Indemnification of the initial purchasers: Overview, definition, and example
What is indemnification of the initial purchasers?
Indemnification of the initial purchasers refers to the process where a party (often the issuer or seller) agrees to compensate or protect the initial purchasers of securities (such as stocks or bonds) from losses, liabilities, or damages arising from certain legal claims or events. These claims could include issues such as misrepresentations in the offering documents, breaches of contract, or legal actions resulting from the purchase of the securities. Indemnification clauses are commonly included in securities offerings and protect the initial purchasers, typically underwriters or investors, from financial harm related to their involvement in the transaction.
In most cases, the issuer of the securities agrees to indemnify the initial purchasers if they face legal action related to the securities offering, including actions from regulators, other investors, or third parties. The indemnification helps ensure that the initial purchasers are not financially burdened by risks outside their control.
Why is indemnification of the initial purchasers important?
Indemnification of the initial purchasers is important because it provides protection and assurance to the parties involved in the securities offering. The initial purchasers, often investment banks or institutional investors, take on certain risks when participating in the offering, including the possibility of legal challenges or claims. By including an indemnification clause, the issuer helps mitigate these risks, making the offering more attractive to potential purchasers.
For businesses, indemnification ensures that they can attract underwriters or other investors to participate in their securities offerings, knowing that they will be protected against certain legal risks. For the initial purchasers, it helps limit exposure to potential losses or liabilities arising from the transaction.
Understanding indemnification of the initial purchasers through an example
Imagine a company issuing bonds to raise capital. The initial purchasers (investment banks) assist in the sale of the bonds to investors. After the sale, a group of investors sues the company, claiming that the offering documents contained misleading information about the company’s financial health. As part of the bond agreement, the company agrees to indemnify the initial purchasers against any losses or legal costs resulting from the lawsuit. This means that if the initial purchasers face any financial loss due to the lawsuit, the company will cover the costs.
In another example, a startup company issues shares to investors with the help of an underwriter. The offering documents are later found to have omitted material facts, leading to a legal dispute. The underwriter, as the initial purchaser, invokes the indemnification clause in the agreement, and the company agrees to cover the costs of any legal defense or settlements related to the issue.
An example of an indemnification of the initial purchasers clause
Here’s how an indemnification of the initial purchasers clause might appear in a securities offering agreement:
"The Issuer agrees to indemnify and hold harmless the Initial Purchasers, their affiliates, and their respective officers, directors, and employees from and against any and all claims, losses, liabilities, or expenses (including legal fees) arising out of or in connection with the offering of the Securities, except where such claims arise due to the negligence or misconduct of the Initial Purchasers."
Conclusion
Indemnification of the initial purchasers plays a crucial role in securities transactions by providing protection against legal risks and liabilities. For issuers, including an indemnification clause helps attract underwriters and investors, as it reduces their exposure to legal challenges. For initial purchasers, it ensures that they are financially protected from the risks associated with their involvement in the transaction. This protection fosters smoother, more secure investments and securities offerings.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.