Indemnification Cap vs. Basket:
The Provisions That Define Seller Liability

An indemnification cap is the maximum amount the seller is required to pay for post-closing indemnification claims by the buyer. It sets a ceiling on the seller's total liability for breaches of representations, warranties, and covenants. General indemnification caps in middle-market transactions are typically set at 10-20% of the purchase price for general representations, held in escrow for 12-18 months. Fundamental representations (title, authority, capitalization, fraud) typically have higher caps - sometimes equal to the full purchase price - and longer survival periods. Without a negotiated cap, the seller's liability is unlimited - the buyer can sue for the full amount of any damage caused by a rep breach, subject only to actual damages.

A basket is a threshold below which the buyer cannot make indemnification claims. It is designed to prevent buyers from pursuing trivial claims. There are two types: a 'tipping basket' (once the buyer's cumulative losses exceed the basket amount, the buyer can recover everything from the first dollar of loss); and a 'true deductible' (the seller is only responsible for losses that exceed the basket amount - the seller keeps the first basket-amount of losses as the buyer's problem). True deductibles are more protective for sellers; tipping baskets are more protective for buyers. The basket is typically set at 0.5-1% of purchase price. Sellers should push for a true deductible structure rather than a tipping basket.

The cap and basket work as brackets around the seller's indemnification obligation. The basket filters out small claims below the threshold. The cap limits total liability at the top. Example: $5M deal, 1% basket ($50K), 15% cap ($750K), true deductible. A buyer who has $200K in losses from rep breaches can only recover $150K (the $200K minus the $50K basket). A buyer who suffers $1M in losses can only recover $750K (capped). A buyer who suffers $40K in losses can recover nothing (below the basket). The space between the basket and the cap is where the practical negotiation lives - sellers want a low cap and a high basket; buyers want a high cap and a low basket.

Fundamental representations - which address core facts about the company's existence and ownership - typically have caps equal to the full purchase price and survive indefinitely (or for the applicable statute of limitations). These include: title to and ownership of the equity being sold, due authorization and execution of the purchase agreement, capitalization of the company, and representations related to fraud and intentional misrepresentation. Tax representations often have their own cap and survival period tied to the tax statute of limitations (typically 3-6 years). General representations (financial statements, material contracts, litigation, intellectual property) have the lower general cap and shorter survival period - 12-18 months is typical.

Yes, significantly. When R&W insurance is used in a transaction, the insurer's policy typically covers losses above a retention (similar to a deductible) up to the policy limit. The seller's direct indemnification obligation can be reduced to a nominal amount (the seller only remains on the hook for fundamental reps), and the buyer's practical protection comes from the insurance policy rather than the seller's indemnification obligation. This allows the parties to reduce the escrow holdback (or eliminate it) because the insurance policy replaces the escrow as the buyer's remedy. In insured transactions, the cap and basket negotiation shifts to the policy's retention and coverage terms rather than the seller's personal indemnification.