What is 'Basket Deductible'

A basket deductible is a single deductible that is designed to pay for losses from different types of risks. A basket deductible is designed to reduce the risk associated with business transactions, such as the purchase of another company, by outlining indemnification and indicating the point at which the seller may be responsible for claims.

BREAKING DOWN 'Basket Deductible'

A basket deductible limits indemnification obligations to prevent an indemnifying party from being liable for inaccuracies in or breaches of certain representations until losses exceed a specified minimum amount.

Businesses may agree to use a basket deductible when going through a merger or acquisition. The size of the basket deductible is determined during the purchase process and is often included in the purchase agreement. The use of a basket makes the purchase process smoother by including all the different risks inherent in purchasing another company and provides a level of protection to the seller. The party selling the business wants a high deductible because it reduces its exposure to losses from claims, while the buyer prefers a lower deductible because it wants to use the amount in the bargaining process.

Basket deductibles work by combining the different material risks that a buyer may experience from claims made after the purchase is complete, called post-closing claims. If the specific amount of deductible is not reached, then the buyer is responsible for the cost of the claims. If the amount of claims exceeds what the buyer and seller agreed to, the buyer may pursue a refund from the seller for the excess loss.

Basket Deductibles vs. Tipping Deductibles

Basket deductibles differ from tipping deductibles, which may also be used in acquisition agreements. Once a specified limit is reached in an agreement featuring a tipping basket, the seller will be responsible for all claims, not just the claims up to a certain point. For example, several months after purchasing a business the buyer believes that there are $600,000 worth of claims that the seller should be responsible for. If a basket deductible with a limit of $500,000 is used, the buyer is only able to pursue the seller for additional funds if total claims exceed $500,000. In this case, $100,000 ($600,000 in claims less the $500,000 deductible limit). Any amount over $500,000 would be the responsibility of the seller. In the case of a tipping basket with a limit of $500,000, any claims that bring the total to a number over $500,000 would require the seller to pay the entire claim. Since the claims total to $600,000, the seller would be responsible for all $600,000.

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