Business, Legal & Accounting Glossary
Baskets and caps are frequently included in a seller’s representations and warranties in a purchase and sale agreement. When a seller makes a representation, the buyer is typically indemnified (typically through the use of a your watch, my watch clause) against the seller’s representation being inaccurate.
The baskets and caps clause precludes the seller from being liable for this indemnification. Generally, the caps concept caps, or restricts, the total amount payable under the indemnity. The most frequently used cap is 50% of enterprise value, but this cap can be negotiated between the parties. The basket concept establishes a ceiling for indemnification, meaning that claims are not payable unless the ceiling, or “basket,” is exceeded.
Generally, the “first dollar” method is applied to baskets. This means that if a basket contains $250,000, any claims exceeding $250,000 will be denied. However, if the claims exceed the basket limit of $250,000, for example, if the claim is $400,000, the full $400,000 will be paid (not just the $150,000 over the basket limit).
Baskets and caps are better understood with the aid of an illustration. One of the critical representations a seller makes in a stock purchase agreement is regarding potential lawsuit liabilities.
Assume a transaction with an enterprise value of $1 million is completed and the seller certifies that it is unaware of any pending lawsuits at the time of closing. The buyer later discovers that there was material litigation pending prior to the transaction that the seller was aware of/should have been aware of. The indemnification clause “on your watch, my watch” would likely apply, allowing the buyer to pursue the seller for any costs incurred as a result of this litigation.
A cap of 50% of the $500,000 purchase price (or 50% of the enterprise value) could have been established. This would cap the seller’s indemnification liability at $500,000. Additionally, a basket worth $50,000 could have been included. If the costs of resolving the litigation are less than $25,000, the seller is not required to pay anything because the amount is less than the basket. If, on the other hand, the costs exceed $75,000, the seller may be liable for the entire $75,000 (not just the $25,000 above the threshold) under the “first dollar” requirement.
Caps and Baskets
Basket and Cap
Cap and Basket
Purchase and Sale Agreement
Buyer Indemnity
Seller Indemnity
Reps and Warranties
Stock Purchase Agreement
Purchase Price
Enterprise Value
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This glossary post was last updated: 26th January, 2022 | 0 Views.