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The accuracy and completeness of many representations and covenants in an acquisition agreement are often qualified by phrases like “in all material respects” or “except where the failure to be accurate or complete would have a material adverse effect” on the target. In certain situations, the agreement calls for a “materiality scrape” to be applied. In effect, a materiality scrape removes the materiality qualifiers attached to a rep for specific situations – usually closing conditions or indemnity rights – arising under the agreement.

A recent Mayer Brown memo on the Delaware Superior Court’s decision in JanCo FS 2 v. ISS Facility Services, (Del. Super. 8/25), points out that the Court applied a contractual materiality scrape to an absence of changes rep in a way that many lawyers may not have expected, which resulted in a negative outcome for the seller. This excerpt explains the Court’s approach:

The buyer alleged that the seller breached the absence of changes representation, which provided in relevant part:

Since June 30, 2021, Sellers have operated only in the Ordinary Course of Business and have not: [(1)] suffered any damage, destruction, or Loss to any asset or suffered any other change, development, or event (individually or in the aggregate) that has had, or could be reasonably expected to have, a Material Adverse Effect on the Target Accounts; [or] [(2)] suffered or experienced any other event or circumstance which has resulted in a Material Adverse Effect on it [sic] or which is reasonably expected to result in such a Material Adverse Effect.

In analyzing the absence of changes representation, the Court cited Delaware Chancery Court precedent for the proposition that a defined term incorporates the entire definition and stated that the “proper order of operations” is to (1) replace the defined term “Material Adverse Effect” with the text of the entire definition of Material Adverse Effect and then (2) employ the materiality scrape to remove the materiality qualifiers from the text of the definition of Material Adverse Effect.

What happened when the Court applied this “order of operations” to the rep in question? Check this excerpt out:

Since June 30, 2021, Sellers have operated only in the Ordinary Course of Business and have not: [(1)] suffered any damage, destruction, or Loss to any asset or suffered any other change, development, or event (individually or in the aggregate) that has had, or could be reasonably expected to have, a Material Adverse Effect any effect, condition, circumstance or change that individually or when taken together with other conditions, effects or circumstances in the aggregate has had a material an adverse effect on the Target Accounts.

Yikes! The Court performed the same operation on the second clause of the rep, which addressed the absence of adverse changes in the target’s purchased assets (including intangible assets), liabilities, condition (financial or otherwise), properties or results of operations or to the ability of any party to consummate timely the transactions contemplated by the agreement.

Naturally, the seller complained that Court’s application of the materiality scrape made the representation overly broad, but the Court pointed out that the basket and cap provisions of the agreement both limited the seller’s indemnification exposure and served as evidence that the parties’ didn’t intend for the buyer to have to prove a material adverse effect in order to obtain indemnification.

The article goes on to recommend some practice pointers in light of the Court’s decision, including a new approach to drafting materiality scrapes that pays “particular attention to the specific drafting of the materiality qualifiers (including within defined terms used in the representations), and tailor[s] the materiality scrape so that it applies to only those representations, and only in the manner, that the parties intend.”

– John Jenkins