Concept and general definition of Materiality
Materiality (in English: materiality or relevance) is a central term in international law, especially in common law, as well as in accounting, auditing, and capital market regulation. The term refers to whether information, a fact, or an action should be considered significant for the decision of a third party – for example, a court, investor, or regulatory authority. Materiality determines whether a fact, variance, or piece of information is so significant that it could reasonably be expected to materially influence the decision-making process.
In legal contexts, materiality is often used to determine the threshold at which an act or omission becomes legally relevant. Its specific formulation and application differ depending on the area of law and jurisdiction, but the concept is considered in numerous rules and standards worldwide.
Materiality in Civil Law
Importance for contract interpretation and declarations of intent
In civil law, materiality plays a significant role particularly in contract interpretation and in the assessment of declarations of intent. In international contract law, especially under the UN Sale of Goods Convention (CISG), a distinction is made between material (material) and immaterial breaches of contract. A material breach entitles the buyer, for example, to terminate the contract, while an immaterial breach generally only leads to claims for rectification or reduction of price.
Rescission and mistake
In connection with rescission due to mistake, it is also decisive whether the mistake concerns a matter of materiality, i.e., whether it was essential for the declaration or formation of the contract. Only then can a rescission be justified.
Materiality in Stock and Capital Market Law
Ad-hoc disclosure and insider information
In capital market law, materiality is a criterion for assessing ad-hoc disclosure requirements and insider information. Issuers are required to publish price-sensitive facts without delay if such information is of such materiality that it can significantly influence the market price of a security. The European Market Abuse Regulation (MAR) and the Securities Trading Act (WpHG) link numerous obligations to the materiality relevance of information.
Prospectus liability
When preparing a prospectus, materiality is crucial in determining which information must be included. There is a prospectus error if a material (material) fact is incorrectly or incompletely presented and a reasonable investor would have based their investment decision on it.
Materiality in Accounting and Auditing
Accounting standards
In international accounting (IFRS, US-GAAP), materiality is a fundamental principle. Accordingly, all material information must be included in the financial statements to present a true and fair view. Immaterial (immaterial) matters, on the other hand, may be omitted or aggregated.
Audit of financial statements
During the audit of financial statements, the examining party assesses the quantitative and qualitative materiality of errors or irregularities. Only those findings classified as material must be disclosed or separately addressed in the report.
Establishment of the materiality threshold
The materiality threshold is determined individually in the context of the audit, based on the company’s circumstances, and represents the limit above which errors are no longer considered immaterial.
Materiality in Insurance Law
Disclosure obligations and duties
In insurance law, the concept of materiality is significant for determining which circumstances a policyholder must disclose when submitting an application. The policyholder must disclose those circumstances that are material for the assessment of the insurance risk by the insurer. A breach of this obligation can result in the insurer being released from liability if the concealed circumstances were significant for the conclusion of the contract.
Materiality in Corporate Law
In corporate law, materiality is a key criterion for distinguishing between routine and extraordinary management measures. Particularly for the granting of authority or veto rights to shareholders, it is important whether a measure is of material relevance (material act) to the company.
Materiality in US Law
Securities and Exchange Commission (SEC) and Supreme Court
Under United States law, materiality is regularly invoked in connection with listed companies’ disclosure obligations and the fight against securities fraud. According to the US Supreme Court’s definition, information is material if “there is a substantial likelihood that a reasonable investor would consider the information important in making an investment decision.”
Application in auditing
In American auditing, materiality is determined using quantitative thresholds and qualitative considerations. The relevant threshold varies depending on company size, industry, and risk profile.
Case law and standards
Significance in case law
The precise interpretation and application of the term materiality is often the subject of court decisions. Leading decisions regularly set out criteria for determining materiality in individual cases, for example, based on the potential impact on the decision of the recipient.
International standards and guidelines
Numerous guidelines for operationalizing materiality in various legal areas are provided by international standard-setting and supervisory organizations (such as IASB, FASB, IOSCO, or ESMA). These contribute to ensuring the predictable and consistent handling of the concept.
Summary and significance for practice
Materiality serves as an indispensable criterion in numerous areas of law for assessing the relevance of facts, circumstances, or errors. The specific threshold and substantive formulation are always case-specific and subject to evaluation in the context and purpose of the respective legal field. Detailed knowledge and application of materiality are a fundamental prerequisite for correct contract practice, proper accounting, regulated disclosure, and compliance with supervisory standards.
Materiality is of particular importance in international business and capital market law as well as in auditing and corporate disclosure. Ongoing developments through legislation, standard-setting, and judicial decisions ensure dynamic application and continuous evolution of the concept.
Frequently Asked Questions
How is materiality determined in a legal context and what are the statutory bases?
The determination of materiality is made in the legal context based on statutory and regulatory requirements that can vary depending on the area of law (e.g., corporate law, capital market law, accounting law, environmental law). Fundamentally, materiality is determined by the potential influence on the decision-making of a reasonable recipient – that is, information is considered material if its omission, distortion, or willful non-disclosure could significantly affect the economic decisions of recipients. In Germany, key legal provisions are anchored in, among others, the Commercial Code (HGB), Stock Corporation Act (AktG), the EU Taxonomy Regulation, IFRS, or the Corporate Sustainability Reporting Directive (CSRD). For example, section 289 HGB requires that only material risks and opportunities are presented in the management report, while section 93 AktG requires the board of directors to exercise the ‘care of a prudent and conscientious manager’ in conducting business, which also means appropriately considering material issues. In capital market law, the requirements for ad-hoc disclosure according to Art. 17 MAR (Market Abuse Regulation) are decisive; they determine when insider information is considered material and, thus, must be disclosed. Its application requires analysis of the specific area of law, the target audience, and the respective sector and company specifics.
What are the legal consequences of an incorrect assessment of materiality?
An incorrect assessment of materiality can have a wide range of legal consequences, depending on the relevant area of application. In accounting and financial reporting, an erroneous assessment of materiality, such as failing to disclose material information, can result in a misleading representation of the asset, financial, and earnings position. This can lead to fines, criminal sanctions for accounting fraud (§ 331 HGB, § 400 AktG), or civil liability for damages. In capital market law, there is the risk of liability for failure to make ad-hoc announcements to investors (§ 37b, § 37c WpHG), which can result in claims for damages and fines imposed by BaFin. In the context of sustainability reporting under CSRD and the EU taxonomy, fines and reputational damage also threaten if material factors are not correctly identified and reported. Ultimately, it is regularly up to the courts to review the adequacy and legality of the assessment in individual cases, with expectations for reasonable diligence being defined.
Who bears legal responsibility for the assessment of materiality in companies?
The legal responsibility for assessing and applying materiality basically lies with the management bodies of a company, usually represented by the board of directors (for stock corporations according to section 76 AktG), management (for GmbHs according to section 43 GmbHG), or equivalent bodies in other legal forms. These bodies are obligated to meet statutory requirements for reporting, disclosure, and risk assessment, and to adequately address materiality. For listed companies, there is increased responsibility for handling material information, particularly in ad-hoc disclosures (Art. 17 MAR). In addition, auditors are required during audits to review the application of materiality principles and report any violations. Within companies, legal responsibility is often supported by appropriate compliance structures and internal control systems, but ultimate responsibility remains with management.
How are materiality decisions documented in the legal context?
The documentation of materiality decisions is a central element of legal protection. Companies are required to present the reasons for their materiality assessments in a transparent and verifiable manner. This is usually achieved through internal guidelines, minutes of meetings, risk analyses, decision templates, and explicit statements in reports or financial statement explanations. During statutory audits (e.g., audit according to section 317 HGB), these documents must be submitted to demonstrate that materiality was appropriately determined and the corresponding risks or facts accurately considered. A lack of adequate documentation can be considered an indication of organizational fault and may be relevant for liability.
What role do court decisions and administrative directives play in the interpretation of materiality?
Court decisions (case law) and administrative directives (such as BaFin notices or IDW auditing standards) play a key role in the interpretation and specification of the legal concept of materiality. Legal definitions, which are often broadly drafted in statutes, are refined by case law and administrative practice, for example, by establishing case groups or defining thresholds. Courts also set standards for the diligence required of acting bodies and determine when information is sufficiently material to trigger reporting requirements. In particular, in capital market and accounting law, there are numerous precedents that influence practical application in companies. Furthermore, sector-specific aspects are explained by administrative directives, which provide affected companies with a legal framework for orientation.
To what extent is there an obligation to review materiality assessments retrospectively or when circumstances change?
In the legal context, there is generally an ongoing obligation to review materiality assessments, as both internal and external circumstances—such as legislative changes, market conditions, or risk profiles—may change. Failure to review or update assessments may constitute a breach of duty. For example, the HGB requires updating risk and opportunity assessments in the management report, and in capital market law, the ongoing assessment of material events is the basis for ad-hoc disclosure obligations. In sustainability reporting under the CSRD, an annual review is also required. Responsible bodies must therefore not only assess materiality initially, but also periodically and as necessary to determine whether previous materiality assessments remain valid or need to be revised.
What audit duties and standards apply to auditors with respect to materiality?
Auditors are obliged under relevant auditing standards – in Germany, for example, according to IDW PS 250 and international auditing standards (ISA 320) – to apply the principle of materiality when auditing financial statements, consolidated financial statements, and management reports. The objective is to ensure that there are no material errors or omissions that could mislead financial statement users. The auditor must document in the audit opinion the basis and thresholds used to determine materiality. This includes quantitative and qualitative aspects; it must also be checked whether management’s materiality assessments are appropriate and comprehensible. If the auditor identifies discrepancies or violations, there is a reporting obligation to the supervisory body and, if necessary, to authorities. Failure to comply with these audit obligations can, in turn, have professional and liability consequences for the auditor.
