A materiality scrape provision works to disregard for purposes of indemnification, any materiality or
material adverse effect qualifiers found in representations.
Here's a typical rendering of the provision: "For purposes of this indemnification section, the representations and
warranties made by the Seller in this Agreement shall not be deemed qualified by any references to materiality or
Material Adverse Effect." [This provision was provided by Tyler B. Dempsey, a partner at Troutman Sanders.]
First, let's lay the contextual groundwork for the provision. We all know that in a cash-financed acquisition, the
seller makes the majority of the representations (and covenants, but for purposes of this article, let's focus just on
representations) in order to induce the buyer to purchase the business.
Recognizing that the seller will bear the financial risk if the facts asserted in any of its representations turn out not
to have been true, the seller will aggressively negotiate to qualify (i.e., dilute) its representations. For example,
instead of representing that its assets are not subject to any liens, the seller might try to qualify by asserting that its
"material assets" are not subject to liens, or that its assets are not subject to "material liens" or liens that "will
have" or "may have"…"a material adverse impact on its business." By qualifying, the seller believes that it has
successfully shifted some of the risk of the specified contingency (e.g., encumbrances) to the buyer (even if the
seller might have only a vague idea of the consequences of how it drafts its qualifier, of which I list just four of the
many possible permutations).
The seller keeps pushing, attempting also to qualify its indemnification provision, agreeing only to indemnify for
"material misrepresentation," or a misrepresentation of a "material representation," etc., which infuses by "stealth"
a materiality requirement into otherwise unqualified representations, or introduces multiple levels of materiality (e.
g., indemnification only for material breaches of representations already qualified by materiality).
And on top of all of that, the seller typically negotiates some kind of indemnification deductible (and even better with
a hard cap added)—either in the form of a basket (i.e., seller indemnifies only for liability amounts exceeding
basket, but under the cap), or a threshold (or "tipping basket," i.e., seller indemnifies only after liability amount
reaches threshold, but all the way back to the first penny, again subject to the cap), or a de minimus provision (i.e.,
seller does not indemnify for small claims no matter what). If the seller also makes sure that any "cumulative
remedies" provision acknowledges the "exclusive" nature of the indemnification remedy for the specified breaches,
then the seller has shifted a good deal of the risk of its own misrepresentations to the buyer.
Talk about 'winning.'
One of the ways a buyer can reflect the risk of seller misrepresentation back to the party making the representation
is to negotiate a materiality scrape provision, which allows the seller to make materiality-qualified representations,
but "scrapes off" all materiality qualifiers for purposes of indemnification. The effect on our example would be to
reduce the risk of buyer claims of fraud in the event of misrepresentation, but to allow the buyer to assert a claim
for indemnification even for non-material liens (subject to any basket or threshold). In fact, the essence of the
buyer's principal argument is that the seller is already protected by one layer of "materiality," personified by the
basket or threshold. The seller's quid pro quo may be a higher deductible, or to replace any threshold with a true
basket.
Materiality scrape provisions are tricky to negotiate because they may introduce unintended ambiguity, especially if
"materiality" is indivisible from the underlying representation (e.g., the 10b-5 Full Disclosure representation or the
MAC or No Material Adverse Change representation), or with respect to list-based representations, among others.
Mr. Dempsey, of Troutman Sanders, offers some insight. "From a seller's perspective, a materiality scrape can
certainly result in yielding back to the buyer some of the hard-fought victories obtained in the representations and
warranties. I think it is safe to say that this provision is not always properly understood or analyzed by deal parties.
In addition to the awkward results in the context of certain representations, such as a 10b-5 representation or 'no
MAE' representation, the materiality scrape leads to a potential outcome where the buyer is entitled to seek
indemnification for items or events that, by definition, it did not care to know about when it agreed to purchase the
business. While every deal of course has its own facts and circumstances, sellers and their counsel may have
some difficulty grasping the logic of that outcome."
He continues: "Common compromises to address each party's perspective on the materiality scrape can include
using dollar-specific thresholds within the representations and warranties instead of materiality qualifiers. Also,
once identified, the awkward results I mentioned can be handled by clearly stating that the materiality scrape does
not apply to certain specified representations. Finally, a common compromise is to provide that the materiality
scrape will apply for purposes of calculating damages or losses but not with respect to determining whether a
breach has occurred."
'Force Majeure' Provision
Next, let's talk about force majeure, an innocuous-looking provision usually buried somewhere toward the back of
the contract, and sometimes glossed over as "mere" boilerplate. Force majeure provisions generally work to
excuse performance if an unforeseen event beyond the control of the impacted party prevents it from performing its
obligations, which historically conjures images of natural disasters and "acts of God." Force majeure disputes
typically revolve around the threshold issue of whether the specified event is covered by the provision.
A lot of contract drafting is about memorializing how the parties decide to allocate risk, and force majeure is no
exception. How do the parties reconcile the need for specificity (in order to show a court that the specified
contingency is one that the parties actually intended to be covered) with the very natural "just in case" desire to
capture similar contingencies? In most cases, you'll need to do both.
The general rule in New York (One World Trade Ctr., LLC v. Cantor Fitzgerald Sec., 789 N.Y.S.2d 652, 655 (N.Y.
Sup. Ct. 2004)) is that the impacted party is excused only to the extent that the provision specifically lists the type of
event that actually prevents performance. Analytically, you draft the provision much in the way an insurance
company drafts a policy—e.g., see how homeowner's policies typically treat water damage caused by wind-driven
rain versus water damage caused by "Bound Brook-type" floods versus water damage caused by day-to-day
hydrostatic pressure. So if you're the obligor, and you want to cover "tsunami" (i.e., you don't want to bear the risk of
having to perform in the event of a tsunami), it's better to list "tsunami," than to hope that a court will include
"tsunami" as a natural extension of the listed "earthquakes." And since courts look askance at "economic
hardship," if you want to include the economic impact of the specified disaster (think of how long it's taken for New
Orleans and Haiti to get back on its feet), then it's better to draft it in there (and specify a procedure and time-line).
Most attorneys make sure to include the catch-all "including, but not limited to" language to capture other
contingencies. Depending on the court reviewing and how carefully the parties draft, the parties might unwittingly
draft the catch-all to capture only other similar types of events when they intended to capture dissimilar events as
well, which narrows the scope of the provision, or to capture similar and dissimilar types of events, when they
intended to capture only similar events, which broadens the scope of the provision.
For purposes of this article, let's assume that the specified event cannot be controlled by the impacted party, and
that the specified event prevents the impacted party from performing. The former takes the proverbial "labor strike"
by the impacted party's employees off the table. Let's focus only on "foreseeability." Generally, but not always (see
below), courts will respect the parties' freedom to allocate risk. If there's any ambiguity about whether an event is
covered, the courts will analyze whether the event was "foreseeable."
William Wright, a real estate law partner in Balch & Bingham, offers some insight. "The common law contractual
defense of force majeure includes a requirement that the performance-excusing event have been unforeseeable at
the time of the contract. This is based on the theory that the non-occurrence of such an event was a basic
assumption or condition of the contract. There should be no inquiry into foreseeability, where an unambiguous
contract provision clearly allocates the risk that the occurrence of certain events may delay or prevent performance.
This has not precluded some courts from applying the requirement in such situations. Even force majeure
provisions that very specifically list certain events, however, may contain a catch-all phrase for 'other similar or
dissimilar events.'"
Mr. Wright continues that the non-specificity of a catch-all phrase may allow an unintended foreseeability
requirement to "creep into the contract," at least with respect to such "similar or dissimilar" events. "To avoid this,
the drafter should add a sentence to the following effect: 'In allocating the risk of delay or failure of performance of
their respective obligations under this Agreement, the parties have not taken into account the possible occurrence
of any of the events listed herein or any similar or dissimilar events beyond their control, irrespective of whether
such listed, similar or dissimilar events were foreseeable as of the date of this Agreement.'"
In situations where it is appropriate to apply a foreseeability requirement, the extent to which an event is or is not
foreseeable may be a function of, among other things, the frequency with which such an event occurs in an area,
Mr. Wright notes. "For example, an unprecedented flood event in a desert is less likely to be deemed to have been
foreseeable than a flood event along the Mississippi River that is similar to any number of other previous floods
that have occurred there," he said. "It is important to note that the requirement is that the event be foreseeable, not
that it be statistically likely or probable. For example, it would seem that although it would be statistically
improbable that a specific site on the Gulf Coast would be struck by a hurricane, it would be foreseeable that such
an event may occur in a general area where there are several hurricanes annually."
Lawrence Hsieh, a corporate attorney and an editor at the Practical Law Company in New York. Lawrence is
author of the "Corporate Transactions Handbook."
Reprinted with permission from the May 12, 2011 edition of the New York Law Journal © 2011 ALM Media
Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact
877-257-3382, reprints@alm.com or visit www.almreprints.com.
material adverse effect qualifiers found in representations.
Here's a typical rendering of the provision: "For purposes of this indemnification section, the representations and
warranties made by the Seller in this Agreement shall not be deemed qualified by any references to materiality or
Material Adverse Effect." [This provision was provided by Tyler B. Dempsey, a partner at Troutman Sanders.]
First, let's lay the contextual groundwork for the provision. We all know that in a cash-financed acquisition, the
seller makes the majority of the representations (and covenants, but for purposes of this article, let's focus just on
representations) in order to induce the buyer to purchase the business.
Recognizing that the seller will bear the financial risk if the facts asserted in any of its representations turn out not
to have been true, the seller will aggressively negotiate to qualify (i.e., dilute) its representations. For example,
instead of representing that its assets are not subject to any liens, the seller might try to qualify by asserting that its
"material assets" are not subject to liens, or that its assets are not subject to "material liens" or liens that "will
have" or "may have"…"a material adverse impact on its business." By qualifying, the seller believes that it has
successfully shifted some of the risk of the specified contingency (e.g., encumbrances) to the buyer (even if the
seller might have only a vague idea of the consequences of how it drafts its qualifier, of which I list just four of the
many possible permutations).
The seller keeps pushing, attempting also to qualify its indemnification provision, agreeing only to indemnify for
"material misrepresentation," or a misrepresentation of a "material representation," etc., which infuses by "stealth"
a materiality requirement into otherwise unqualified representations, or introduces multiple levels of materiality (e.
g., indemnification only for material breaches of representations already qualified by materiality).
And on top of all of that, the seller typically negotiates some kind of indemnification deductible (and even better with
a hard cap added)—either in the form of a basket (i.e., seller indemnifies only for liability amounts exceeding
basket, but under the cap), or a threshold (or "tipping basket," i.e., seller indemnifies only after liability amount
reaches threshold, but all the way back to the first penny, again subject to the cap), or a de minimus provision (i.e.,
seller does not indemnify for small claims no matter what). If the seller also makes sure that any "cumulative
remedies" provision acknowledges the "exclusive" nature of the indemnification remedy for the specified breaches,
then the seller has shifted a good deal of the risk of its own misrepresentations to the buyer.
Talk about 'winning.'
One of the ways a buyer can reflect the risk of seller misrepresentation back to the party making the representation
is to negotiate a materiality scrape provision, which allows the seller to make materiality-qualified representations,
but "scrapes off" all materiality qualifiers for purposes of indemnification. The effect on our example would be to
reduce the risk of buyer claims of fraud in the event of misrepresentation, but to allow the buyer to assert a claim
for indemnification even for non-material liens (subject to any basket or threshold). In fact, the essence of the
buyer's principal argument is that the seller is already protected by one layer of "materiality," personified by the
basket or threshold. The seller's quid pro quo may be a higher deductible, or to replace any threshold with a true
basket.
Materiality scrape provisions are tricky to negotiate because they may introduce unintended ambiguity, especially if
"materiality" is indivisible from the underlying representation (e.g., the 10b-5 Full Disclosure representation or the
MAC or No Material Adverse Change representation), or with respect to list-based representations, among others.
Mr. Dempsey, of Troutman Sanders, offers some insight. "From a seller's perspective, a materiality scrape can
certainly result in yielding back to the buyer some of the hard-fought victories obtained in the representations and
warranties. I think it is safe to say that this provision is not always properly understood or analyzed by deal parties.
In addition to the awkward results in the context of certain representations, such as a 10b-5 representation or 'no
MAE' representation, the materiality scrape leads to a potential outcome where the buyer is entitled to seek
indemnification for items or events that, by definition, it did not care to know about when it agreed to purchase the
business. While every deal of course has its own facts and circumstances, sellers and their counsel may have
some difficulty grasping the logic of that outcome."
He continues: "Common compromises to address each party's perspective on the materiality scrape can include
using dollar-specific thresholds within the representations and warranties instead of materiality qualifiers. Also,
once identified, the awkward results I mentioned can be handled by clearly stating that the materiality scrape does
not apply to certain specified representations. Finally, a common compromise is to provide that the materiality
scrape will apply for purposes of calculating damages or losses but not with respect to determining whether a
breach has occurred."
'Force Majeure' Provision
Next, let's talk about force majeure, an innocuous-looking provision usually buried somewhere toward the back of
the contract, and sometimes glossed over as "mere" boilerplate. Force majeure provisions generally work to
excuse performance if an unforeseen event beyond the control of the impacted party prevents it from performing its
obligations, which historically conjures images of natural disasters and "acts of God." Force majeure disputes
typically revolve around the threshold issue of whether the specified event is covered by the provision.
A lot of contract drafting is about memorializing how the parties decide to allocate risk, and force majeure is no
exception. How do the parties reconcile the need for specificity (in order to show a court that the specified
contingency is one that the parties actually intended to be covered) with the very natural "just in case" desire to
capture similar contingencies? In most cases, you'll need to do both.
The general rule in New York (One World Trade Ctr., LLC v. Cantor Fitzgerald Sec., 789 N.Y.S.2d 652, 655 (N.Y.
Sup. Ct. 2004)) is that the impacted party is excused only to the extent that the provision specifically lists the type of
event that actually prevents performance. Analytically, you draft the provision much in the way an insurance
company drafts a policy—e.g., see how homeowner's policies typically treat water damage caused by wind-driven
rain versus water damage caused by "Bound Brook-type" floods versus water damage caused by day-to-day
hydrostatic pressure. So if you're the obligor, and you want to cover "tsunami" (i.e., you don't want to bear the risk of
having to perform in the event of a tsunami), it's better to list "tsunami," than to hope that a court will include
"tsunami" as a natural extension of the listed "earthquakes." And since courts look askance at "economic
hardship," if you want to include the economic impact of the specified disaster (think of how long it's taken for New
Orleans and Haiti to get back on its feet), then it's better to draft it in there (and specify a procedure and time-line).
Most attorneys make sure to include the catch-all "including, but not limited to" language to capture other
contingencies. Depending on the court reviewing and how carefully the parties draft, the parties might unwittingly
draft the catch-all to capture only other similar types of events when they intended to capture dissimilar events as
well, which narrows the scope of the provision, or to capture similar and dissimilar types of events, when they
intended to capture only similar events, which broadens the scope of the provision.
For purposes of this article, let's assume that the specified event cannot be controlled by the impacted party, and
that the specified event prevents the impacted party from performing. The former takes the proverbial "labor strike"
by the impacted party's employees off the table. Let's focus only on "foreseeability." Generally, but not always (see
below), courts will respect the parties' freedom to allocate risk. If there's any ambiguity about whether an event is
covered, the courts will analyze whether the event was "foreseeable."
William Wright, a real estate law partner in Balch & Bingham, offers some insight. "The common law contractual
defense of force majeure includes a requirement that the performance-excusing event have been unforeseeable at
the time of the contract. This is based on the theory that the non-occurrence of such an event was a basic
assumption or condition of the contract. There should be no inquiry into foreseeability, where an unambiguous
contract provision clearly allocates the risk that the occurrence of certain events may delay or prevent performance.
This has not precluded some courts from applying the requirement in such situations. Even force majeure
provisions that very specifically list certain events, however, may contain a catch-all phrase for 'other similar or
dissimilar events.'"
Mr. Wright continues that the non-specificity of a catch-all phrase may allow an unintended foreseeability
requirement to "creep into the contract," at least with respect to such "similar or dissimilar" events. "To avoid this,
the drafter should add a sentence to the following effect: 'In allocating the risk of delay or failure of performance of
their respective obligations under this Agreement, the parties have not taken into account the possible occurrence
of any of the events listed herein or any similar or dissimilar events beyond their control, irrespective of whether
such listed, similar or dissimilar events were foreseeable as of the date of this Agreement.'"
In situations where it is appropriate to apply a foreseeability requirement, the extent to which an event is or is not
foreseeable may be a function of, among other things, the frequency with which such an event occurs in an area,
Mr. Wright notes. "For example, an unprecedented flood event in a desert is less likely to be deemed to have been
foreseeable than a flood event along the Mississippi River that is similar to any number of other previous floods
that have occurred there," he said. "It is important to note that the requirement is that the event be foreseeable, not
that it be statistically likely or probable. For example, it would seem that although it would be statistically
improbable that a specific site on the Gulf Coast would be struck by a hurricane, it would be foreseeable that such
an event may occur in a general area where there are several hurricanes annually."
Lawrence Hsieh, a corporate attorney and an editor at the Practical Law Company in New York. Lawrence is
author of the "Corporate Transactions Handbook."
Reprinted with permission from the May 12, 2011 edition of the New York Law Journal © 2011 ALM Media
Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact
877-257-3382, reprints@alm.com or visit www.almreprints.com.
 |  |  |  |
© 2008 Lawrence Hsieh
New York Law Journal - Archived Article - May 12, 2011
"Materiality Scrape and Force Majeure Provisions"
"Materiality Scrape and Force Majeure Provisions"
This website and other publications of Lawrence Hsieh contain practical and useful information on a wide variety of small business
contract matters. The information in this website or any publication of Lawrence Hsieh is not intended to constitute legal,
accounting or professional advice. If you require legal or other expert assistance, then you should seek the services of a licensed
professional. Thank you.
contract matters. The information in this website or any publication of Lawrence Hsieh is not intended to constitute legal,
accounting or professional advice. If you require legal or other expert assistance, then you should seek the services of a licensed
professional. Thank you.
The Contract Adviser
Practical Common Sense Insight about
Contracts and Corporate Transactions
Contracts and Corporate Transactions
Special thanks to Tyler B. Dempsey, a partner at Troutman Sanders and William Wright, a real estate law
partner in Balch & Bingham for their expert guidance.
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The article is also available at the ALM "GC New York" website (free registration). Click here to read the article
at GC New York.
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partner in Balch & Bingham for their expert guidance.
To listen, click on the audio icon (to the right).
Or, click here to listen to the audio file on You Tube.
The article is also available at the ALM "GC New York" website (free registration). Click here to read the article
at GC New York.
Click here to return to the NYLJ archived articles page.
Note to readers: In each of my New York Law Journal columns, I will focus on two types of provisions - a “deal
point” provision and a “boilerplate” provision. Today, let’s focus on the materiality scrape provision, which you
may encounter in acquisition agreements, and the force majeure provision, a staple of boilerplate.
point” provision and a “boilerplate” provision. Today, let’s focus on the materiality scrape provision, which you
may encounter in acquisition agreements, and the force majeure provision, a staple of boilerplate.