February 14, 2011

Understanding “Double Materiality”

Ken Adams has been sharing his contract interpretation wisdom with us for some time. So I was excited to see that he has packaged his knowledge into a new PDF-only book entitled, “The Structure of M&A Contracts.” Here is an excerpt that deals with the phrase “double materiality”:

Another issue related to materiality is “double materiality.” It ostensibly arises when a materiality qualification is included in the bringdown condition to one party’s obligation to close as well as in one or more representations of the other party. The concern is apparently as follows: If the bringdown condition to the buyer’s obligation to close incorporates a materiality qualification, then to determine whether that condition has been satisfied you apply a discount to the accuracy required for any given seller representation to be accurate. If a seller representation itself includes a materiality qualification, the same discount is also applied to the representation, with the result that the level of accuracy required to satisfy the bringdown condition is further reduced. Consequently, the buyer could be required to close even if a seller representation was on the date of the agreement, or is at closing, materially inaccurate.

It’s common practice for drafters to seek to neutralize double materiality. To do so, either they incorporate in the bringdown condition a materiality qualification only with respect to those representations that do not themselves contain a materiality qualification, as in [12f], or for purposes of the bringdown condition they strip out materiality qualifications from those representations that have them and apply instead a materiality qualification across the board, as in [12g].

But such contortions are unnecessary. If material conveys the “affects a decision” meaning (see 2.77)–and using the proposed definition of Material and Materially would make it clear that that’s the case (see 2.86)–then materiality qualifications are not in fact equivalent to an across-the board discount on accuracy, and materiality on materiality isn’t equivalent to a discount on a discount. Instead, for purposes of determining both accuracy of a representation subject to a materiality qualification and satisfaction of a bringdown condition subject to a materiality qualification, one would consider the same external standard–whether the representation inaccuracy in question would have affected the buyer’s decision to enter into the contract or would affect the buyer’s decision to consummate the transaction. Because the same standard applies in both contexts, for purposes of determining satisfaction of the bringdown condition it’s irrelevant whether the representation too contains a materiality qualification.

So the notion of double materiality is based on a misunderstanding of how materiality operates in M&A contracts. It should come as no surprise that caselaw makes no mention of double materiality–it’s a figment of practitioner imagination.

West is new to ebooks, so for the moment the book is available only by calling West at (800) 308-1700. It only costs $25! The first chapter is available for free to give you more of a taste. Learn more about the book.