Double Materiality Is a Figment of Practitioner Imagination: Quod Erat Demonstrandum

Those who don’t do M&A may leave the room.

In MSCD and in my ebook The Structure of M&A Contracts, I explain that double materiality is a figment of practitioner imagination, one that has left no trace in the caselaw. But at one of my “Structure of M&A Contracts” seminars the other day, I realized that I have to do a better job of showing that. Here’s my initial attempt.

Below are a representation (aka a statement of fact) and the associated bringdown condition, neither qualified by materiality:

Acme’s financial records contain no inaccuracies.

that the representations made by the Seller in article 3 were accurate on the date of this agreement and are accurate at Closing;

Now here they are, qualified by materiality:

Acme’s financial records contain no inaccuracies other than inaccuracies that would not reasonably be expected to result in a Material Adverse Change.

that the representations made by the Seller in article 3 were materially accurate on the date of this agreement and are materially accurate at Closing;

The conventional wisdom is that qualifying a representation by materiality acts as a discount on the accuracy required, and that having the bringdown condition subject to a materiality standard too applies a discount on the representation discount, the effect being that even if the representation is inaccurate, the buyer might nevertheless be compelled to close because of the reduced level of accuracy required by the condition. As a result, it’s routine that the bringdown condition is tweaked to ward off double materiality.

In effect, the conventional wisdom applies the logic of arithmetic to the relationship between representations and the bringdown condition. Here’s my illustration of that:

Acme’s financial records are at least 90% accurate.

that the representations made by the Seller in article 3 were 90% accurate on the date of this agreement and are 90% accurate at Closing;

If the financial statements are 85% accurate, the representation would be inaccurate. But due to the discount-on-a-discount effect, the financial statements would have to be less than 81% accurate (90% × 90%) for the bringdown condition not to be satisfied with respect to that representation.

But the discount-on-a-discount analysis misconstrues materiality. Something is material if it would affect the buyer’s decision. That’s demonstrated by my proposed definition of Material (and Materially):

Material” and “Materially” refer to a level of significance that would have affected any decision of a reasonable person in the Buyer’s position regarding whether to enter into this agreement or would affect any decision of a reasonable person in the Buyer’s position regarding whether to consummate the transaction contemplated by this agreement.

Here’s my illustration of the significance, or rather lack of it, of materiality on materiality:

Acme’s financial records contain no inaccuracies other than inaccuracies that would not reasonably be expected to change the Buyer’s mind.

that the representations made by the Seller in article 3 were accurate on the date of this agreement and are accurate at Closing, except, in both cases, for inaccuracies that wouldn’t change the Buyer’s mind;

This oversimplification shows that if a representation and the bringdown condition are both qualified by materiality, then instead of effecting a discount on a discount, they both look to the same external standard, which is a function of the effect on the buyer.

So double materiality is a figment of practitioner imagination. Q.E.D.

Categories M&A

About the author

Ken Adams is the leading authority on how to say clearly whatever you want to say in a contract. He’s author of A Manual of Style for Contract Drafting, and he offers online and in-person training around the world. He’s also chief content officer of LegalSifter, Inc., a company that combines artificial intelligence and expertise to assist with review of contracts.