The Delaware Court of Chancery issued a precedent recently, whereby an acquisition agreement may be cancelled due to the occurrence of a “Material Adverse Effect” (MAE) in the acquired entity. In Akorn vs. Fresenius, the court ruled in favor of Fresenius, a German pharmaceutical company, and allowed it to back out of the agreement to purchase the American pharmaceutical company Akorn on the grounds that Akorn has suffered “material adverse effects” during the period between the signing of the acquisition agreement and the closing, and, in addition, misrepresentations of Akorn’s business and profitability data and the misrepresentations regarding compliance with standards and Federal Drug Administration (FDA) regulatory requirements.
Fresenius acquired Akorn for USD 4.75 billion in 2017. Akorn appealed to the court to enforce the closing of the transaction, notwithstanding the allegations raised by Fresenius.
During the trial, Fresenius claimed that a dramatic downturn in Akorn’s business results was recorded in the months following the signing of the agreement, and that Fresenius received anonymous letters from employees of Akorn warning about both Akorn’s dishonesty when it furnished its business data and Akorn’s violations of FDA standards. In its ruling, the court analyzed the material adverse changes and the breach of agreement committed by Akorn when it issued false representations of its regulatory compliance and business data, relative to what was required of Akorn upon closing of the transaction.
A “Material Adverse Effect” clause is included in nearly all M&A agreements. Many of these deals do not come into effect on the signing date of the agreement, but rather on the transaction closing date, due to the fact that all requisite approvals must be obtained in order to close the transaction, such as regulatory approvals, approvals from financial institutions, approvals from third parties, etc. The interim period between the signing and the closing may last from several weeks up to more than a year, depending on the nature and complexity of the transaction. The purpose of the “Material Adverse Effect” clause is to protect the buyer, so that if a material adverse effect occurs in the purchased entity during this interim period, the buyer is entitled to cancel the acquisition agreement.
As a result of this precedent, we may see attorneys of the parties to a transaction making specific revisions to the MAE clause. These could include, for example, a more precise definition of the instances deemed “material adverse effects” and the inclusion of additional exceptions to the application of the MAE clause, in order to clarify ambiguities.