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Indemnification cap.

Aka. Indemnity cap · liability cap
All terms

What is an indemnification cap?

An indemnification cap is the maximum amount a seller can be required to pay a buyer to make good on breaches of the representations and warranties in a purchase agreement. After close, if the buyer discovers that something the seller represented was untrue — undisclosed liabilities, overstated revenue, a missing contract — it can claim indemnification. The cap is the dollar ceiling on those claims.

It is one of the most negotiated numbers in any M&A deal. The cap allocates post-closing risk: a low cap means the seller's exposure ends quickly and the buyer absorbs most of the downside; a high cap means the seller stays on the hook for more. It is typically expressed as a percentage of the purchase price.

The cap rarely stands alone. It works alongside the survival period (how long claims can be brought), the basket or deductible (a minimum threshold before any claim is paid), and the escrow or representation-and-warranty insurance that actually backs the seller's promise to pay.

How the cap fits the indemnification structure

The cap is the top of a layered structure that governs which losses are recoverable and up to what amount.

  1. Basket or deductible. Small losses below a threshold are not recoverable at all; the cap only matters once claims clear this floor.
  2. General cap. The ceiling on ordinary representation breaches, commonly a single-digit percentage of purchase price when claims are backed by escrow or insurance.
  3. Carve-outs to a higher cap. Fundamental representations — title, authority, capitalization — and items like fraud, taxes, or specified liabilities are usually capped much higher, often at the full purchase price, or not capped at all.
  4. Funding the cap. How a claim gets paid — from an escrow holdback, from a representation-and-warranty insurance policy, or directly from the seller — determines how easily the buyer actually collects up to the cap.

The rise of representation-and-warranty insurance has pushed general caps lower, because the buyer looks to the policy rather than the seller for recovery.

Why the cap is so heavily negotiated

The cap is where the parties draw the line on lingering deal risk. Buyers want a high cap and broad coverage so they are protected if the business turns out to be different from what was represented. Sellers — especially private-equity sellers seeking a clean exit and final distribution to LPs — want a low cap and a short survival period so their liability is small and ends fast.

The structure of carve-outs is just as important as the headline number. A seller can agree to a low general cap precisely because fundamental representations, fraud, and tax claims are excluded from it and sit at a much higher ceiling. Reading only the headline percentage without the carve-outs misstates the real exposure on both sides.

Frequently asked.

5 questions
01 How is the indemnification cap usually set?

As a percentage of the purchase price. General representation breaches are commonly capped at a single-digit percentage when escrow or insurance backs the claim, while fundamental representations and items like fraud and taxes are capped much higher — often at the full purchase price or with no cap at all.

02 What is the difference between the cap and the basket?

The basket (or deductible) is the floor: a minimum amount of losses the buyer must absorb before any claim is payable. The cap is the ceiling: the maximum the seller can ever be required to pay. Together they define the band of recoverable loss — claims below the basket and above the cap fall outside it.

03 Are all claims subject to the same cap?

No. Ordinary representation breaches are subject to the general cap, but fundamental representations — title, authority, capitalization — and special items such as fraud, tax, and specified known liabilities are usually carved out to a much higher cap or are uncapped. The carve-outs are as important as the headline number.

04 How does representation-and-warranty insurance affect the cap?

It tends to lower the seller's cap. When the buyer can recover from an insurance policy instead of from the seller, the parties often agree to a small seller cap — sometimes just enough to cover the policy retention — with the insurer covering losses above it. This is a major reason private-equity sellers favor R&W insurance.

05 Why does the exact cap language need to stay accessible after close?

Because indemnification claims surface months or years later, and whether a loss is recoverable turns on the precise cap, basket, survival period, and carve-out language buried in the purchase agreement. Reconstructing those terms from memory or a scattered file is how disputes start.

Keeping the indemnity structure tied to the rest of the deal record means the exposure is answerable the moment a claim appears, not after a document hunt.

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