Materiality serves a purpose in representations, in the bringdown condition, and in indemnification provisions (in the form of a basket). It would be redundant to include it in termination provisions too.

The cumulative effect of non-material inaccuracies is something that you’d address in the brindown condition with “individually or in the aggregate” language. It wouldn’t be a factor that materializes separately in termination provisions.

So nothing in your comment suggest that the reasoning in my post is flawed. But this stuff isn’t conducive to analysis by blog-post comment. I’m hopeful that before too long I’ll have produced a full analysis for public consumption. In the course of working on it, I’ll revisit your comment.

Ken

Materiality scraping provisions basically serve as a nickel-and-diming purchase price adjustment, a means to close and sue. They allow a buyer to close the deal (because it is forced to by reason of the rep bringdown condition being qualified by materiality) but then sue to recover under the indemnity for the various immaterial breaches. With a small basket/deductible, the buyer might even recover money. But at worst the buyer gets the basket chewed through. When I represent seller, I push hard for materiality scraping to be eliminated and the most effective way I get clients to back me on it (and winning the day in the negotiation) is by characterizing it as a purchase price adjustment. Ennables the client to tell her counterparts at the buyer “Why do you want to nickel and dime me?”

If the bringdown condition is subject to a materiality standard, immaterial representation inaccuracies are relevant only for purposes of indemnification, unless you make representations too subject to a materiality standard. You can do that in the representations themselves or effectively do so by means of an indemnification basket.

I suggest that using a basket makes more sense: it gives you one item to negotiate, as opposed to negotiating materiality or other related qualificatios in perhaps numerous representations.

And regarding the merit of incorporating a materiality standard in the bringdown condition, I suggest that that horse has left the stable: in the ABA 2007 Deal Points survey, 98% of the 143 agreements in the study incorporated materiality in the bringdown condition.

But your comment reminded me of a potentially useful distinction. Materiality qualifications can serve to address (1) inaccuracies that the seller is aware of at signing, (2) inaccuracies that the seller is aware of at closing and that are due to changes that occur between signing and closing, and (3) inaccuracies that the seller is unaware of, both at signing and at closing. A seller may elect to address the first of these by means of materiality exceptions in the representations, on the grounds that it wants the basket to be solely for that which is unknown at signing. In other words, it wants to take the signing inaccuracies off the table rather than get into the uncertain business of having a dollar value assigned to them.

Ken

So let’s say we have the rep “Except as set forth on Schedule N, nothing bad has occurred since 1/1/08.”

- For the disclosure piece, some paralegal or first year now has to go through and disclose every single bad event OR we have to qualify the rep. The qualification is typically “nothing materially bad has occurred” or “nothing bad has occurred except as would be a MAC” or “nothing likely to be worse than $x has occurred.”

- For the closing piece, the company can either breach, albeit immaterially because something bad has always happened if there is no limit, or we have to qualify the closing condition (“the reps are true in all material respects” and the rep has no qualifier) OR we give an unqualified closing condition (“the reps are all true” but we qualify the actual reps “nothing materially bad has happened” or one of the other qualifiers described above)

- For the indemnity, we have to assume that there is some amount of pain that sophisticated buyers are willing to tolerate. This ends up with all the caps and baskets and minibaskets and whatnot. But still, you have the same dichotomy: typically, “I seller will indemnify you for all breaches of reps” (with reps qualified by materiality) or “I seller will indemnify you for all material breaches of reps” (with reps not so qualified). This is the part where “the business people” get involved and want to know EXACTLY how much pain they’re exposed to. So rather than lawyers saying “well, it’s material breaches, and that’s typically [10%] and so on,” you stop talking about materiality at all for the indemnity. You say “I seller will indemnify you for all breaches of reps without giving effect to any materiality qualifier for amounts in excess of $A but less than $A+B.” (Ignore the negotiation of whether you then go back to dollar one, whether there is a per-claim threshhold, etc.)

That’s why you scrape for the indemnity. But for disclosure and closing, you have to have a materiality qualifier somewhere. It seems to make sense to have the qualifier in the warranty so it’s consistent for the two places you do need it and take it out for the one place you don’t, rather than inserting materiality qualifiers in two other places just so it doesn’t exist in one.

Further, there are certain reps that you wouldn’t want qualified by materiality for closing purposes. For example, if you took out all of the qualifiers in the reps then made the closing condition that the reps are all materially true, you might end up arguing that the due authorization or qualification rep (which you might be black or white on) not being true is immaterial or material in the grand scheme of things. Perhaps it’s better to qualify only the reps you want qualified and avoid that discussion.

Anyway, just some quick thoughts.