Delaware Superior Court Establishes “Order of Operations” for Applying “Materiality Scrapes” to Post-Closing Indemnity Claims

DELAWARE CORPORATE LAW BULLETIN

Delaware Superior Court Establishes “Order of Operations” for Applying “Materiality Scrapes” to Post-Closing Indemnity Claims

But Court awards no damages as buyer’s claimed losses

fell within excluded Asset Purchase Agreement categories

Robert S. Reder Professor of the Practice of Law, at Vanderbilt University Law School / Retired Partner, Milbank LLP

Jessica Fuchs-Shafer J.D. Candidate, Vanderbilt University Law School, May 2026 M.A. in Statistics, Columbia University B.A. in Cognitive Neuroscience, Washington University in St. Louis

INTRODUCTION ............................................................................. 118 LEGAL BACKGROUND ......................................................... 118 I. FACTUAL BACKGROUND ..................................................... 120 II. The Transaction ..................................................... 120 A. Key APA Provisions ................................................ 121 B. Absence of Changes ..................................... 121 1. Material Adverse Effect .............................. 121 2. Materiality Scrape ...................................... 121 3. Indemnification Limits and Damages 4. Exclusions ................................................... 121 Post-Closing Disputes and Procedural Posture ....... 122 C. JUDGE ADAMS’ ANALYSIS ................................................... 122 Applying the Materiality Scrape ............................ 122 A. Breach of Representation........................................ 124 B. Willful Misconduct and Fraud ............................... 124 C.

II.

Willful Misconduct ...................................... 124 Fraud .......................................................... 124

1. 2. Diminution in Value and Consequential Damages ......................................... 125 CONCLUSION ................................................................................ 125

D.

So-called “materiality scrapes” appear in many sophisticated acquisition agreements. Yet, according to Judge Meghan A. Adams of the Delaware Superior Court’s Complex Commercial Litigation Division, opining in JanCo FS 2, LLC v. ISS Facility Servs., Inc., No. N23C-03005 MAA CCLD (Del. Super. Ct. Aug. 21, 2025) [hereinafter “JanCo”], materiality scrapes generally are poorly understood in their application.

In JanCo, a post-closing dispute arose from the $80 million sale of a commercial cleaning business. Buyer alleged that seller not only breached a key representation and warranty in the related asset purchase agreement, but fraudulently induced buyer into the transaction by concealing a decline in the business’s financial condition. Although Judge Adams, after clarifying the application of a materiality scrape, found that seller breached a key representation and warranty relating to the financial condition of the business at closing, she awarded no damages to buyer.

Materiality scrapes enter acquisition agreements as a counterweight to a seller’s protective use of materiality qualifiers. Buyer, trying to learn about the target business and seeking certain contractual undertakings from seller, requires seller to make various representations and warranties (hereinafter, “representations”) in the acquisition agreement concerning, among other things, the assets, liabilities, financial condition, and results of operations of the target business. Seller, in turn, often negotiates for “materiality” qualifiers as a protective measure, ensuring that only departures of consequence will constitute a breach of the representations.

Sometimes, to expand the scope of the qualifier from simple “materiality,” a seller will incorporate the defined term “Material Adverse Effect” (commonly referred to as “MAE”) into key representations. The customary MAE clause operates as a single contractual unit that encompasses not only the operative definition but also a set of negotiated

carve-outs. These carve-outs typically exclude market-wide downturns, changes in law, natural disasters, and industry-wide disruptions— events that will not trigger an MAE, regardless of their severity. Often, the MAE qualifier is included in the so-called “absence of changes” representation, which typically “brings down” the target financial representations from the most recent audited (or, in some cases, unaudited) financial statement date to the signing date. This broader qualifier, in effect, allocates to buyer the risk of changes between those two key dates, at least so long as they do not rise to the level of an MAE.

For its part, a buyer then may seek to improve its chances of securing recovery for breaches of representations by negotiating for a “materiality scrape.” A materiality scrape essentially is a direction in one section of an acquisition agreement to “disregard” the use of materiality qualifiers in another. For example, insertion of a materiality scrape in the indemnification provisions of an acquisition agreement can enhance a buyer’s ability to claim indemnity from seller for losses caused by breaches of the representations discovered post-closing. In practice, a direction to disregard a materiality qualifier lowers the bar for a buyer to prove a breach: buyer must prove only that a breach occurred, not that the breach was material. Materiality scrapes operate along two dimensions: first, they expand the universe of facts that may constitute a breach by stripping the materiality threshold from the breach determination and, second, they expand the potential magnitude of recoverable damages by removing qualifiers that would otherwise limit indemnifiable losses.

And why would a seller agree to a materiality scrape in the indemnification provisions after negotiating for materiality qualifiers in the representations? Perhaps to secure more direct limitations on its exposure to pay indemnity post-closing, such as a threshold below which buyer is not entitled to any indemnity (a “basket”) and an upward limit on indemnity (a “cap”). These are the several pieces of the typical indemnification puzzle.

* * *

In JanCo, the question arose precisely how a materiality scrape operates when the representation it impacts does not use the standalone qualifier “material,” but instead employs an MAE clause that itself contains a materiality qualifier embedded within its definition. Despite their ubiquity, materiality scrapes have generated little judicial guidance, and even sophisticated counsel may negotiate them on assumptions that turn out to be incorrect.

In the absence of controlling precedent, Judge Adams articulated the proper “order of operations” for applying a materiality scrape to a representation qualified by MAE: the full definition must be inserted wherever the capitalized term appears before the scrape operates. Applying this methodology, Judge Adams found that seller breached the scraped representation. However, Judge Adams denied damages to buyer because its omnibus damages theory failed to isolate harm attributable to the specific breach and rested on categories of loss that the APA expressly excluded.

A. The Transaction

The ISS Group (“ISS”) “provides workplace and facility management services on a global scale.” Early in 2020, ISS began exploring the sale of its U.S. commercial cleaning division (the “Business”). ISS hired Harris Williams as its financial advisor and Ernst & Young “to prepare a quality of earnings report for the . . . Business.”

In late 2020, Harris Williams contacted potential buyers, including the Argenbright Group, a “workforce solutions” provider (“Argenbright”). At a March 12 management presentation, ISS disclosed to Argenbright that “the Business suffered from employee headcount decline and experienced high employee turnover.” Nevertheless, on May 27, Argenbright proposed to acquire the Business for $80 million and organized a group of Delaware limited liability companies (“Buyer”) to pursue the acquisition.

During the ensuing due diligence process, Buyer hired Virtas Partners (“Virtas”) “to conduct financial due diligence.” In a July draft report, Virtas “emphasized problems with the Business’ staffing and recruiting.” Another consultant warned “of ‘overall labor shortages . . . which has led to an increase in overtime hours.’ ” Then, at in-person meetings in July and August, “ISS operational leaders told [Buyer] that the Business had 400 to 500 open positions and was using temporary labor and overtime to cover.”

The parties signed an Asset Purchase Agreement (“APA”) on September 20, 2021. Before closing, ISS provided Buyer with updated financial reports for July through October of 2021. Buyer generated its own monthly profit and loss statements from those materials, enabling it to identify the increase in temporary labor in an email dated November 21, nine days before closing. The transaction closed on November 30, 2021.

B. Key APA Provisions

Judge Adams’s analysis turned on four key provisions of the

APA:

1. Absence of Changes

Section 4.10(l) represented that “[s]ince June 30, 2021,” the Business had not “suffered or experienced any . . . event or circumstance which has resulted in a Material Adverse Effect on it or which is reasonably expected to result in such a Material Adverse Effect . . . .” (the “Absence of Changes Representation”).

2. Material Adverse Effect

Section 9.1’s definition of “Material Adverse Effect” was “circular” in a precise and consequential way: any effect that “has had a material adverse effect on the . . . assets . . . , liabilities, condition (financial or otherwise), properties or results of operations . . . .” of the Business, with the embedded phrase in lowercase. The definition also contained four negotiated carve-outs specifying categories of adverse changes that, regardless of their severity, could not constitute a Material Adverse Effect: disruptions to “financial, banking, or securities markets”; changes in the “industry . . . and the United States economy as a whole,” except to the extent those changes did not “have a disproportionate affect . . . relative to other participants in the industry”; actions expressly “contemplated by [the APA]”; and “any business disruption or material Losses as a result of COVID-19.”

3. Materiality Scrape

Section 7.5(f) provided that “[f]or purposes of the indemnities . . . all qualifications and limitations set forth in the Parties’ representations and warranties as to ‘materiality,’ ‘Material Adverse Effect,’ . . . 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 in this [APA]” (the “Materiality Scrape”).

4. Indemnification Limits and Damages Exclusions

Section 7.4 provided for various limitations on ISS’s indemnification obligations: Buyer was not entitled to indemnification unless it could demonstrate losses exceeding a $500,000 basket, its total recovery was subject to a cap equal 12.5% of the $80 million purchase price, and

any damages based on “ ‘lost profits’ and ‘diminution in value’ ” were excluded. However, these limitations did “not apply in cases of ‘fraud or willful misconduct.’ ”

C. Post-Closing Disputes and Procedural Posture

By the first anniversary of the closing, the Business’ cash flows declined significantly from the values that formed the basis of the purchase price. Buyer issued “Claims Notices” to ISS alleging breach of representations in the APA, including the Absence of Changes Representation, as a prelude to seeking indemnification. In response, ISS filed a complaint in December 2022 seeking a declaration that Buyer was not entitled to indemnification under the APA. Judge Adams held a trial in November 2024 and issued her post-trial opinion on August 21, 2025. Ultimately, among other rulings, and despite finding a breach of the Absence of Changes Representation by ISS, Judge Adams awarded Buyer no damages.

A. Applying the Materiality Scrape

Buyer argued that “ ‘massive’ changes occurred between June 30, 2021, and Closing,” triggering a breach of the Absence of Changes Representation that effectively was restated at closing. This required Judge Adams to consider the impact of the Materiality Scrape on the Absence of Changes Representation’s use of the defined term Material Adverse Change. Judge Adams borrowed the phrase “verbal jiu-jitsu” from the Court of Chancery’s decision in AB Stable VIII LLC v. Maps Hotels & Resorts One LLC, 2020 WL 7024929 (Del. Ch. Nov. 30, 2020), judgment entered, (Del. Ch. 2021) and aff’d, 268 A.3d198 (Del. 2021) [hereinafter “AB Stable”], to describe the circularity inherent in the typical MAE definition. According to Judge Adams, the lowercase usage within the capitalized definition signaled “an intent for the Court to apply the term as it is defined under Delaware law.” (For a discussion of AB Stable, see Robert S. Reder and Katie Clemmons, Chancery Court— For the First Time—Releases Buyer from Obligation to Close due to Target MAE, 73 VAND. L. REV. EN BANC, 19 (2020).)

The parties promoted different methodologies for application of the Materiality Scrape. Judge Adams rejected both approaches, instead instructing that the proper approach required two sequential steps. First, “the Court will first insert the definition of Material Adverse Effect wherever the term ‘Material Adverse Effect’ is found in the APA.”

Second, only after this insertion may the Materiality Scrape operate to strip the word “material” and “words of similar import” targeted by the Materiality Scrape. As a result, “adverse effect” survives the “scrape” as the operative standard that a buyer must satisfy to prove a breach of representation. After Judge Adams applied this two-step process to the Absence of Changes Representation, it then read:

In short, Judge Adams wrote, “[i]nserting the definition before employing the Materiality Scrape is the proper order of operations, as it prevents the [APA] from becoming illegible.” The Judge remarked that “neither of the Parties’ explanation for the interplay of the clauses matches the Court’s analysis.”

The structural features of the MAE definition (its operative scope, its four carve-outs, and its deeming provision) carried significance beyond the definition itself. As Judge Adams’ two-step order-ofoperations methodology made clear, the Materiality Scrape does not erase the defined term. Rather, it first expands the capitalized term into its full definition, and only then strips the word “material” from the embedded lowercase phrase. The carve-outs and the deeming provision therefore survive the Materiality Scrape’s operation intact: they ride along into the Absence of Changes Representation when the definition is inserted and are not themselves subject to elimination.

ISS argued that this broad reading of the Absence of Changes Representation, after application of the Materiality Scrape in the “proper order of operations” promoted by Judge Adams, was “unreasonable” as it “renders the representations overbroad.” Judge Adams rejected this argument, finding the APA’s indemnification structure provided sufficient counterbalancing constraints through the quantitative and qualitative limits it placed on recovery. As Judge Adams explained, the lower threshold provided by the basket “would likely be irrelevant” if Buyer were required to prove an MAE, as Buyer “would need to prove damages exceeding the cap imposed by the APA, let alone exceeding the basket.” In so ruling, Judge Adams inferred that the parties intended a low breach threshold for the Absence of Changes Representation. Accordingly, she opined, “the APA does not require [Buyer] to show a material adverse effect in order to prove a breach of the Adverse Changes Representation.”

B. Breach of Representation

With the breach standard established, Judge Adams focused on whether Buyer proved a violation of the Adverse Changes Representation by demonstrating an “adverse” change in the Business. The Judge found that Buyer “cleared this low hurdle” by (among other things) presenting evidence “indicating the Business suffered an increase in temporary labor as a percentage of revenue . . . between June 30, 2021 and Closing.”

C. Willful Misconduct and Fraud

Even when a buyer proves breach of a contractual representation, a basket and cap can limit its indemnification recovery. Buyer’s success on its breach of the Absence of Changes Representation claim therefore was only the first step. To recover meaningful damages, Buyer had to escape the APA’s indemnification limits. Notably, under APA Section 7.7, those limits did not apply in cases of willful misconduct or fraud.

1. Willful Misconduct

For a buyer to demonstrate willful misconduct, it must prove seller took an intentional action knowing the action would breach the contract. In this connection, Judge Adams observed that the interaction between the Absence of Changes Representation and the Materiality Scrape was “presumably not obvious to the layman” and that “neither party explained the application of the Materiality Scrape to the Absence of Changes Representation with complete correctness.” Given that even sophisticated counsel on both sides failed to correctly interpret the provisions after post-trial briefing, oral argument, and supplemental briefing, the Judge concluded that ISS employees could not be found to have possessed the knowledge that their non-disclosure of the Business’ decline constituted a breach of the scraped Absence of Changes Representation. While “ISS employees may have known the Business was struggling, . . . that does not prove they knew they were breaching the APA.”

2. Fraud

According to Judge Adams, “[f]raud claims require proof of ‘a certain level of scienter on the part of the defendant.’ ” Specifically, in this case, Buyer “must be able to show that its reliance on the Absence of Changes Representation was justified.” When “an alleged fraud victim has information contradicting a false representation before acting

in purported reliance on that representation, that alleged victim cannot demonstrate justifiable reliance.”

The Judge determined that Buyer knew, or at least should have known, that the Business was suffering from staffing shortages and increased temporary labor costs in light of its due diligence, its advisors’ reports, and the financial materials ISS provided before closing. In short, “[i]t was not reasonable for [Buyer], a sophisticated business entity that was informed before and after Signing that ISS was dealing with staffing and HR issues, to blindly rely on a representation that the Business had not declined at all between June 30, 2021, and Closing.” Rather, Buyer “ ‘passed warning sign after warning sign’ as the true state of the Business stared [it] in the face.” Finally, Judge Adams noted that the existence of “a broad indemnification remedy is a factor which weighs against a finding of justifiable reliance.”

D. Diminution in Value and Consequential Damages

Turning to Buyer’s damages theory, Judge Adams found that not only did Buyer fail to “prove its fraud and willful misrepresentation claims,” but “[m]ore problematic . . . is the issue of [Buyer]’s inability to specifically tie its damages to the breach of the Absence of Changes Representation.” Buyer’s theory rested on a single omnibus calculation claiming approximately $43.2 million in damages, reflecting the spread between what Buyer paid and its expert’s estimation of the Business’ value at closing. Buyer did not provide a separate damages theory for each claim. In fact, Buyer ‘s expert admitted at trial that the damages figure did not depend on whether any specific representation was breached and, even worse, the figure would remain the same whether one representation or many were breached. Judge Adams found these concessions fatal.

APA Section 7.4(e) established that “indemnifiable Losses may not include losses based on ‘diminution of value’ . . . [or] ‘lost profits.’ ” However, Buyer’s “damages calculation alleges a diminution of value for the Business as a whole, as reflected by its lost profitability. Such damages for breach are barred by the APA.”

JanCo illuminates a gap in acquisition agreement drafting that deserves practitioner attention. The opinion offers three consequential takeaways. First, JanCo provides a clear judicial articulation of the “order of operations” for applying a “materiality scrape” to a representation that incorporates a typical MAE definition. For sellers, the two-

step process means the MAE definition provides less protection against indemnification claims than they may have anticipated, as once the definition is expanded and materiality is “scraped,” an “absence of changes representation” requires the buyer to prove only some adverse effect, not a material one. For buyers, the same methodology confirms that a properly applied materiality scrape delivers the lowered breach threshold the buyer intended, but only when the scrape operates on the fully expanded definition rather than the capitalized term standing alone. Buyers who draft materiality scrapes without verifying that the MAE definition will survive insertion into the operative representations risk producing an incoherent representation rather than the expanded breach standard they sought.

Second, JanCo illustrates the practical consequences of contractual damages exclusions that practitioners often treat as routine. Despite Judge Adams’ finding that ISS breached its Absence of Changes Representation, the exclusion of consequential damages, lost profits, and diminution in value meant that Buyer recovered nothing. In effect, these countervailing terms created a structural gap between the breach threshold and the recovery threshold. Practitioners should devote the same care to negotiating damages exclusions as they devote to the scope of representations and materiality scrapes.

Third, JanCo reinforces that sophisticated buyers who possess information contradicting a seller’s representations before closing will face significant obstacles in establishing justifiable reliance on those representations. A buyer who secures strong indemnification rights signals it was relying on those contractual remedies rather than on representations it had reason to question. The practical consequence is that if warning signs emerge after an acquisition agreement is signed but before closing, buyer may be stymied from obtaining full recovery postclosing if seller has successfully negotiated limits on indemnity, even if accompanied by a materiality scrape. Closing in the face of such warning signs and seeking fraud remedies afterward will be perilous.

In sum, JanCo demonstrates that a buyer can negotiate a materiality scrape that lowers the threshold for breach, secure a broad absence of changes representation, satisfy its burden of proof at trial, and still face a limited recovery. The path from breach to recovery is narrower than the drafting of many acquisition agreements implies, and JanCo clarifies each point at which that path can close.

--- FOOTNOTES ---

INTRODUCTION

I. LEGAL BACKGROUND

II. FACTUAL BACKGROUND

II. JUDGE ADAMS’ ANALYSIS

Since June 30, 2021, Sellers . . . have not suffered or experienced any . . . event or circumstance which has resulted in an any effect, condition, circumstance or change that individually or when taken together with other conditions, effects or circumstances in the aggregate has had an adverse effect on the . . . assets . . . liabilities, condition (financial or otherwise), properties or results of operations of the Sellers.

CONCLUSION