On October 1, the Delaware Court of Chancery concluded that German healthcare company Fresenius SE was not required to close its acquisition of Akorn, Inc. due to the occurrence of a Material Adverse Effect (MAE) under the terms of the merger agreement.
The 246-page post-trial decision, Akorn, Inc. v. Fresenius Kabi AG,1 marks the first time the Court of Chancery has held that a buyer validly terminated an acquisition due to an MAE.
Fresenius entered into an agreement to purchase U.S. generic drugmaker Akorn for US$4.75 billion (US$34 per share) on customary terms. After signing but prior to closing, Fresenius become aware of two different circumstances that it argued qualified as MAEs under the agreement.
The first was financial: after the deal was signed, Akorn’s business dropped precipitously. Year-over-year revenue decreased 25%; year-over-year operating incomed dropped 105%; and year-over-year earnings per share dropped 113%. During each of the four quarters post-signing, Akorn’s income dropped between 84 and 124% and its earnings per share dropped between 96 and 300%. The results were not only below projections but also below Akorn’s low-end forecasts.
The second was regulatory: after receiving several letters from whistleblowers reporting concerns over regulatory compliance, Fresenius hired counsel to investigate Akorn and learned of pervasive, systemic flaws in Akorn’s data management. Fresenius alleged that the Food and Drug Administration would have grounds to question the company’s representations.
The Court’s Decision
The Court found that two independent MAEs had occurred: first, the financial conditions of the target constituted a general MAE; second, the seller breached specific representations regarding the company’s regulatory compliance, constituting a regulatory MAE.
Key to Vice Chancellor Laster’s decision was that, unlike earlier Delaware MAE cases, such as the seminal decision IBP, Inc. v. Tyson Foods, Inc.,2 the financial changes here were not solely relevant to the company’s short-term prospects. For example, in the 2008 Huntsman v. Hexion decision,3 the Court of Chancery found that a one-year projected EBITDA that was 3.6% lower than at the time of signing was insufficient to conclude that a “consequential [change] to the company’s long-term earnings over a period of years” had occurred. Here, the Court found the target’s decline in performance to be “material when viewed from the longer-term perspective of a reasonable acquirer” and “durationally significant.” The Court noted that the decline showed “no sign of abating.”
MAEs are not mythical creatures—they exist.
With respect to regulatory compliance, the Court found that Akorn’s violations were pervasive and had, in fact, deteriorated after signing. The Court estimated it would cost over US$900 million to fix Akorn’s regulatory and quality control problems (approximately 20% of the total transaction value). The Court viewed that number—a 20% reduction in deal value—as “material when viewed from the longer-term perspective of a reasonable acquirer.” The Court bolstered that materiality conclusion by noting that a 20% decline in stock price signifies a bear market. The Court also cited statistics from M&A studies, such as the average deal price after an MAE-related renegotiation (15% less than the initial price), and the typical lower bounds of M&A collars (10-20% less than the closing price). The Court used those indicators as support for its conclusion that a 20% remediation cost would be material to a reasonable buyer.
The Court also found that there were separate grounds for permitting the buyer to terminate: Akorn breached its contractual obligation to continue to operate the business in the ordinary course between signing and closing. The Court found that Akorn breached this obligation by, among other things, cancelling scheduled audits and ongoing compliance assessments, failing to properly investigated whistleblower letters, submitting questionable data to the FDA, and failing to remediate deficiencies.
Takeaways From the Decision
MAEs are not Mythical Creatures—They Exist
Akorn represents the first time that a Delaware court permitted a buyer to terminate a public company merger agreement and terminate the deal on the basis of an MAE.
The Court applied its existing MAE precedent to new facts: the changes in financial circumstances here were particularly severe. More importantly, unlike in Hexion, the financial changes were indicative of long-term problems, not short-term dips. And although Akorn blamed its financial condition on industry-wide changes, the Court found that even if such changes existed, Akorn’s performance was significantly worse than others in the industry. Further, the regulatory and compliance concerns were so serious that the Court estimated it would cost almost US$1 billion to fix Akorn’s quality control problems (approximately 20% of the total transaction value). The Court held that Fresenius “carried its heavy burden” to demonstrate that Akorn had suffered two MAEs.
Purchaser Sought to Salvage the Deal in Good Faith
Even after uncovering the MAEs, Fresenius continued to work to close the transaction. That fact worked against allegations by Akorn that Fresenius was simply trying to get out of a deal it no longer found to be economically attractive. The Court wrote that this case was “markedly different” from prior Delaware cases in which buyers sought to extricate themselves from purchase agreements after cyclical or industry-wide changes.
Compare this to Hexion, in which the court found that after short-term losses the buyer intentionally sought to disrupt the financing when it commissioned an insolvency opinion without notifying the target and sent it to the bank leading the financing in a successful attempt to cause the bank to pull its financing.
“Sandbagging” is Still Permitted
Akorn argued that the buyer was precluded from terminating because it knew of the regulatory and data integrity issues through pre-closing diligence. The Court re-affirmed that Delaware is generally a pro-sandbagging state and cited Delaware precedent that a buyer’s knowledge is not a barrier to pursuing breach of contract claims under Delaware law. Contractual representations are bargained-for provisions that operate as risk-allocation mechanisms, such that knowledge is not relevant to the inquiry of breach.
MAEs in Canadian Courts
In Canada, there is a dearth of case law on MAE clauses involving large or complex M&A transactions. Canadian courts will typically resort to the definitions of materiality in analogous contexts, such as accounting practice and securities law, in order to discern whether a particular development is material.