Indemnification Caps: Limiting Liability in Contracts
What Is an Indemnification Cap?
An indemnification cap sets the maximum amount one party can recover from the other for indemnification claims. Once the cap is reached, the indemnifying party has no further obligation to compensate for losses, even if actual damages exceed the cap.
Caps are one of the most heavily negotiated provisions in acquisition agreements and commercial contracts.
How Caps Are Typically Set
- Percentage of deal value — In M&A, caps commonly range from 10% to 25% of the purchase price for general representations
- Fixed dollar amount — Some contracts set a flat cap regardless of deal size
- Multiple caps — Agreements may have different caps for different categories of claims (general vs. fundamental representations)
Cap Structures in Practice
A well-drafted agreement typically layers several limits:
- Per-claim mini-basket — Individual claims below a minimum are excluded
- Aggregate basket — Total claims must exceed a threshold before recovery begins
- General cap — Maximum recovery for standard indemnification claims
- Fundamental cap — Higher cap (often 100% of purchase price) for fundamental representation breaches
- Fraud carve-out — No cap applies to fraud claims
Red Flags for Buyers
- Caps set unreasonably low relative to deal value
- No carve-outs for fraud, willful breach, or fundamental representations
- Cap includes attorneys' fees and costs, further reducing actual recovery
Red Flags for Sellers
- Broad carve-outs that effectively eliminate the cap for large categories of claims
- Special indemnities outside the cap structure
- Vague definitions of "fundamental representations" that could expand uncapped liability
When to Consult a Lawyer
Indemnification caps directly affect your maximum financial exposure or recovery. Consider having an attorney model different scenarios to understand the practical impact of the cap structure in your specific deal.
This article is for informational purposes only and does not constitute legal advice. Consult a licensed attorney for guidance specific to your situation.