Basket Deductible

What Is a Basket Deductible?

A basket deductible is a single deductible that is designed to fund losses from multiple types of risks. For example, the common types of insurance for businesses — property and general liability — protect against completely different types of loss exposures.

A basket deductible is usually used by companies seeking to reduce the risk associated with business transactions — such as a merger or an acquisition — by outlining indemnification and indicating the point at which the seller of the business may be responsible for claims.

A basket deductible is similar to the concept of a deductible in an insurance policy. An insurance company defines a deductible in its insurance policy; in the purchase agreement of a business, the basket deductible specifies the dollar amount of post-closing claims from the buyer which must be exceeded before the buyer may pursue a refund for the claim from the seller.

How a Basket Deductible Works

A basket deductible limits indemnification obligations in order 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 an 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 deductible makes the purchase process smoother because it combines all the different risks inherent in purchasing another company in one deductible; in addition, it 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 Deductible Vs. Tipping Deductible

Basket deductibles differ from tipping deductibles, which may also be used in purchase agreements. Both a basket deductible and a tipping deductible are referred to as indemnification baskets (in the context of purchase agreements).

Once a specified limit is reached in an agreement that includes a tipping basket, the seller will be responsible for all claims, (not just the claims up to a certain point, as is the case with basket deductibles).

For example, several months after purchasing a business the buyer believes that there is $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 total claims amount is $600,000, the seller would be responsible for the entire $600,000 amount.