Whether you’re buying or selling, Post-closing Indemnities (“PCIs”) are an essential piece of every transaction. Perhaps even more important than the assets themselves, PCIs are obligations tied to each party that survive closing and allocate the liability stemming from specific claims related to the assets. While not typically the driving force behind a transaction, PCIs are important enough that they should be given the same attention and negotiation as items like diligence periods, purchase price, or closing dates. Keep reading for a quick guide on how to leverage PCIs to your benefit when negotiating your next transaction.
Thus, for oil and gas counsel, effective guidance hinges not just on understanding the rules but on aligning operational decisions with regulatory realities, managing agency interactions, and anticipating areas of potential scrutiny and regulatory evolution.
PCI Considerations: What to Look Out for
From a buyer’s perspective, PCIs should be as broad as possible, but a seller will typically want PCIs to be as narrow as possible. So how do parties reconcile their objectives when negotiating PCIs? As in any negotiation, PCIs are a give and take. When negotiating PCIs, first consider the risk involved with the assets themselves. Are they high-risk assets? Is there a history of claims associated with the assets? If the assets are not high-risk or have no history of associated claims, it may be worthwhile for a seller to assume more PCI obligations in exchange for valuable concessions elsewhere. Secondly, consider who you are transacting with. How experienced is the other party? How big are they? What is their reputation in the industry? Will they be around and have the capital to cover any potential claims after closing? Does the seller plan to wind-down shortly after the transaction? Will it be able to do so if it takes on too many contingent PCI liabilities? Keeping these questions in mind and conducting a thoughtful analysis of the transaction, assets, and parties involved is key to creating the perfect PCI scheme.
Finding the Right Fit for Your Transaction
What are some typical PCI structures? For starters, let’s focus on representations and warranties (“R&Ws”). In almost every transaction, PCIs covering each party’s potential breach of their R&Ws should be expected. Limiting PCIs to each party’s R&Ws allows the parties to clearly identify their potential liabilities, tease out risks, and set them out in a dedicated section or disclosure schedule of the transaction documents. These are the promises the other party relies on to understand the assets, the counterparty, and the scope of risk involved in consummating the transaction. The idea is simple: a seller should only represent and warrant what it can truthfully do, and a buyer should insist upon fulsome warranties that go to the heart of the ownership risk. If a seller won’t back up its R&Ws with a PCI obligation, there is often little recourse, and the R&Ws have little value. When structuring PCIs to match R&Ws, parties should consider the survivability/effective windows of each R&W, as well as whether R&W insurance is appropriate. Another common PCI tool is a “our watch your watch” indemnity. In an our watch your watch scheme, the parties agree to split all claims down the middle based on the date the ownership/control/operation of the assets transfers from seller to buyer, with each party being responsible for the claims that arise from actions or operations occurring when that party has control of the assets. Just like R&W indemnities, there are a lot of levers to pull to “right-size” such an indemnity. Caps, thresholds, deductibles, ramp-downs, and the length of survival can all be tailored to get both parties comfortable. Lastly, escrow arrangements can provide assurance to the buyer and flexibility for the seller in structuring PCI obligations. While it is not the most common PCI structure, parties can negotiate an agreed-upon amount to be placed in escrow to cover a party’s PCI obligations. Should any claims arise, the escrow funds can be immediately deployed to cover any claims. This relieves the buyer of the collection risk while allowing the seller to make distributions to investors and to cleanly book and schedule the remaining liabilities. However, calculating the appropriate escrow amounts and the length of time the funds may be held in escrow will likely be a significant negotiation between parties.
Conclusion
In any type of transaction, crafting liabilities and indemnity obligations is often a make-or-break negotiation, before and after closing. Buyers with limited access to diligence items concerning the assets and sellers looking to sell their assets and move on are sitting at opposite ends of the spectrum when it comes to allocating liability for post-closing claims. Regardless of which side of the transaction you sit, understanding the importance of PCIs and properly drafting your transaction documents to clearly allocate the responsibilities of each party after closing is an essential skill for any business looking to buy or sell assets, whether liability is allocated through R&Ws, transfer of control, or escrowed funds or any combination of the three. For more information on structuring your next transaction, reach out to the team at RR&A.
Saayem is a Junior Associate at R. Reese & Associates and part of the Corporate and Outsourced Legal Department Teams. To learn more about Saayem, visit his attorney page.
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