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Materiality scrapes are a key risk allocation mechanism in M&A. A recent, and notably rare, Delaware dispute illustrates the complexities that can arise when applying a materiality scrape in practice. We review the court’s ruling to provide negotiation and drafting takeaways for Canadian dealmakers.
Our key practical takeaways include:
- Deal point studies indicate that more than half of Canadian deals include at least one type of materiality scrape and that their use in Canadian M&A has been growing.
- Where a materiality scrape is used in the indemnity section of an M&A agreement, the parties should consider clearly specifying whether it applies to (1) whether a breach of a representation has occurred, or (2) the losses flowing from such a breach, or (3) both.
- An indemnity section materiality scrape can significantly alter the parties’ post-closing risk allocation. If included, it should be considered in tandem with related limitation of liability clauses such as tipping and deductible baskets.
- The application of a materiality scrape to certain materiality qualifiers may be more complicated than others. This should be kept in mind when deciding which type of materiality qualifier to apply to a particular representation.
- A principal explanation for the increased use of indemnity section materiality scrapes in Canadian M&A is likely the increased use of representation and warranty insurance (RWI) in Canadian dealmaking.
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Materiality Scrapes and Trends in Brief
A materiality scrape is a clause in an M&A agreement that eliminates, or “scrapes” out, the effect of materiality qualifiers found elsewhere in the agreement.
Materiality scrapes typically appear in one or both of two different sections of an M&A agreement: (1) the closing condition regarding the accuracy of the seller’s representations and warranties (R&Ws),1 and/or (2) the seller’s post-closing indemnities for a breach of its R&Ws.2
Materiality scrapes are buyer-friendly. The materiality qualifiers they negate operate in the seller’s favour by increasing the hurdle the buyer must clear to establish (1) that the closing condition regarding the accuracy of the seller’s R&Ws has not been satisfied, and/or (2) that indemnification is owed for a breached seller R&W.
Both varieties of materiality scrapes are historically more common in the U.S. than in Canadian M&A.3 That said, more than half of Canadian deals include at least one type of materiality scrape and the use of materiality scrapes in the indemnity section of Canadian M&A agreements has been steadily growing.4
It is therefore important to appreciate that a materiality scrape in the indemnity section of an M&A agreement can generally take one of two forms. It can scrape out materiality qualifiers for all indemnification-related purposes, i.e., both for the purpose of determining whether a seller R&W has been breached and for the purpose of calculating the amount of buyer losses flowing from that breach.5 Or it can scrape out materiality qualifiers solely for the purpose of calculating the amount of buyer losses flowing from a breached seller R&W.6
Deal point studies indicate that in Canada, where a materiality scrape is included in the indemnity section of an M&A agreement, 56% of the time it will scrape out materiality qualifiers for all indemnification-related purposes.7 In the U.S., this figure is 82%.8
What Happens When a Materiality Scrape Meets an MAE Qualifier?
The dispute before the Delaware Superior Court in JanCo v. ISS Facility Services9 involved an indemnity section materiality scrape and arose from the sale of a cleaning business for US$80 million under an asset purchase agreement (APA).
The APA included relatively standard seller R&Ws, including an absence of changes representation. This provided that, since June 30, 2021 – being several months before the closing date – the target had not suffered any adverse event that had, or could reasonably be expected to have, a “Material Adverse Effect” (the No Adverse Event Rep).
The APA’s definition of a Material Adverse Effect (MAE) was also relatively standard. It was near a page long and, as most MAE definitions do, it included several carveouts to what could cause an MAE.10
The buyer commenced a post-closing breach of R&W claim against the sellers under the No Adverse Event Rep. The claim was based on higher labour costs and operational disruptions caused by a bungled rollout of the target’s new HR system. The APA indemnity section included a materiality scrape that scraped out materiality qualifiers for the purpose of determining whether any of the seller’s R&Ws had been breached, and thus was (arguably) functionally similar to a materiality scrape that scraped out materiality qualifiers for all indemnification-related purposes.11 The key question for the court was the appropriate interaction of the materiality scrape with the MAE qualifier in the No Adverse Event Rep.
The Materiality Scrape Creates a Flat Seller Representation and a Low Buyer Hurdle
The buyer argued that the materiality scrape meant that the buyer only needed to prove it had “suffered some adverse effect, but not necessarily a material one.” The sellers argued that this rendered the representation unreasonably overbroad. The court ultimately agreed with the buyer but also noted that neither party’s application of the materiality scrape to the No Adverse Event Rep was technically correct.
The sellers’ approach failed because simply striking out the MAE definition from the No Adverse Event Rep left unworkable gaps in the language. The court also rejected the sellers’ concern that the buyer’s approach rendered the No Adverse Event Rep unreasonably overbroad, finding that the APA’s indemnity basket and cap mitigated this. The basket set a minimum damages threshold and the cap set a maximum damages amount, and together they indicated an objective intent for the materiality scrape to reduce the No Adverse Event Rep to a flat R&W.
The error in the buyer’s approach was that it was entirely conceptual. It argued that the materiality scrape simply meant the No Adverse Event Rep should be breached by any adverse effect rather than only a material one. While this ultimate result was correct, the court held that the proper method was first to import the full MAE definition into the No Adverse Event Rep and then to strike every reference to materiality in the combined representation. Without this “proper order of operations”, the court found the interaction of the materiality scrape and the representation would become “illegible”.
The court added that it was inconsequential that the result was a “low hurdle” that was easy for the buyer to clear. It would not “punish” the buyer for “succeeding at the bargaining table.”
Key Negotiation and Drafting Takeaways for Canadian Dealmakers
It remains to be seen whether a Canadian court would take any guidance from JanCo v. ISS. Even so, the ruling remains valuable. We are unaware of any previous precedent in Canada or Delaware applying a materiality scrape in an M&A dispute, and the court did not cite any.
Materiality Scrapes Can Take Different Forms
The ruling’s principal lesson is that materiality scrapes can take different forms. Regarding materiality scrapes in the indemnity section of an M&A agreement, the ruling highlights the difference between scraping out materiality qualifiers for all indemnification purposes versus only for the purpose of calculating damages. M&A parties should carefully consider not only whether to include an indemnity section materiality scrape but also which of these two varieties to employ if one is to be included.
Materiality Scrapes Should Be Drafted Carefully
The drafting of the indemnity section materiality scrape in JanCo v. ISS could have benefitted from better drafting: it spoke to its impact on breach, but not to its impact on losses. This is a reminder that, where an M&A agreement includes an indemnity section materiality scrape, the parties should consider expressly specifying whether materiality qualifiers in the seller’s R&Ws will be scraped out (1) for the purposes of determining whether the seller’s R&Ws have been breached, or (2) for the purposes of calculating the buyer’s losses flowing from a breached seller R&W, or (3) both. M&A parties can also consider whether an indemnity section materiality scrape should provide specific treatment for defined terms that include references to materiality, e.g., the definition of “Material Contracts”.
Material Scrapes Can Significantly Alter Risk Allocation
An indemnity section materiality scrape that scrapes away materiality qualifiers for all indemnification purposes can significantly alter the parties’ post-closing risk allocation. Specifically, it can result in essentially flat seller R&Ws that are easily breached. This in turn highlights the important role that other indemnity limitations play in allocating post-closing risk. One example is the potentially elevated significance of the distinction between a deductible basket (where only damages above the minimum liability threshold are payable) and a tipping basket (where all damages from zero become payable if the amount of damages climbs above the minimum liability threshold). Another example is the potential value of a “de minimis” clause to mitigate against the possibility of “nickel and dime” post-closing claims by a buyer.
Choose Carefully Among Materiality Qualifiers
The application of a materiality scrape to certain materiality qualifiers may be more complicated than others. At issue in JanCo v. ISS was the interaction of the materiality scrape with an MAE qualifier, and neither party’s proposed approach fully persuaded the court. The court instead adopted a two-step analysis that resulted in a convoluted hybrid clause. This complexity suggests that a similar future dispute could be decided differently.12 It also suggests that the application of a materiality scrape to different types of materiality qualifiers could present fewer difficulties, e.g., a simple one word “materiality” qualifier or an “in all material respects” qualifier. M&A parties should bear this in mind when deciding which type of materiality qualifier to apply to a particular R&W.
The Impact of Representation and Warranty Insurance (RWI)
As mentioned, more than half of Canadian deals include at least one type of materiality scrape and the use of materiality scrapes in the indemnity section of Canadian M&A agreements has been steadily growing. Also, where an indemnity section materiality scrape is included, 56% of the time it will scrape out materiality qualifiers for all indemnification-related purposes. In the U.S., this figure is 82%.
We expect that a principal explanation for the increased use of indemnity section materiality scrapes in Canadian M&A is the increased use of representation and warranty insurance (RWI) in Canadian dealmaking: where the buyer obtains an RWI policy (which by its nature transfers all or part of the risk of a breached R&W away from the seller), the seller may be more agreeable to including a materiality scrape in the M&A agreement’s indemnity section.
Footnotes
1. See the ABA Canadian Private Target M&A Deal Point Study (including transactions from 2020, 2021 & 2022) published in 2025 (the ABA 2025 Canadian Study) at pg. 93.
2. See the ABA 2025 Canadian Study at pg. 125.
3. Compare pages 94 and 126 of the ABA 2025 Canadian Study with pages 67 and 101-102 of the ABA Private Target Mergers & Acquisitions Deal Points Study (including transactions from 2024 and Q1 2025) published in 2025 (the ABA 2025 U.S. Study). Regarding closing conditions, about 90% of U.S. deals include a materiality scrape while only about 60% of Canadian deals include one. The divergence is similar regarding materiality scrapes in the indemnity section, with 87% of U.S. deals including one and only 45% of Canadian deals including one.
4. 45% of deals in the ABA 2025 Canadian Study included a materiality scrape in the indemnity section. In the 2018 study this figure was 42%, in the 2016 study it was 39%, and in the 2014 study it was only 11%.
5. See the ABA 2025 Canadian Study at pg. 125: “For purposes of this Article VIII (Indemnification), the representations and warranties of Target shall not be deemed qualified by any references to materiality or to MAE.”
6. See the ABA 2025 Canadian Study at pg. 125: “For the sole purpose of determining Losses (and not for determining whether or not any breaches of representations or warranties have occurred), the representations and warranties of Target shall not be deemed qualified by any references to materiality or to MAE.”
7. See the ABA 2025 Canadian Study at pg. 126.
8. See the ABA 2025 U.S. Study at pg. 102.
9. JanCo FS 2, LLC v. ISS Facility Services, Inc., 344 A.3d 1009 (Del. Super. August 21, 2025). – https:/courts.delaware.gov/Opinions/Download.aspx?id=383920
10. These were any adverse development relating to (1) financial markets, (2) the target’s industry or the U.S. economy, (3) any action taken under the APA, or (4) any business disruption resulting from the Covid-19 pandemic (which was ongoing at the time).
11. The materiality scrape read: “all qualifications and limitations set forth in the p. arties’ representations and warranties as to ‘materiality,’ ‘Material Adverse Effect,’ ‘Material Adverse Change’ and words of similar import shall be disregarded in determining whether there shall have been any inaccuracy in or breach of any representations and warranties.”
12. Note that the court’s approach was arguably incomplete. While it imported the main operative portion of the MAE definition into the No Adverse Event Rep, it did not import the entire MAE definition, leaving out the four carveouts summarized in footnote 6 above.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
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