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M&A Vocabulary – Explained by the experts: Limitation of liability (de minimis, basket, cap)

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​In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner present an important term from the specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give a basic understanding or refresher of a term and some useful tips from our consultancy practice.

A fundamental component of company acquisition contracts are the arrangements to limit the vendor’s liability to the buyer. While the vendor is usually interested in being able to predict and restrict his overall liability, the purchaser usually attempts to provide complete cover for all the uncertainties relating to the company which is the subject or the transaction. These include, in particular, those uncertainties that were identified during the due diligence.


In this context, the vendor generally provides guarantees, e.g. for circumstances governed by company law, the ownership arrangements relating to the significant assets or to the existence of significant contracts. If guarantees are not honoured, the purchaser is basically legally entitled to submit a claim for the reinstatement of the situation which would exist, if no breach of warranty had occurred. Only as a fallback, if a claim to reinstatement of the situation is not successful or not feasible, can a claim for payment of damages follow.


The resulting legal consequences, contrary to the provision of unlimited liability generally prescribed by law, can be substantially modified or restricted by using de minimis- basket- or cap liability clauses or caps, in the purchase contract between the parties.

 

De minimis clauses

A materiality threshold is agreed for a de minimis clause. The purchaser can only press claims for damages for breaches of the warranties against the vendor once this threshold, which is defined as a fixed amount, has been exceeded. This protects the vendor from the submission of many minor claims for compensation, which are immaterial compared to the agreed purchase price. At the same time, the de minimis clause helps to avoid a large number of legal disputes between the parties over minor amounts.

 

Basket clauses

Baskets are often agreed in connection with de minimis clauses. In this process, the claim items are first pooled, and can only be reimbursed or a claim made once the agreed sum (the threshold) is exceeded. Symbolically, all claims are put in a basket and as soon as the basket is full, they can be processed.


Two types of thresholds then exist - a deductible and a tipping basket. When a deductible basket is agreed, only claims that exceed the agreed amount can be submitted (excess only). A level of the deductible is agreed. Only the claims that exceed the basket can be enforced.


With a tipping basket, the total amount (first dollar) can be claimed once the total basket exceeds the agreed amount.

 

Liability cap clause

The liability cap clause for its part defines an upper limit to the amount, referred to as maximum liability limit or cap, up to which the vendor is liable. The cap relates to specific guarantees, such as ownership of the shares or title guarantee of the purchase price. Often, the Parties also agree on a lower cap relating to non-compliant warranty issues, based on a percentage of the purchase price. In cases of deliberate intent, the cap does not apply, and the damage must be repaid in full, i.e. unlimited.

 

Limitation periods

In addition to provisions concerning the level of liability, the liability of the vendor is also usually limited in terms of time (limitation periods). Care must be taken to ensure that longer periods of limitation or assessment periods apply in relation to tax claims. In practice, the time frame of the limitation of liability is normally between 18 and 36 months from the closing date, which is the date of completion of the purchase contract. In the case of violations of tax-related guarantees, depending on the country, liability may be customary for a period of up to six years from the closing date. 

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