Materiality
Standards

SUMMARY

A materiality standard is a threshold governing disclosure requirements (e.g., in representations and warranties), performance obligations (e.g., in pre-closing covenants), and requirements for satisfaction (i.e., in closing conditions).

HIGH V. LOW

Higher materiality thresholds will limit disclosure requirements under representations and warranties, increase the scope of actions (particularly on the buy-side) that must be taken under pre-closing covenants, and make closing conditions easier to satisfy (particularly for sellers). Accordingly, higher thresholds are associated with seller-friendly formulations.

Lower thresholds will increase disclosure requirements, limit actions under pre-closing covenants, and make it more difficult to satisfy closing conditions. Accordingly, lower thresholds are typically seen as buyer-friendly.

IN ORDER

As an example, here is a list of thresholds frequently encountered in mergers and acquisitions, arranged from highest to lowest:

• material adverse effect;

• material;

• material, individually or in the aggregate; and

• material, or reasonably likely to be material, individually or in the aggregate.

TARGETS WITH SUBSIDIARIES

Where a target business is comprised of multiple entities, “taken as a whole” may be added to further raise the materiality standard.

For example, if a purchase agreement’s customer representation requires the disclosure of any customer disputes “other than those that would be material to the company and its subsidiaries, taken as a whole”—“taken as a whole” would mean a seller would not need to disclose a material customer dispute at the subsidiary-level so long as the dispute was not material to the target enterprise as a whole.

NEGOTIATIONS

Appropriate materiality thresholds depend on deal dynamics, due diligence findings, and common market practice.

DEFINITIONS & DOLLAR THRESHOLDS

Other than MAE, parties usually leave concepts like “material” undefined in the main transaction agreement, except where specific dollar thresholds might be added for added guidance.

DISPUTES

In a dispute, the exact meanings of materiality standards and their components would be determined by the contract’s terms (if defined) as well as the relevant court or arbitral body charged with resolving disputes under the contract.