Materiality Scrape Clause
(Indemnification)

Summary

This clause contains what is known as a “materiality scrape” and may be used in the context of the indemnification provision of an acquisition agreement. This clause contains practical guidance, drafting notes, and alternate clauses. Since many of the representations in the purchase agreement are qualified by materiality, the buyer may suffer losses resulting from inaccuracies of those representations and warranties even though such losses are not material enough to constitute an actual breach. In the aggregate, these losses may be significant, but because the representations and warranties have not actually been breached (because of the materiality qualifiers) the buyer may not be entitled to indemnification from the indemnifying parties. In this situation, the indemnification basket and/or any de minimis requirement for indemnification claims serve as the “materiality” qualification for the representations. A materiality scrape is a buyer-friendly provision and sellers will likely attempt to limit the effect of the materiality scrape by excluding certain representations, particularly those that may be excluded from the basket or for which materiality is otherwise particularly important (see alternate clause, below). The seller may also respond to a materiality scrape by negotiating for a higher indemnification basket (and therefore an increased materiality threshold for indemnification liability. Another alternative is to “scrape” the materiality qualifications only for the purpose of calculation of damages but leave it intact with respect to determining whether a representation has been breached. This allows the seller to maintain the benefit of its negotiated qualifications but permits the buyer to recover the full indemnification amount, subject to any basket, once it has been determined that there has been a breach (see alternate clause, below). For further discussion of indemnification provisions and their interaction with representations and warranties, see Indemnification Provisions in Private Acquisition Agreements and Representations and Warranties in Acquisition Agreements. For an example of a materiality scrape in the context of a closing condition, see Bring-Down Condition (with Materiality Scrape).