Retained Liabilities: Expiration of an Indemnification Obligation Respecting a Retained Liability Does Not Impose the Retained Liability Upon the Indemnified Party

Why should deal lawyers read cases? The answer is simple: “Good transactional lawyers … ‘study past disputes in order to draft contractual provisions that will avoid similar disputes in the future.’”[1] A recent Delaware Court of Chancery decision interpreting an asset purchase agreement (the “APA”),[2] provides a good example.

In Merck & Co., Inc. v. Bayer, AG, 2023 WL 2751590 (Del. Ch. April 3, 2023), the APA governed a $14 billion acquisition by the buyer of certain of the seller’s product lines, including one that was talc-based. The dispute concerned the interpretation of two provisions of the APA. 

As is not uncommon in asset purchase agreements, the APA had specifically allocated liabilities related to the purchased assets such that the seller, “retained” and remained liable for liabilities arising from products sold prior to closing, while the buyer, “assumed” and agreed to be liable for liabilities arising from products sold after the closing.  Stated differently, the buyer was only assuming acquired product claims that arose from product sales that occurred post-closing and any other liabilities were not being assumed, but instead remained liabilities of the seller.  So far, pretty standard stuff. 

But, as is also not uncommon in asset purchase agreements, the seller had agreed in the indemnification section of the APA to indemnify the buyer for any losses arising from the buyer’s involvement in any claims respecting product liabilities that the buyer had not assumed—i.e., those arising from pre-closing sales). And, there were durational limits on the various indemnification obligations related to certain representations, warranties and stand-a-lone indemnification obligations, including those related to certain specified retained liabilities. Specifically, the indemnification obligations relating to the pre-closing product claims (referred to in the APA as the “Section 2.7(d) Liabilities”) terminated “on the seventh (7th) anniversary of the Closing Date.”

Following the expiration of the 7th anniversary of the Closing Date, the seller claimed that the buyer was now liable for all pre-closing product-related claims because the seller’s retention of those liabilities had now sunset pursuant to the indemnification provision, which was specified to be the “sole and exclusive remedy” of the parties “for all matters arising under or in connection with this Agreement.” The buyer disagreed, claiming that only the indemnification obligation sunset, and nothing in the agreement required the buyer to now assume liabilities that had been retained by the seller following the termination of the indemnification obligations.  In other words, while the seller may no longer be required to indemnify the buyer respecting costs incurred in defending any product claim relating to pre-closing sales, the seller was still required to pay those claims because they remained the seller’s liability and had never been assumed by the buyer.

Vice Chancellor Cook sided with the buyer, concluding that the APA “clearly and unambiguously provides that [the seller] indefinitely retained substantive liability for the product liability claims related to products sold prior to the closing of the transaction.” Just because the indemnification provisions had terminated on the 7th anniversary of the closing date did not impose the previously indemnifiable liabilities upon the buyer—i.e., those liabilities originated with the seller, were retained by the seller at closing, and the buyer did not, either at closing or at any time after closing, assume those liabilities (or agree to indemnify the seller for those liabilities).

It does seem odd that an indemnification obligation for retained liabilities by a seller would have a durational limit.  And there is no explanation for why that durational limit was there if in fact the intent was an indefinite retention of product liabilities for pre-closing sales.  On the other hand, retained liabilities for pre-closing sales of product lines being acquired in a transaction are different than retained liabilities related to product lines not being acquired (and there does not appear to be any durational limit on indemnification for retained liabilities other than those related to pre-closing sales of the acquired product lines).[3] But if there was an intent to only retain liabilities for seven years, relying on a survival period in the indemnification obligations seems an incomplete way to go about it.  Expiration of an indemnification obligation cannot impose liabilities on the indemnified party; they simply end a particular obligation of the indemnitor to the indemnified party.  Unless liabilities are assumed by the buyer, they remain with the seller.  In fact, even if liabilities are assumed by the buyer, they are not transferred to the buyer, the seller still has them.  That is why sellers insist on being indemnified against assumed liabilities by the buyer.  Similarly, even when liabilities are retained by a seller, and not assumed by a buyer, the buyer can nevertheless be exposed to claims for those liabilities; and that is why buyer’s insist that seller’s indemnify buyers for retained liabilities (and the indemnity covers actual judgments not just costs of defense).[4]

Vice Chancellor Cook’s decision has been appealed to the Delaware Supreme Court.  Whether one agrees or disagrees with Vice Chancellor Cook’s conclusion, the goal for transactional lawyers is to avoid a situation where your agreement could be interpreted in a manner inconsistent with the deal (whatever that may have been here).  You cannot transfer liabilities at all, you can only assume them or retain them. And you certainly cannot contractual agree to terminate a liability to a third party through an agreement that does not include that third party.


Endnotes    (↵ returns to text)
  1. 1. Glenn D. West, Consequential Damages Redux: An Updated Study of the Ubiquitous and Problematic “Excluded Losses” Provision in Private Company Acquisition Agreements, 70 Bus. Law. 971, 1004 (2015), quoting Mitu Gulati & Robert E. Scott,  The Three And A Half Minute Transaction:  Boilerplate and the Limits of Contract Design, at 4 (2013) (quoting  Robert E. Scott & Jody Kraus, Contract Law and Theory vii (4th ed. 2007)).
  2. 2. Technically, the purchase agreement was a combination asset purchase and stock purchase agreement, but that was not really relevant to the interpretive issue being considered by the court.
  3. 3. The APA also had a deductible and cap applicable to the 2.7(d) Liabilities, unlike any of the other “retained liabilities.”  See Section 10.2(c)(i) of the Stock and Asset Purchase Agreement, between Bayer AG and Merck & Co., Inc., dated May 5, 2014.
  4. 4. Vice Chancellor Cook seems to imply that the indemnification obligation respecting the retained liabilities was designed solely to cover costs of defense and not settlements or judgements.