Indemnity Basket

What is an indemnity basket?

Indemnity Basket (in German Schwellenbetrag, basket for short) describes an amount agreed in the company purchase agreement that the buyer's claims for breach of warranty must together exceed before the seller becomes liable. Below this amount, the buyer bears the losses itself. Depending on the design, the basket works as a deductible (German Freibetrag) or as a tipping basket (German Freigrenze). The name describes the principle: smaller losses are collected as in a basket, and only when the basket is filled beyond the agreed rim must the seller pay.

Together with the de minimis threshold for individual claims and the liability cap, the basket is one of the seller's monetary limitations of liability. It applies to claims under the business-related warranties, that is, the assurances on the condition of the company. As a rule not covered are title warranties, which concern the existence and ownership of the shares, and tax and other indemnifications by which the seller assumes individual risks. In cases of intent or fraudulent concealment, the basket does not apply by operation of law. Type and amount are sometimes already recorded in the letter of intent (LOI) and spelled out in the purchase agreement.

Deductible and tipping basket

The two basic forms differ in what happens once the threshold amount is exceeded. Their German designations are not always used uniformly in the market; in a dispute, the mechanism that the contract describes is what counts.

Deductible (Freibetrag)

With a deductible, the seller is liable only for the part of the claims that exceeds the threshold amount. The threshold amount remains permanently with the buyer, similar to an excess in insurance. This form favours the seller, because the sum of the claims is always reduced by the full threshold amount.

Tipping basket (Freigrenze)

With a tipping basket, once the sum of the claims exceeds the threshold amount, the seller is liable for the entire amount from the first euro. Below the limit it pays nothing, above it everything; in English usage the basket “tips”. This form favours the buyer and creates a jump at the limit: an additional claim of a few thousand euros can lift the payment obligation from zero to the full sum.

In negotiation, form and amount are moved together. A seller who secures a deductible often accepts a lower threshold amount, while a tipping basket usually goes with a higher threshold amount. Hybrid forms also occur, for example a tipping basket of 1% of the purchase price, after which the seller reimburses everything above 0.5%.

Amount of the basket and reference measure

The threshold amount is agreed as a fixed EUR amount or as a percentage of the purchase price. As a rule of thumb it is around 0.5% to 1% of the purchase price. With a percentage, the contract must clarify which purchase price is meant. Candidates are the amount at closing (the transfer of the shares against payment), the amount after purchase price adjustment, or the amount including later performance-related payments under an earn-out. Some contracts refer to enterprise value including financial debt (enterprise value) rather than to the purchase price for the shares (equity value). Where the company is highly indebted, the difference is considerable. A fixed EUR amount avoids these questions.

Economically, the basket is meant to filter out claims that are immaterial in relation to the transaction. It must therefore be tuned to the structure of the business: a company with many small customer contracts generates more individual claims of small amounts than a provider with a few large customers.

Which claims the basket covers

Only claims that do not fall under the de minimis threshold flow into the basket; smaller claims lapse and usually do not count towards the sum either. The loss is credited under the contractual crediting rules. Deducted, for example, are insurance payments and amounts already settled through the purchase price adjustment based on the effective-date accounts (completion accounts). The sum is carried forward over the entire limitation period.

Exceptions

Outside the basket regularly stand claims under title warranties, tax indemnities and special indemnities, as well as claims for intent and fraudulent concealment. Breaches of conduct obligations between signing and closing are often added. These claims are reimbursed from the first euro; whether they at the same time contribute to exhausting the basket is regulated by the contract.

Materiality qualifiers (materiality scrape)

If a warranty already contains a materiality qualifier, for example “no material legal disputes”, and a basket also applies, the threshold works twice. Buyers therefore often require that materiality qualifiers be disregarded for the calculation of the loss (materiality scrape). If this also applies to the question whether a breach of warranty exists at all, this is called a double materiality scrape. Whether the clause is appropriate depends on how many warranties contain materiality qualifiers.

Basket and warranty insurance

In a transaction with warranty insurance, which covers losses from breaches of warranty in place of the seller, the policy's retention performs a similar function. Losses up to its amount are borne not by the insurer but by the buyer or, as far as agreed, the seller. Basket in the purchase agreement and retention of the policy are therefore aligned, so that neither a gap in cover nor a double reduction arises.

Worked example: indemnity basket as a deductible and as a tipping basket

A company is sold for EUR 12 million. The contract provides for a de minimis threshold of EUR 15,000 per individual claim and a basket of 1% of the purchase price, that is, EUR 120,000. After closing, the buyer asserts four breaches of warranty with losses of EUR 9,000, EUR 42,000, EUR 51,000 and EUR 38,000.

• De minimis threshold: The claim of EUR 9,000 lies below it and lapses completely.
• Sum of the remaining claims: 42,000 plus 51,000 plus 38,000 = EUR 131,000
• Comparison with the basket: EUR 131,000 exceeds EUR 120,000; the threshold is exceeded.
• Deductible: The seller pays 131,000 minus 120,000 = EUR 11,000.
• Tipping basket: The seller pays the full EUR 131,000.

If the third loss is only EUR 25,000 instead of EUR 38,000, the sum is 42,000 plus 51,000 plus 25,000 = EUR 118,000 and thus below the threshold. The seller then pays nothing in either model. With the tipping basket, a difference of EUR 13,000 in the claims therefore decides whether the seller pays nothing or EUR 131,000; with the deductible, it concerns EUR 11,000.

Distinction: basket, de minimis threshold, liability cap and retention

• De minimis threshold (also mini-basket): threshold for the individual claim. It decides which claims reach the basket at all.
• Liability cap: upper limit of liability. The basket determines from when liability arises, the cap up to what amount.
• Retention under warranty insurance: acts like a deductible in relation to the insurer but is part of the policy and not of the purchase agreement.
• Materiality qualifier: restricts an individual warranty in substance, while the basket works by amount across all claims.

Common mistakes

• Label instead of mechanism. Deductible, tipping basket and retention are labelled inconsistently in the market. Without an express description of whether reimbursement is from the first euro or only of the excess, a dispute is built in.
• Open reference measure. A percentage of the purchase price without specifying which purchase price is meant leads to changing thresholds with adjustments and earn-out payments.
• Unresolved minor claims. If there is no rule on whether claims below the de minimis threshold count towards the basket, the interplay of the two limits remains open.
• Incomplete exceptions. If title warranties and indemnifications are not expressly excluded, the basket can also apply where the parties wanted liability from the first euro.
• Double threshold overlooked. Materiality qualifiers and basket together can restrict liability more than the buyer intended.

Frequently asked questions

What is the difference between a deductible and a tipping basket?

With a deductible, the seller reimburses only the amount above the threshold; with a tipping basket, once the threshold is exceeded, the entire amount from the first euro. The deductible corresponds to the Freibetrag, the tipping basket to the Freigrenze.

How high is a basket usually in a company sale?

As a rule of thumb around 0.5% to 1% of the purchase price. The amount depends on the size of the transaction, the structure of the business and whether a deductible or a tipping basket is agreed.

Does the basket also apply to fraudulently concealed defects?

No. In cases of intent and fraudulent concealment, the seller cannot rely on contractual limitations of liability, and that includes the basket. The buyer in this case receives reimbursement from the first euro.

How is a tipping basket worded in the contract?

In simplified form: “The seller is liable for claims for breach of warranties only if their total amount exceeds EUR 120,000; it is then liable for the entire amount.” With a deductible, the clause instead ends with “it is then liable only for the excess amount”.

Is basket amount the same as indemnity basket?

Yes. Basket, basket amount and indemnity basket denote the same threshold amount. For the effect, all that matters is whether the contract provides for a deductible or a tipping basket.

The Roemer Capital view

Before fixing a negotiating position, we calculate several claim scenarios for sellers: typical small losses from due diligence, a bundle of medium claims and a single larger claim. Only the comparison shows whether a higher threshold amount as a tipping basket or a lower one as a deductible is more favourable for the sellers.

We never look at type and amount of the basket in isolation, but together with de minimis threshold, exceptions and liability cap, because only their interplay determines the actual liability risk. The contractual implementation lies with the client's law firm.