victorian-297856_960_720This is a follow up post on our series of merger and acquisition issues.  If you are selling your company you’ll be faced with the prospect of indemnifying the purchaser for any damages they suffer in connection with the sale.  Now such indemnification may arise for a number of reasons, such as an unknown debt or lien that was on an asset you sold, a claim that an employee or third party made against the company or an asset which you did not inform the purchaser of, or a number of other issues.  These are usually breaches of the representations and warranties that sellers have to make to the buyers in the asset purchase agreement.   For example, the seller will represent (i.e. state as true at the time of signing or closing or both) that there are no debts owed by the company or liens on the company assets.  If the deal closes and a lender or lien of the company did exist, its a breach of that representation, and the seller is liable to the buyer for any resulting damages.

Now, without a basket and a cap, the seller has unlimited liability to the buyer for indemnification purposes.  And this has happened, if there is no cap on environmental liability for example, you may sell your company for $5,000,000 and be liable for indemnification for environmental reasons for $10,000,000 (or more).

A “cap” is essentially a maximum amount for which the seller will be liable to the buyer for any issue.  So in the above example with the environmental liability, if the cap was $1,000,000, the seller would only be liable for that amount, no matter how much the actual damage was.  Typically the cap will be the purchase price, or some percentage thereof (20%, 50% or some other number).

Now a “basket” prevents a seller from getting nickel and dimed by the buyer.  If there is no basket, then the buyer can look to the seller for indemnification when there is one cent due.  The basket will set an amount which all damages the buyer suffered will have to exceed before the buyer can look to the seller for indemnification.  For example, if there was a $25,000 basket, and the buyer suffered multiple issues, each in the amount of $5,000, the buyer could not go after the seller for indemnification until the fifth item (which would cause the basket amount to be exceeded).  The basket is usually a percentage of the purchase price, such as 1% or less. It can also be set as a reasonable amount, usually $25,000 or $50,000 for smaller transactions.