Business Law Breakdown: Materiality Issues in M&A Deals

Materiality in M&A deals is, these days, normally a heavily negotiated issue. There’s often a push and pull between sellers and purchasers. Sellers often try to qualify their representations and warranties in the definitive agreements with materiality in order to avoid being found liable for immaterial breaches or for immaterial damages.

Indemnity Basket

Parties typically include an indemnity “basket” to try and address this. For example, a basket might sound something a lot like, “The seller will not be liable for a breach of a rep or warranty unless the loss suffered by the purchaser as a result of that breach exceeds a certain minimum or a material amount.”

Double Materiality Scrape

Purchasers often attempt to include a double materiality scrape in definitive agreements. The provision typically excludes or “scrapes” the materiality qualifiers in sellers’ reps and warranties for purposes of determining whether a breach of a rep or warranty has occurred, and also the amount of the identifiable losses resulting from that breach. Hence, a double scrape.

Materiality Scrapes: Seller Perspective

In response to this, sellers typically resist these materiality scrapes, arguing that such provisions render the materiality qualifiers in the reps and warranties as pointless. Also, they often contend that it saddles them with an unreasonable burden of disclosing everything they can possibly imagine in the disclosure schedules to ensure that they’re not in breach of a representation or warranty that would be more appropriately qualified by materiality.

Materiality Scrapes: Purchaser Perspective

On the other hand, purchasers, from their perspective, including a materiality scrape is already addressed in the indemnity basket. If not, the purchaser would first have to overcome the materiality qualifier in the rep and warranty, and then prove that the losses sustained exceed the minimum amount in the indemnity basket. Also, having a materiality scrape often avoids post-closing disputes over the meaning of what is material, if the seller is found to be in breach of a rep and warranty that’s also qualified by materiality.

Compromises Regarding Materiality in M&A Deals

Often times, the parties will compromise, and there is a middle ground. Materiality qualifiers will continue to apply to determine whether the seller breached a rep or a warranty, but if the breach is found to have occurred, that materiality qualifier will be ignored for purposes of determining damages. The result is that it’s still subject to an indemnity basket and other indemnity limitations in the definitive agreement, but the purchaser will be entitled to recover the full amount of its damages resulting from a breach.

Basically, often sellers will say, “I have not breached any material contracts prior to the date of closing, and even if I breached them, if the damage is less than $10,000,”—or the basket—”then I don’t owe you anything.” It’s only if it goes over that basket, then it becomes more material.

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