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.
5 thoughts on “Double Materiality Is a Figment of Practitioner Imagination: Quod Erat Demonstrandum”
There seems to be a lot of conventional wisdom in M&A that is unsupported by case law. I put it down to the fact that M&A transactions are mostly about process and risk analysis (and endless meetings), with not much law, and group think develops in a way that might not occur in areas where more freehand drafting is required.
You may recall that my first responsibility is to semantics, with caselaw playing a supporting role. Well, in the case of M&A conventional wisdom, it’s support by neither semantics nor caselaw. As to the cause, I agree with you. Perhaps the M&A world is beyond redemption.
And Wright Burke shows up 8 years late for the party.
M&A is not my area of practice, so I claim the outsider’s right to comment like a kindergartener.
If the representation is that Acme’s records are accurate in all material respects at a specified point in time (eg, signing), the rep is either true or false when made. That can never change.
A closing condition that the representation was true when made and is also true at a later point amounts to requiring the seller to make the same representation at a later date. It might make sense as a way making the Seller say it has discovered nothing in the interim suggesting that the earlier rep was untrue when made. If that’s the intended meaning, I’d prefer to express it more directly. But still, the same records that were materially accurate at point A cannot become materially inaccurate at later point B.
It would be possible, of course, to represent (1) the material accuracy of records existing at point A and to later represent (2) that further records created between points A and B are also materially accurate as of point B. That would at least be intelligible, but it isn’t clear that the pairs of statements in the post are getting at anything like that.
If the above makes logical sense, there’s no room for ‘double materiality’. It’s a nonsense concept.
As for definitions, here’s my stab:
‘Material’ means ‘having any tendency to make a reasonable person in the Buyer’s position more likely or less likely to sign this agreement or, having signed, to close’.
‘Materially adverse’ means ‘having any tendency to make a reasonable person in the Buyer’s position less likely to sign this agreement or, having signed, to close’.
I suppose the liquor has long since been put away, in one sense or another. Price of tardiness, I guess. -Wright
What took you so long! :-) And as usual from A. Wright Burke, mission creep! The materiality stuff has been superseded by what’s in MSCD4. I’ll revisit your thoughts when it’s time to prepare MSCD5.