United States: Delaware Reaffirms High Bar For Establishing A Material Adverse Effect

In the first case following Akorn v. Fresenius to rule on a party's entitlement to terminate a merger agreement on the basis of a material adverse effect (MAE), the Delaware Court of Chancery ordered Boston Scientific Corporation to complete its $275 million acquisition of Channel Medsystems Inc., and emphatically reaffirmed the high bar facing a party seeking to terminate a merger agreement for an MAE. The court's decision in Channel Medsystems, Inc. v. Boston Scientific Corp., et al., confirms that Akorn does not signal a change in MAE jurisprudence, and stands as an important reminder that an acquirer's change of heart will not negate its contractual obligations.

Shortly after entering into an agreement to be acquired by Boston Scientific, Channel discovered that its vice president of quality committed fraud that may have impacted certain company filings with the FDA related to the approval of Channel's only product, the Cerene Cryotherapy Device. Approval of Cerene was a condition to Boston Scientific's obligation to close the acquisition. Although, as noted by the court, Channel responded to the fraud discovery swiftly and thoroughly, including by making appropriate disclosures to both Boston Scientific and the FDA, and the FDA ultimately approved the Cerene device, Boston Scientific delivered notice purporting to terminate the merger agreement, claiming that the fraudulent FDA filings constituted a breach of Channel's representations that had or would reasonably be expected to have an MAE on Channel. Channel thereafter sought specific performance against Boston Scientific, alleging that no MAE had occurred and that Boston Scientific had failed to use commercially reasonable efforts to consummate the transaction as required by the agreement.

In granting Channel specific performance, the court found that even though a number of Channel's signing date representations in the merger agreement were breached, there was no reasonable expectation that those breaches would result in an MAE. Consistent with past decisions, including Akorn, the court considered both quantitative and qualitative factors in evaluating the existence of an MAE, noting that "a mere risk of an MAE cannot be enough" and "[t]he important consideration... is whether there has been an adverse change in the target's business that is consequential to the company's long-term earnings power over a reasonable period, which one would expect to be measured in years rather than months" (quoting Akorn). The court also examined the interplay of the closing condition and termination provisions of the merger agreement, determining that Boston Scientific bore the burden of showing that, as of the date of termination, the inaccurate Channel representations would reasonably be expected to have an MAE as of the expected closing date of the merger.

The court's decision in Channel underscores and reaffirms the meaningful difference under Delaware law between a theoretical risk and a determined MAE. A party seeking release in Delaware courts from its contractual obligation to close a merger still needs to show far more than "unsubstantiated speculation" to establish an MAE.

The Channel decision is also significant as a reminder that Delaware courts will require merger parties to act in good faith and honor contractual commitments, even after their business objectives change. Evidence introduced at trial revealed that Boston Scientific had determined as a business matter that it no longer wanted to complete the Channel deal. The court in Channel held that Boston Scientific breached its contractual efforts obligation to consummate the merger, observing that Boston Scientific "simply pulled the ripcord" and then rationalized its way into contractual grounds for terminating the merger agreement. The court's holding reaffirms that Delaware courts will hold parties to their obligations and will cast a skeptical eye on unilateral attempts to undo contracts when circumstances change.

Key Takeaways

• Akorn did not herald a sea change in Delaware MAE jurisprudence. Buyers continue to bear an extremely heavy burden in establishing an MAE to avoid their obligations to close.
• A "mere risk of an MAE" is not enough to establish an MAE under a merger agreement. Buyers claiming an MAE must show evidence that there is a basis in law and in fact for the "serious adverse consequences prophesied" by the buyer and courts will scrutinize both the "quantitative and qualitative" aspects of the alleged MAE.
• Forward-looking MAE standards in merger agreements are evaluated as of the time that the parties otherwise expected to close the transaction. Thus, the court in Channel required Boston Scientific to show that Channel had breached a representation that, as of termination, would reasonably be expected to have an MAE as of the date the parties anticipated the merger would close.
• General "efforts" provisions in merger agreements impose meaningful obligations on parties to use good faith efforts to solve problems as they arise during the pendency period and seek to close transactions. A party that ceases working toward closing does so at the risk that a court will take a critical view of the remedies to which it should be entitled.

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