Canada: In A First, Delaware Finds Deal Properly Terminated Due To Material Adverse Effect

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.

Background

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.

Outlier Facts

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.

We have previously written about M&A drafting tips which you can read in our article " The Big MAC in M&A: Hold the Carve-Outs Please."

Footnote

1 Akorn Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018) (Laster, V.C.)

2 In re IBP Shareholder Litigation, 789 A.2d 715 (Del. Ch. 2001).

3 Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions