to prove a loss and a causal connection, an indemnity is a direct obligation to pay a specific amount if a defined event occurs. That makes an indemnity a stronger protection for the buyer than an equivalent warranty.
When is an indemnity used?
Typically when due diligence uncovers a concrete, identified problem the parties can't or won't resolve before closing — e.g. a pending dispute with a former employee, an unresolved tax matter, or known environmental contamination. Instead of letting the deal fall through, the parties agree that the seller indemnifies the buyer for exactly that matter.
Who bears the burden of proof?
This is exactly where the difference from a warranty becomes concrete: with an indemnity, the buyer generally doesn't need to prove a "loss" in the legal sense — the obligation is simply triggered when the defined event occurs. It's therefore one of the points negotiated hardest, when due diligence has uncovered a concrete problem.
How is the amount secured in practice?
The amount an indemnity can trigger is often secured through an escrow or holdback arrangement, so the money is available if the claim is triggered. Note that most standard W&I insurance policies specifically don't cover matters the parties already knew about during due diligence — so a known risk typically needs to be handled in a different way than through insurance.
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