Anatomy of indemnification limitations
M&A indemnification regimes use three primary financial limitations to allocate post-closing risk between buyer and seller: the cap (maximum aggregate seller liability), the basket (threshold below which no claims are paid), and the deductible (similar to basket but limits recovery to amounts exceeding the threshold). Together these mechanics turn unlimited common-law breach of contract liability into a calibrated allocation.
Cap
- General cap: commonly 10-20% of purchase price for representations breach.
- Special caps: typically purchase price (full) for fundamental representations (capitalisation, authority, ownership), tax, fraud — uncapped in many jurisdictions for actual fraud.
- R&W insurance interplay: with insurance, cap is often reduced to 0.5-1% with insurance picking up above.
Basket (tipping basket) vs. deductible (true basket)
- Tipping basket: once aggregate claims exceed threshold, seller liable from dollar one (first-dollar recovery).
- Deductible (true basket): seller liable only for amounts exceeding threshold; threshold acts like an insurance deductible.
- Typical size: 0.5-1% of purchase price.
De minimis threshold
A per-claim de minimis threshold (e.g., USD 25-50k) excludes nuisance claims from counting toward the basket — only claims above the de minimis count toward basket fulfilment.
Special carve-outs from caps/baskets
- Fundamental representations (cap = purchase price; no basket).
- Tax (often own structure with longer survival and separate cap).
- Fraud (typically uncapped).
- Specific indemnities (pre-closing tax, identified liabilities, etc. — separate uncapped).
Caps, baskets and deductibles in practice
The indemnity architecture is a three-dial machine: the cap (maximum recovery — market for business reps often 10–30% of price, fundamentals at price), the basket (claims ignored until aggregate losses cross a threshold) and the basket’s character — tipping (first lira recoverable once crossed) versus deductible (only the excess recoverable), a one-word difference worth real money. De minimis floors filter nuisance claims below a per-item size. The negotiation logic: sellers trade higher caps for deductible-style baskets; buyers concede baskets but defend carve-outs (fraud, fundamentals, tax, specific indemnities sit outside the dials). In W&I-insured deals the policy retention replaces the basket economics. Whatever the dials, write worked examples into the SPA — arithmetic disputes about “does the basket tip” are the most avoidable kind.