Prior to the Delaware Court of Chancery's opinion in Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff'd 198 A.3d 724 (Del. 2018), no Delaware court had found the existence of a material adverse effect (MAE) warranting the termination of a merger. When the COVID-19 crisis sparked a flurry of new MAE cases, the Akorn precedent led observers to wonder whether the courts would now be more likely to find MAEs. The Court of Chancery's July 9, 2021 decision in Bardy Diagnostics, Inc. v. Hill-Rom, Inc., C.A. No. 2021-0175-JRS, 2021 WL 2886188 (Del. Ch. July 9, 2021) makes clear, however, that buyers seeking to terminate a deal still face an uphill battle to prove an MAE, even in light of surprise adverse events beyond the parties' control.


On Jan. 15, 2021, Hill-Rom, Inc. (Hillrom), a publicly traded medical technology company, agreed to acquire Bardy Diagnostics, Inc. (Bardy). Bardy develops cardiac monitoring devices and currently manufactures only one product, called the CAM patch. Medicare insures a significant number of patients using the CAM patch. While the Centers for Medicare & Medicaid Services (CMS) typically administers Medicare reimbursement rates, CMS sometimes authorizes contractors to establish pricing for new services. With the CAM patch, Novitas Solutions, Inc., has historically set the Medicare reimbursement at approximately $365. Prior to their agreement, the parties expected Novitas to raise the reimbursement rate for the CAM patch and at worst to maintain the status quo rate, but recognizing the uncertainty around the future reimbursement rate, they structured the purchase price for Bardy to be contingent on its 2021 and 2022 revenue.

The purchase agreement included an MAE clause with several carve-outs. The agreement defined an MAE as "any fact, event, circumstance, change, effect or condition that, individually or in the aggregate, has had, or would reasonably be expected to have a material adverse effect on ... the Business of the Acquired Companies, taken as a whole." The agreement defined "Business" as the "design, development, manufacture, production, assembly, marketing, promotion, distribution, sale, clinical use and other commercialization activities involving ... cardiac digital health, diagnostics, data management and remote patient monitoring devices ... technologies and services." The definition of MAE in the agreement carved out, among other things, "any condition or change in economic conditions generally affecting the economy or the industries or markets in which [Bardy] operates" and "any change in any Law (including any COVID-19 Measures and any Health Care Law)." The agreement further provided that such carve-outs may still constitute an MAE "to the extent such matter has a materially disproportionate impact on [Bardy] compared to other similarly situated companies operating in the same industries or locations ... as the Business."

On Jan. 29 — two weeks after the parties signed their purchase agreement — Novitas announced that the reimbursement rate for the CAM patch and similar devices would be reduced from approximately $365 to between $42.68 and $49.70. This dramatic drop "shocked" the parties to the transaction and the entire industry, and the consensus was that "Novitas must have made a mistake." Hillrom engaged outside counsel and, on Feb. 21, notified Bardy that the rate change was an MAE relieving Hillrom of its obligation to close. On Feb. 28, Bardy commenced a lawsuit against Hillrom. On April 10, Novitas revised its reimbursement rates for the CAM patch and similar devices to between $103.44 and $133.47, a marked increase from the January announcement but still far below the historical rate for these devices.

A trial was held between May 5 and 7, 2021. Hillrom advanced two arguments in support of its position that it was relieved of its obligation to close. First, Hillrom argued that even the less severe, post-termination April rate changes constituted an MAE under the purchase agreement. Hillrom presented expert testimony that neither Novitas nor CMS would revisit the rate decisions over the next five years, let alone restore the rates to historical levels. Hillrom further argued that the carve-out for changes in "Health Care Law" was inapplicable, and that even if it did apply, the impact of the reimbursement rate changes had a "materially disproportionate impact" on Bardy compared to "similarly situated companies operating in the same industries." Second, Hillrom argued that the doctrine of frustration of purpose applied to the purchase agreement and relieved Hillrom of its duty to close in light of the Novitas rate changes.

The Opinion

The court held that Hillrom failed to meet its burden of demonstrating an MAE, and that even if it had been able to do so, the carve-out for changes in Health Care Law applied. While it acknowledged that this was not a case of "buyer's remorse" where a buyer actively seeks to scuttle a deal after adverse developments, the court nonetheless found that Hillrom failed to prove that the rate changes "substantially threaten[ed] the overall earnings potential of [Bardy] in a durationally-significant manner." For its analysis, the court assumed that the rate changes had an MAE on Bardy at the time Hillrom refused to close, but determined that Hillrom was required to and failed to prove that it "reasonably expected neither Novitas nor CMS would readjust Medicare reimbursement rates for the relevant [reimbursement rate] codes any time soon" (emphasis in original). It observed that Hillrom had assumed that Bardy would be unprofitable for three years regardless of the rate changes. The court determined that Bardy could operate under the revised rates for two years without suffering an MAE — the record reflected that Bardy continued to grow in 1Q 2021 and was able to raise debt financing even with the lower reimbursement rates.

The court also concluded that Hillrom did not meet its burden to prove that neither Novitas nor CMS would revisit or revise the rate changes over the next two years. It discredited the testimony of Hillrom's expert that the rate changes would not be revisited for five years, finding instead that Novitas was unpredictable and it was "just as likely as not" that it or CMS would revisit the rate changes. In a footnote, the court acknowledged that buyers face a "nearly insurmountable" burden of proving an MAE when the MAE is dependent on future decision-making by third parties:

By necessity, the party seeking to prove an MAE has occurred must convince the court (by a preponderance of evidence) to see the future the way it sees the future in order to demonstrate durational significance. Not an easy task ... ever. As explained below, when future outcomes rest in the hands of unpredictable actors, the burden to prove durational significance becomes nearly insurmountable. Such is the state of the evidentiary record confronting Hillrom.

Next, the court determined that the carve-out in the MAE clause for changes in "Health Care Law" was applicable to the Novitas reimbursement rate changes, and that even if the rate changes were an MAE, they did not have a disproportionate impact on Bardy. The court noted that Medicare rate changes by CMS are regulations under law, and that changes delegated to Novitas or others also can be classified as "Health Care Law" under the parties' agreement. Turning to whether Bardy was disproportionately impacted, the court noted that the Hillrom agreement used the phrase "similarly situated companies operating in the same industries," while the agreements in other recent Delaware MAE cases used the phrase "comparable entities operating in the [same] industry." The court interpreted the phrase "similarly situated" to refer to "company characteristics related to the 'matter' the exception is addressing," and concluded that the only company comparable to Bardy under that definition is one company that produces a product competitive to the CAM patch and that was similarly affected by the rate changes. The court acknowledged that "there might appear to be circularity in a reading of 'similarly situated' that limits the disproportionate impact exception to companies that share a similar product mix with the target and, therefore, might be expected to suffer similar impacts from external events affecting the featured product(s)." It reasoned, however, that it was "not surprising" that Bardy "bargained for a narrower, more target-friendly exclusion to the MAE carve-outs."

Finally, the court rejected Hillrom's argument that the purpose of the acquisition had been frustrated. It did not credit Hillrom's contention that the rate changes rendered Bardy less than worthless, observing that Bardy had operated at a loss and successfully raised capital throughout its history. The court explained that "Hillrom sought to acquire a growth company with clinically superior technology to expand its cardiology offering; Bardy remains exactly that."

Key Takeaways

The Bardy opinion has significant implications for future deal agreements and litigation. Specifically:

  • Notwithstanding Akorn, buyers still face a significant burden in establishing an MAE, particularly when its durational significance will be determined by unpredictable future events. The purpose of an MAE clause is to allocate certain unanticipated risks to the seller. But the Bardy court reiterated that a buyer invoking an MAE clause caused by the surprise behavior of third parties must prove, notwithstanding the buyer's failure to anticipate the adverse development prior to agreeing to the acquisition, that the third parties are unlikely to change their conduct. According to the court, while proving an MAE is "[n]ot an easy task ... ever," the burden of proving an MAE contingent on the decisions of "unpredictable actors" is "nearly insurmountable."

  • Unlike some other Delaware MAE cases in which the court found that a buyer had schemed to kill the deal (see An Ounce of Prevention: Delaware Court of Chancery Orders Specific Performance in Private Equity Deal Nearly a Year After Deal Collapse), the court in Bardy determined that the buyer acted in good faith and made efforts to reverse the rate decisions and save the deal. Nonetheless, the court strictly held the buyer to its burden to prove the durational significance of the MAE.

  • In the context of exceptions to MAE carve-outs for when an MAE disproportionately affects the seller compared to others in its industry, Delaware courts will interpret the phrase "similarly situated companies" as narrow and seller-friendly language. The Bardy court read this language to relate to the carve-out to the MAE clause itself, and compared the impact on Bardy to its most similar competitor offering a similar product, not to other cardiac monitoring device makers that were unaffected by the reimbursement rate decisions. Buyers should be cognizant that Delaware courts may interpret the phrase "similarly situated companies" more narrowly than the phrase "comparable entities."

  • The Delaware Court of Chancery will support, where appropriate, highly expedited litigation, notwithstanding the lingering effects of the pandemic. See Sue First, Talk Later: Lessons From Recent Delaware Court of Chancery Decisions on Expediting Proceedings During the COVID-19 Pandemic. The parties went from complaint to trial — including 18 depositions, 11 live witnesses and 824 exhibits — in a little more than two months, and from commencement of the action to a decision in a little more than four months.

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