M&A Vocabulary – Understanding Experts: “Limitation of Liability (De-minimis, Basket, Cap)”

Provisions for limiting the seller’s liability toward the buyer constitute an essential component of company purchase agreements. While the seller is typically interested in making their liability calculable and limiting it overall, the buyer will generally attempt to comprehensively hedge against all uncertainties regarding the transaction object. This includes, in particular, uncertainties identified during due diligence.

In this context, the seller typically assumes warranties, e.g., regarding corporate law relationships, ownership relationships concerning essential assets, or the existence of material contracts. If warranties are breached, the buyer is generally entitled first to a remedy that would restore the condition that would exist if the warranty breach had not occurred. Only secondarily, i.e., if restoration of the condition is not successful or not possible, does a claim for monetary damages arise.

The resulting legal consequences can be largely modified or limited, deviating from the unlimited liability generally provided for by law, through so-called de-minimis, basket, or cap liability clauses or through caps in the purchase agreement between the parties.

De-minimis Clauses

A de-minimis clause establishes a materiality threshold. Only when this threshold, which is set by a specified amount, is exceeded can the buyer assert damage claims against the seller for warranty breaches. This protects the seller from the assertion of many minor damage claims that are insignificant compared to the agreed purchase price. At the same time, the de-minimis clause prevents numerous legal disputes between the parties over smaller amounts.

Basket Clauses

In connection with de-minimis clauses, so-called baskets are often agreed upon. In this case, damage items are first collected and can only be compensated or claimed once the agreed sum (threshold) has been exceeded. Figuratively speaking, all claims are placed in a basket and as soon as the basket is full, they can be enforced.

Two types of thresholds must be distinguished – the deductible and the tipping point. When agreeing on a deductible (also called deductible basket), only claims exceeding this amount can be asserted (excess only). It is agreed as a retention. Only the claims that fall out of the basket can be enforced.

With a tipping point (also called tipping basket), however, all claims from the basket can be asserted once the agreed amount is exceeded (first dollar).

Cap Liability Clause

The cap liability clause, in turn, establishes an upper limit on the amount, the so-called maximum liability limit or cap, up to which the seller is liable at most. The cap is referenced to the purchase price with respect to certain warranties, such as ownership of the shares or freedom from encumbrances (title guarantee). The parties often also agree on a lower cap regarding non-material warranty matters, which is based on a percentage of the purchase price. In cases of intentional conduct, the cap is disregarded and the damage must be compensated in full, i.e., without limitation.

Limitation Periods

In addition to provisions regarding the amount of liability, the seller’s liability is typically limited in terms of time (limitation periods). It should be noted that longer limitation or assessment periods must be considered for tax claims. In practice, the time frame for liability limitation is regularly between 18 to 36 months from the closing date, i.e., the day of execution of the purchase agreement. For breaches of tax-related warranties, depending on the country, liability for a period of up to six years from the closing date may be customary.

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