No ‘Material Adverse Effect’ Occurred to Relieve Purchaser of Obligation to Close $10.6 Billion Acquisition

On September 29, 2008, Vice Chancellor Stephen P. Lamb of the Delaware Court of Chancery issued his highly anticipated decision in the litigation filed by Hexion Specialty Chemicals, Inc. seeking to terminate its obligation to consummate the $10.6 billion merger through which it planned to acquire Huntsman Corporation, a Salt Lake City-based specialty chemical manufacturer. See Hexion Specialty Chemicals Inc. v. Huntsman Corp., C.A. No. 3841-VCL, slip op. (Del. Ch. Sept. 29, 2008). The decision follows a rare trial to determine whether a potential purchaser may opt out of a previously agreed-upon merger and the extent to which the purchaser may do so without incurring liability to the target. The decision also provides critical guidance from the Court of Chancery on how it will determine whether a downturn in the target’s business constitutes a “Material Adverse Effect,” a term that has become commonplace in mergers and acquisitions. Finally, the Hexion-Huntsman litigation represents a cautionary tale for merger partners (and their counsel) who may find themselves experiencing buyer’s remorse after signing a merger agreement.

In his 89-page post-trial opinion, Vice Chancellor Lamb ordered Hexion to comply with its obligations under the parties’ merger agreement, finding that Huntsman’s business had not suffered a “Material Adverse Effect” that would have permitted Hexion to terminate the agreement without penalty. In addition, the court found that Hexion, in part through its efforts to obtain an “insolvency opinion” that it believed rendered it unable to obtain financing for the transaction, knowingly and intentionally breached its obligation under the merger agreement to use its “reasonable best efforts” to close the merger. As a result of this finding, Hexion’s liability to Huntsman for any damages caused by its breaches (and the liability of its majority owner, private equity firm Apollo Global Management) potentially may exceed the agreement’s $325 million termination fee.


On July 12, 2007, Hexion agreed to acquire Huntsman for $28 per share in cash. Hexion proposed to fund the merger through debt financing provided by Credit Suisse and Deutsche Bank pursuant to a commitment letter. Under the terms of that commitment letter, funding from Hexion’s lenders was conditioned upon confirmation from Hexion, Huntsman, or an outside appraiser that the combined company will be solvent.

Almost one year later, on June 18, 2008, Hexion and several Apollo affiliates filed a complaint in the Court of Chancery seeking to terminate the proposed merger. Earlier that same day, Hexion’s board of directors had received an opinion from valuation firm Duff & Phelps that the combined Hexion-Huntsman entity would not be solvent.

Based on the Duff & Phelps opinion, Hexion concluded that it would be unable to secure funding from Credit Suisse and Deutsche Bank under the commitment letter. As a result, Hexion sought from the Court of Chancery a declaratory judgment that it was not obligated to close the merger if the combined company would be insolvent. Hexion further sought a declaration that, if it was unable to consummate the merger because of a lack of financing, its liability to Huntsman would be limited to the $325 million termination fee provided in the merger agreement.

Hexion also asked the court to determine whether, because of the alleged “deterioration in Huntsman’s financial performance and increase in Huntsman’s net debt,” Huntsman had suffered a “Company Material Adverse Effect,” as defined in the merger agreement. As is typical in most merger agreements, the occurrence of an MAE would permit Hexion to terminate the merger without paying any fee to Huntsman.

On July 2, 2008, Huntsman filed its own counterclaims against Hexion and Apollo. Among other things, Huntsman alleged that Hexion breached the merger agreement by failing to use its “reasonable best efforts” to secure financing and consummate the merger. Huntsman also alleged that Hexion’s breaches of the merger agreement were knowing and intentional, thereby entitling Huntsman to damages above and beyond the $325 million termination fee.

The Merrill Lynch Discovery Order

Vice Chancellor Lamb agreed to hear the parties’ declaratory judgment and specific performance claims on an expedited basis, and scheduled trial to begin September 8, 2008. During discovery, the court issued a significant opinion compelling Huntsman to produce materials prepared by its investment banker, Merrill Lynch, after litigation had commenced June 18. In doing so, the Vice Chancellor rejected Huntsman’s contention that it had retained Merrill Lynch as a “litigation consultant” and, as such, its work product was protected under Rule 26(b)(4)(B). The court held that, since Merrill Lynch was a “key fact witness” in its role as financial adviser on the merger, Huntsman could not “use] the façade of litigation consulting as an excuse to withhold discoverable documents prepared by or relating to Merrill Lynch’s continuing activities in that role.” See Hexion Specialty Chemicals Inc. v. Huntsman Corp., C.A. No. 3841-VCL, 2008 WL 3878339 (Del. Ch. Aug. 22, 2008).

The Trial

At the six-day trial, the court was presented with two key issues:

  • Whether the combined Hexion-Huntsman entity will be insolvent, and thus whether Hexion could terminate the merger for lack of financing in exchange for payment of the $325 million termination fee
  • Whether Hexion is excused from closing the merger—without paying any penalty—because Huntsman suffered an MAE

Hexion argued that the post-merger company would be insolvent under any of three recognized solvency tests—balance sheet, ability to pay debts when due, and capital adequacy. As a result, Hexion contended that it was unable to secure financing to close the merger either pursuant to Credit Suisse’s and Deutsche Bank’s commitment letter, or from any alternative source. According to Hexion, its failure to close the merger therefore would be neither deliberate nor intentional, and pursuant to the terms of the merger agreement, Huntsman would be entitled to no more than the $325 million termination fee.

In response, Huntsman argued that the merger agreement requires Hexion to use its “reasonable best efforts” to close the merger, regardless of whether it can secure financing. In fact, Huntsman accused Hexion of knowingly and intentionally breaching the merger agreement by seeking the “insolvency opinion” from Duff & Phelps, and then furnishing that opinion to its banks.

The parties similarly differed on whether Huntsman’s recent decline in earnings constituted an MAE. The merger agreement defined an MAE as specifically excluding any event “resulting from or relating to changes in general economic or financial market conditions,” unless the event has had a “disproportionate effect” on Huntsman “as compared to other Persons engaged in the chemical industry.” While Hexion and Huntsman argued whether or not Huntsman’s poor financial performance was long term and “material,” their experts also presented diverging views as to the appropriate peer group to include within the “chemical industry” and how to measure “disproportionality” compared with that group.

The Court’s Opinion

MAE Analysis. In his post-trial opinion, Vice Chancellor Lamb first considered whether Hexion’s obligation to close the merger was excused by the occurrence of an MAE. Citing its earlier decision in In re IBP, Inc. Shareholders Litigation, 789 A.2d 14 (Del. Ch. 2001), the court observed preliminarily that “[f]or the purpose of determining whether an MAE has occurred, changes in corporate fortune must be examined in the context in which the parties were transacting…. The important consideration therefore 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 commercially reasonable period, which one would expect to be measured in years rather than months.” Slip op. at 39.1 The court further stated that a target’s pre-closing decline in earnings “to constitute a material adverse effect … must be expected to persist significantly into the future.” Id. at 40.

Vice Chancellor Lamb’s opinion made other significant rulings concerning how the court determines whether an MAE has occurred. For example, the court held that, regardless of whether an MAE clause is framed as a representation, a warranty, a condition to closing or otherwise, the burden of proving an MAE “rests on the party seeking to excuse its performance under the contract.” Slip op. at 42. In considering the appropriate benchmark to use in examining a target’s business operations, the court rejected the use of earnings per share, opting instead to consider Huntsman’s EBITDA as “a better measure of the operational results of the business.” Id. at 43.

Applying this analytical framework, the court found that, while Huntsman had suffered through a difficult year since signing the merger agreement, its performance was not sufficiently impaired to constitute an MAE.

First, Vice Chancellor Lamb rejected Hexion’s argument that Huntsman’s failure to meet its management’s 2007 projections was an MAE, finding that Huntsman expressly disclaimed in the merger agreement making any representations or warranties concerning those projections. Instead, the court examined Huntsman’s EBITDA for each relevant year and quarter, and compared it with the prior year’s equivalent period—for example, Huntsman’s 2007 EBITDA was 3 percent lower than 2006, and projections for 2008 EBITDA estimated a decrease of 7–11 percent from 2007. In sum, the Court found that these declines “do not add up to an MAE, particularly in the face of macroeconomic challenges Huntsman has faced since the middle of 2007 as a result of rapidly increased crude oil and natural gas prices and unfavorable foreign exchange rates.” Slip op. at 50-51.

Vice Chancellor Lamb also declined to focus on Huntsman’s two most troubled divisions, holding instead that the MAE should be determined based on an examination of the company as a whole. Having found that Hexion did not carry its burden of proving the existence of an MAE in the first instance, the court found it unnecessary to consider whether the merger agreement’s “disproportionate effect” carve-out applied.

Second, the court considered whether Hexion had knowingly and intentionally breached the merger agreement and, thus, whether its liability for any failure to close would exceed the agreed-upon $325 million termination fee. Drawing upon traditional criminal law notions of intent, the Vice Chancellor concluded that “a ‘knowing and intentional’ breach, as used in the merger agreement, is the taking of a deliberate act, which act constitutes in and of itself a breach of the merger agreement, even if breaching was not the conscious object of the act.” Slip op. at 59-60. Applying this definition, the court found that Hexion knowingly and intentionally breached its obligations under the merger agreement to (1) “use its reasonable best efforts” to consummate financing with Credit Suisse and Deutsche Bank, and (2) notify Huntsman within two business days if, for any reason, Hexion “no longer believes in good faith that it will be able to obtain all or any portion of the Financing.” Among other things, the court held that Hexion’s solicitation of the insolvency opinion from Duff & Phelps, and its subsequent failure to notify Huntsman once it believed that opinion compromised its ability to secure financing, were deliberate breaches of these covenants.

The court further concluded that, even if the combined entity would be insolvent, the merger agreement contained no “financing out” clause for Hexion that would excuse it from closing the merger. As a result, Vice Chancellor Lamb declined to resolve the solvency issue, holding that such an issue would not arise unless and until the lenders determined whether to fund the transaction under the Commitment Letter. 

Interestingly, the merger agreement contained express provisions permitting specific performance of the agreement, but particularly excluded specific performance of the purchaser’s obligation to close the merger. Accordingly, Huntsman was not entitled to an order specifically directing Hexion to close the merger.

However, the court did order Hexion to perform its other obligations under the agreement, including its obligation to pursue financing of the transaction. If Credit Suisse and Deutsche Bank later agree to fund the transaction, Hexion could nonetheless decide not to close. As the court noted, however, doing so could potentially render Hexion liable to Huntsman for contractual damages in excess of $325 million, based on the court’s finding of a knowing and intentional breach.