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A representation might contain only one noun that could be modified by Material, as in [1].

[1]     Schedule 4.8 lists each Material contract to which the Seller is party.

But often a representation contains two such nouns, raising the question whether, for purposes of adding a materiality qualification to the representation, you should modify one or the other noun, as in [2] and [2a], or both, as in [2b]. It would make the most sense to modify the noun that represents the focus of the representation. The focus of [2] and its variations is contract defaults, not the contracts themselves, so it would make the most sense to have Material modify default, as in [2].

[2]     The Seller is not in Material default under any contract to which it is party.

[2a]   The Seller is not in default under any Material contract to which it is party.

[2b]   The Seller is not in Material default under any Material contract to which it is party.

By contrast, [2a] would seem both overinclusive and underinclusive—it would be rendered inaccurate by any default under any of the contracts in question, no matter how trivial, but wouldn’t be rendered inaccurate by default under a contract that doesn’t meet the high level of significance inherent in Material, no matter how serious the consequences of that default. And [2b] would be underinclusive—it would seem illogical to exclude from the scope of the representation, just because they involve contracts other than Material contracts, defaults that would otherwise fall within the definition of Material.

One of Hexion’s claims was that the “Material Adverse Effect” clause under the merger agreement had been triggered. I keep an eye on MAC litigation (I recommend using MAC rather than MAE as your defined term; see MSCD 8.57), as I attempted to address the subject somewhat comprehensively in chapter 8 of MSCD. More often than not the litigation is fact-driven and so of limited interest to me, and that’s the case with Hexion v. Hunstman, but the opinion did contain nuggets relevant to the contract drafter.

Heavy Burden

The court noted that any buyer seeking to invoke a MAE bears a “heavy burden” and has to show that the circumstances in question threaten the target business’s earnings potential in a “durationally-significant manner.” No surprise there—the IBP case (see MSCD 8.3) made that clear.

“Taken As a Whole”

In the Hexion–Huntsman agreement, MAE was defined to mean a material adverse effect on Huntsman and its subsidiaries “taken as a whole.” That led the court to reject the weight Hexion had assigned to problems at two Huntsman divisions in arguing that Huntsman had suffered a MAE. This seems straightforward, but it’s of interest if for no other reason than I can’t recall any recent MAC caselaw on taken as a whole.

Operation of Carve-outs

The definition of MAE contained a carve-out for industry-wide effects, unless they have a disproportionate effect on Hunstman. Hexion argued that determining whether an MAE had occurred required comparing Huntsman’s performance against that of the chemical industry in general. The court rejected this approach and held that the first step is to determine whether the target had suffered an MAE; only then do carve-outs come into play. This too stands to reason, but it’s useful to have it articulated.

How MAC Provisions Relate to Other Provisions

The court held that because in the merger agreement Hexion disclaimed reliance on any Huntsman projections, the question of whether Huntsman suffered an MAE shouldn’t be measured by how it performed compared with its projections:

Hexion agreed that the contract contained no representation or warranty with respect to Huntsman’s forecasts. To now allow the MAE analysis to hinge on Huntsman’s failure to hit its forecast targets during the period leading up to closing would eviscerate, if not render altogether void, the meaning of [the section disclaiming any representations regarding projections].

So this case can be added to the caselaw showing that in determining whether a MAC occurred under a given agreement a court might well take into account what is, or isn’t, included in the other provisions of that agreement; see MSCD 8.125–128.

Implications of the Field of Change

The court concurred with Huntsman’s expert that the terms “‘financial condition, business or results of operations’ are terms of art, to be understood within reference to their meaning in Reg S-X and Item 7, the ‘Management’s Discussion and Analysis of Financial Conditions and Results of Operation’ section” of SEC filings. In that section, companies are required to disclose their results for the reporting period as well as their results for the same time period in each of the previous two years.

That led the court to conclude that to assess whether changes in a company’s performance amount to an MAE, it’s appropriate to examine each year and quarter and compare it to the equivalent period in the previous year.

The cited terms are standard elements of what I call the “field of change” (see MSCD 8.86). I don’t think any meaning conveyed by those terms mandates the timeframe specified by the court, so I don’t see this part of the opinion affecting how MAC is defined.

Burden of Proof

The court held that Hexion had the burden of proof in showing that Huntsman had suffered an MAE. It suggested, in footnote 60, that one could specify by contract who has the burden of proof for establishing an MAE.

In that regard, here’s part of what I say regarding the burden of proof starting page 46 of my otherwise superseded law-review article on MAC (discussion of MAC burden-of-proof issues didn’t make the cut for purposes of MSCD):

If you want to address MAC-related burden-of-proof issues in a contract, state who has the burden of proof when a MAC provision or any carve-out is invoked and what the burden of persuasion is in each case. The alternative would be to have the contract be silent; if the issue were to arise in litigation, the courts would decide it. The latter approach has more to recommend it. For one thing, it seems a little unrealistic to expect a contract to address such matters comprehensively; the author has yet to see a contract that does.

For more about the opinion, check out the Deal Professor or Travis Laster.

By extrapolating from my analyses of material and material adverse change (the most recent being the third article in this issue of Deal Lawyers), I came up with the definition of material breach contained in the following provision:

2.3 Termination for Breach. If either party commits a Material Breach of its obligations under this agreement, the other party may terminate this agreement by giving the breaching party at least ten days’ prior notice, except that any such notice will not result in termination if the breaching party cures that breach before the ten-day period elapses. For purposes of this agreement, “Material Breach” means, with respect to a given breach, that a reasonable person in the position of the nonbreaching party would wish to terminate this agreement because of that breach.

What do you think?

I have in mind that this definition would apply only in the context of termination. When it comes to remedies, if you want to incorporate a significance qualifier, you’d probably want it to express a lesser level of significance, so you wouldn’t want to use the word material.

But the sad fact is that the utterly fact-specific nature of MAC disputes means that generally they’re not conducive to glib pronouncements—the best I can offer is a snooze-inducing explanation of where MAC provisions fit in the M&A scheme of things. Don’t expect to see my name in any news accounts of this dispute.

This article represents a boiled-down version of my recent New York Law Journal article on the subject. But thanks to valuable input from two readers of this blog, I’ve made some useful changes: I jettisoned the defined terms “Non-Trivial” and “Trivial” in favor of “Significant” and “Insignificant”—they’re much less awkward and there’s solid legal precedent for the notion that “significant” means less important than “material.” I’ve also simplified the definitions themselves.

By the way, my NYLJ article and the blog post in which I first reassessed “material” elicited less reader response than I would have expected, given that they discuss significant confusion over a fundamental contract concept. Perhaps if an analysis is sufficiently disruptive, people will tend to avert their gaze.

The article in question is about “material adverse change” (MAC) provisions. (Yes, materiality again!) It focuses on the definition of MAC in the agreement providing for sale of Home Depot’s supply unit, and it says the following:

A material adverse effect in this case is defined as “any event, change, circumstance or effect that individually or in the aggregate has had or would reasonably be expected to have a materially adverse effect on the business, assets, results of operations, or financial condition” of the company.

The article suggests that presence of the word “circumstance” in this definition might serve to make it easier to trigger a MAC provision:

It’s hard to say exactly what type of difference [the word "circumstance"] can make. But such words can muddy an agreement. The buyers’ lawyers might claim that “circumstance” refers to the perception of certain facts changing, despite the facts themselves staying the same. The seller would almost certainly disagree.

This dissent could land the two parties in court—something neither has an interest in happening.

I have no idea where the author got this idea; she doesn’t cite any support. I suggest that the author is attributing way too much significance to the word “circumstance.” Here’s what I say in my MAC law review article:

Instead of referring to a material adverse change, often the definition of MAC will state that MAC means any change, effect, development, or circumstance that is materially adverse to … , or some variation thereon. The extra language is superfluous and is evidence of lawyers’ penchant—generally misguided—for synonyms and near-synonyms. It is better simply to state that MAC means any material adverse change in ….

But that doesn’t mean that a misguided court couldn’t somehow attribute significance to “circumstance.” If you include blather in your contracts, you can’t complain if someone seeks to attribute unintended meaning to it.