When we use the word “material” as an adjective in ordinary writing, such as in “a material event occurred yesterday,” we typically mean that the noun (“event”) being modified by the adjective (“material”) is one of real significance, importance or consequence—i.e., not a normal run-of-the-mill occurrence. But “material” is one of those English words that has many meanings depending on the context. Thus, when Madonna proclaimed, in her 1985 song, “Material Girl,” that “we are living in a material world and I am a material girl,” her singing persona did not mean she was living in a significant world compared to other possible worlds and that she was an important woman in that world. Rather, she apparently meant that we live in a world composed of matter and that accumulating matter is preferred over other more ethereal things (and her singing persona was embracing that supposed reality fully). Dictionary definitions of the word “material” support either of these uses of the word as an adjective. But when used to modify a covenant or warranty in an acquisition agreement, the meaning of the word “material” is not necessarily derived from dictionary definitions.
Buried in the wider discussion of the meaning and application of the term “material adverse effect” in Chancellor Bouchard’s recent Delaware Court of Chancery decision, Channel Medsystems, Inc. v. Boston Scientific Corp., C.A. No. 2018-0673-AGB, 2018 WL 4719347 (Del Ch. Dec. 18, 2019), is the meaning of “material” when used in other contexts in an acquisition agreement. As noted in our prior piece about the Channel Medsystems decision, Chancellor Bouchard definitively reconfirmed what all deal professionals and their counsel should know about the meaning of the three-word term “material adverse effect”: whatever it may mean in other contexts, in the business acquisition context it means much more than just that a significantly negative impact has happened to the acquired business. Instead it has the meaning ascribed to it by Delaware precedent—i.e., an impact that “substantially threaten[s] the overall earning potential of the target in a durationally-significant manner.” No matter how significant, important or consequential the negative event, a “material adverse effect” does not exist unless that caselaw-based definition is met.
Before addressing whether there had been a “material adverse effect,” however, Chancellor Bouchard addressed another materiality issue—the meaning of “material” when used to modify a representation. He did so because the acquisition agreement only permitted the buyer’s termination if “(i) one of more the representations in the Agreement was inaccurate as of the Agreement Date and (ii) the failure of such representation(s) to be true and correct ‘has or reasonably would be expected to have a Material Adverse Effect’ on [the target].” And each of the claimed inaccurate representations had a materiality qualifier and there was no “materiality scape” provision that eliminated those qualifiers when considering whether an overall Material Adverse Effect had occurred for the purposes of the closing condition. Thus, Chancellor Bouchard was required to determine whether each of the representations was materially inaccurate before determining if any such inaccuracy would be expected to result in a Material Adverse Effect. Noting that “the concept of ‘Material Adverse Effect’ and ‘material’ are analytically distinct,” Chancellor Bouchard analyzed representations concerning “material” compliance with healthcare laws, compliance “in all material respects” with certain medical and research procedures, absence of any “material” defect in the target’s products, and the fact that the target’s filings with governmental agencies were accurate “in all material respects.”
In Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL, 2018 WL 4719347 (Del Ch. Oct. 1, 2018), Vice Chancellor Laster noted that the term “material” or “in all material respects” is typically intended by practitioners “to exclude small, de minimis, and nitpicky issues that should not derail an acquisition.” That understanding of the use of material as a modifier of a representation or covenant in an acquisition agreement could lead one to conclude that a “material default” or a “material contract” is simply one that is, using Ken Adams’ terminology, “nontrivial” or “important enough to merit attention.” Vice Chancellor Laster, however, was making that observation only to distinguish the contractual use of the modifier “material” from the common law doctrine of “material breach,” which is a doctrine that permits a non-breaching party to be “excused from performance under a contract if the other party is in material breach thereof.” And under the common law, a breach is only “material” “if it goes to the root or essence of the agreement between the parties, or touches the fundamental purpose of the contract and defeats the object of the parties in entering into the contract.” In other words, a “material breach” for the purpose of the common law doctrine excusing performance by the non-breaching party is where the covenant being breached by the breaching party “is of such importance that the contract would not have been made without it.”
But Vice-Chancellor Laster suggested that the materiality standard in a covenant requiring compliance “in all material respects” was “different and less onerous than the common law doctrine of material breach.” Instead, “in all material respects” needed to be evaluated in light of a disclosure-based standard that “requires only a ‘substantial likelihood that the … fact [of breach] would have been viewed by the reasonable [buyer] as having significantly altered the ‘total mix’ of information’” available to that buyer in deciding to enter into the agreement. Thus, the standard for evaluating whether something is “material” is not simply something “important enough to merit attention” or “nontrivial,” but something important enough that had it been know at the time of contracting it would have significantly altered the total information upon which the buyer was basing its decision to enter into the transaction, even if it would not have necessarily been so critical that it would have resulted in a decision not to do the deal. Ken Adams calls this meaning of “material” the “affects-the-decision” meaning. So, something between simply important enough to merit attention or nontrivial and something that goes to the core of the agreement’s value to the buyer is the apparent meaning of “material” when used as a modifier in a covenant or representation.
Chancellor Bouchard borrows Vice Chancellor Laster’s disclosure-based “affects-the-decision” meaning of “material” in Channel Medsystems and applies it to several different contractual representations that the buyer argued were inaccurate. Because the undisclosed facts involved the existence of some falsified documents in reports that were submitted to the FDA, it may seem far from clear how the use of the disclosure-based “affects-the-decision” standard of materiality could actually have resulted in a different outcome than would the use of the “nontrivial” or “important enough to merit attention” standard. After all, it is hard to imagine any scenario where even a few falsified documents would be deemed trivial or not worthy of attention, even if the existence of those documents did not otherwise impact the viability of the device in question. And Chancellor Bouchard, in fact, concluded that the disclosure-based “affects-the-decision” standard was met in each of the affected representations, excepting only one where he concluded that the buyer had actually “failed to identify any evidence of an actual material defect.” But in each case where Chancellor Bouchard concluded that the representation was inaccurate after applying the materiality qualifier, he concluded that a reasonable acquirer would have viewed the existence of the falsified documents as presenting a significant risk that FDA approval would not be obtained. So, however nontrivial the falsified documents were standing on their own, more was required to meet the disclosure-based materiality standard; and one could imagine a scenario in which a finding was made that the falsified documents were not of sufficient import that a reasonable acquirer would conclude that a significant risk existed that FDA approval would not be obtained. Of course, Chancellor Bouchard then concluded that despite the fact that the materiality standard had been met for the purpose of making the various representations inaccurate, no actual Material Adverse Effect occurred.
A better case demonstrating the potential difference the two materiality standards can make is Frontier Oil Corp. v. Holly Corp., No. Civ. 20502, 2005 WL 1039027 (Del Ch. April 29, 2005). In Frontier Oil, Vice Chancellor Noble concluded that an undisclosed indemnity agreement that made Frontier liable directly for matters that were the subject of certain “threatened litigation” was not a material contract for the purposes of determining the breach of a warranty made by Frontier concerning the existence of material contracts. He did so because (using the “affects-the-decision” meaning of material) the risk that liability would result from any such threatened litigation and therefore implicate that indemnity was too uncertain at the time the warranty was made to be “material,” even though it turned out later that the actual litigation was more significant and potentially impactful. But it is hard to imagine that the existence of such an indemnity would not have been considered “material” under the “important enough to merit attention” meaning, given that the existence of the threatened litigation was recognized as being potentially problematic and was believed, absent the existence of the indemnity agreement, to be housed in a separate subsidiary of Frontier.
If a matter will matter it may be best to recast a material liability, a material contract or a material litigation as a liability, contract or litigation involving (or that potentially could involve) more than a specified dollar amount (below which dollar threshold any such liability, contract or litigation would be considered insignificant). But, depending on the nature and extent of any materiality scape for the purposes of determining the existence of, or damages recoverable on account of, a breach of representations and warranties, or the satisfaction of closing conditions regarding the accuracy of the representations and warranties, any such issues may be of less concern because all materiality qualifiers are eliminated (although materiality scrapes do not ordinarily cover compliance, “in all material respect,” with covenants as a closing condition).
Sometimes the vague, if not ambiguous, “material” is all you can get and is perhaps good enough (but at least know that the term is fraught with uncertainty).
- Glenn D. West, Richard W. Slack & Joshua M. Glaser, Just Because a Really Bad Thing Happens Does Not Mean a Material Adverse Effect has Occurred: Assessing the Latest Delaware MAE Decision, Weil’s Securities Litigation Alert, December 24, 2019.↵
- See Glenn West, Avoiding the Mindless Use of the Brainless MAC Clause, Weil Insights, Weil’s Global Private Equity Watch, August 7, 2017; Glenn West, A Delaware Case Has Finally Determined That There is Such a Thing as a “Material Adverse Effect, Weil Insights, Weil’s Global Private Equity Watch, October 8, 2018.↵
- See Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL, 2018 WL 4719347, at *85 (Del Ch. Oct. 1, 2018).↵
- Kenneth A. Adams, A Manual of Style for Contract Drafting §9.1-9.16 (4th Ed. 2017).↵
- Akorn, 2018 WL at *84.↵
- Adams, supra note 4, at §9.3.↵
- See Frontier Oil, 2005 WL at *38.↵
- Adams, supra note 4, at §9.3-9.9.↵