In October, the Delaware Court of Chancery made the unprecedented finding in Delaware corporate law that a material adverse effect (MAE) had occurred pursuant to a merger agreement that permitted the buyer, Fresenisu Kabi AG, to terminate its merger with the seller, Akorn, Inc. The Delaware Court of Chancery is widely regarded as the nation’s preeminent forum for corporate and commercial disputes, and Delaware corporate law is viewed as the standard for corporate law developments worldwide. This decision is likely to have far-reaching impacts on mergers and commercial contracts given that 65 percent of Fortune 500 companies and over half of all U.S. publicly traded companies are incorporated in Delaware.
After a five-day trial, Vice Chancellor Travis Laster issued a 267-page opinion, noting that “[t]his case is markedly different” from typical MAE claims where buyers have second thoughts about an acquisition after “cyclical trends or industrywide effects negatively impacted their own businesses, and who then filed litigation in an effort to escape their agreements without consulting with the sellers.” Here, the Court found that Fresenius responded to “a dramatic, unexpected, and company-specific downturn in Akorn’s business” and “whistleblower letters that made alarming allegations about data integrity issues at Akorn.” Moreover, while Fresenius properly conducted an investigation into Akorn’s downturn and alleged data-integrity issues, it nevertheless continued to move forward with the transaction. As the first case in the history of Delaware jurisprudence to find a MAE, this case will likely set the standard for future litigants seeking to terminate a merger agreement prior to closing.
As an initial matter, the court found that the parties’ relationship was governed by the merger agreement, and thus the court did not analyze equitable defenses because they were duplicative of the contractual claims.
The court made three key findings in Fresenius’s favor supporting the MAE: First, “Fresenius validly terminated the Merger Agreement because Akorn’s representations regarding its compliance with regulatory requirements were not true and correct, and the magnitude of the inaccuracies would reasonably be expected to result in a Material Adverse Effect.” Second, “Fresenius validly terminated because Akorn materially breached its obligation to continue operating in the ordinary course of business between signing and closing.” And third, “Fresenius properly relied on the fact that Akorn has suffered a Material Adverse Effect as a basis for refusing to close.” The court also found that Fresenius had fulfilled its own contractual obligations, a material breach of which would have prevented Fresenius from exercising the termination rights on which it relied.
The court’s opinion centered on the deterioration of Akorn as a company, unique to broader industry or market trends. For example, Akorn’s financial performance declined materially since the signing of the merger agreement with its EBITDA declining 86 percent. Moreover, Akorn’s regulatory compliance problems were significant because of “overwhelming evidence of widespread regulatory violations and pervasive compliance problems,” that existed at signing and worsened thereafter. Significantly, Akorn was found to have failed to use commercially reasonable efforts to operate in the ordinary course of business. The court found that, as soon as the merger agreement was signed, Akorn cancelled regular audits, assessments, and inspections of known problems specifically because of the pending merger. Akorn also did not maintain its data integrity system and submitted regulatory filings with fabricated data, none of which was done in the ordinary course. Notably, the court found that these ordinary course violations were material because they cost Akorn “a year of what could have been meaningful remediation efforts.”