Indemnification Cap
The maximum aggregate amount a seller may be obligated to pay under the indemnification provisions of an M&A agreement. Limits seller exposure for breach of representations and warranties.
An indemnification cap is the maximum aggregate amount a seller may be obligated to pay under the indemnification provisions of an M&A agreement. The cap limits the seller's exposure for breach of representations and warranties and provides cost certainty for the post-closing period.
Cap categories
General cap: applies to breach of general representations and warranties. Typical sizing in current Texas market: 10%–15% of enterprise value where RWI is not used; reduced to RWI retention level (~0.5% of EV) where RWI replaces seller indemnity.
Fundamental cap: applies to breach of fundamental reps (organization, capitalization, authority, ownership) and certain other specified items. Typically equal to 100% of purchase price.
Special indemnity caps: apply to specifically identified risks (pre-closing environmental, identified litigation, tax). Negotiated separately based on the particular risk's expected severity.
Carve-outs from the cap
Most caps exclude: (1) fundamental reps; (2) tax reps; (3) fraud or intentional misrepresentation; (4) covenants; (5) specific indemnities. Fraud carve-outs are essentially universal, sellers cannot contractually limit liability for fraud under Texas law in most circumstances.
RWI implications
Buy-side RWI policy limits typically range from 10% to 30% of enterprise value, sized to provide indemnification coverage above the seller's contractual cap (or in lieu of any seller cap). A "tower" of indemnification often runs: escrow → seller direct cap → RWI policy → uninsured exposure.