Humans, animals, and modern machine learning models exhibit impressive abilities to learn complex behaviors and generalize these behaviors to unseen situations. This ability requires us to learn rules and regularities that allow for such generalizations. At the same time, in most complex environments, any rule will have its exceptions. How do learning systems balance between learning general regularities and memorizing exceptions? We argue that a lack of task paradigms has hindered the study of this essential ability. To address this gap, we introduce a novel task, transitive inference with exceptions, that tests for relational generalization and memorization of an exception to the relational rule. We then analytically characterize the behavior of a simple, theoretically tractable model of neural network learning (kernel ridge regression) across a broad family of representations and task parameters. We find that these models can balance between relational generalization and memorization, but unlike for transitive inference without an exception, successful generalization is sensitive to the specific representational geometry. We explain why this task is more challenging mechanistically by drawing on our analytical theory. Finally, we validate our theoretical insights in pretrained language models that are finetuned on ordered relations, finding that these models successfully generalize according to the transitive rule, but also make the kinds of systematic mistakes predicted by our theory. Overall, our theory shows how learning systems can balance between relational generalization and memorization, explains how this can go wrong, and emphasizes the need for new task paradigms designed to probe this ability.