What is an indemnity cap?
The indemnification cap refers to the financial limit or cap to which typically the seller is liable against any breach of reps or warranties. Fundamental reps and warranties, such as a representation that the seller is the owner of the shares or assets being sold—are fundamental to the successful transaction. The purchaser must be provided with some insurance that these representations are true. If it comes to light post-sale that a representation was false, thereby incurring loss, the purchaser can recover his loss up to a certain limit. This limit is often valued at 50% of the enterprise value of the purchase although the amount can vary greatly depending on the size of the transaction. Smaller transactions usually realize larger percentage caps.
What is an indemnity basket?
An indemnification basket refers to the size of the damage incurred before a seller become liable to reimburse the purchaser for any losses. There are two types of “baskets”: true deductibles and threshold/tipping baskets. In other words, if the purchaser were to suffer a loss of $500, is this sufficient to action the indemnity? When an indemnity is actioned, lawyers become involved and legal fees will likely well exceed the $500 claim. For this reason, a basket is introduced to ensure that only significant claims will tip the basket.
What is the difference between a true deductible basket and a threshold or tipping basket?
True deductibles obligates the seller to reimburse the value of the damage that exceed the basket. The threshold/tipping basket obligates the seller to reimburse the purchaser against losses only when the tipping point of the basket is reached. Once reached, the seller but pay out not only the value exceeding the basket but the full amount: the basket amount and the value in excess of the basket.
