You’ve done the due diligence, negotiated hard, and signed the merger agreement. The press release goes out and champagne gets uncorked. So what happens now? Under Delaware law—the law that governs most M&A agreements—the parties to a merger are required to use “commercially reasonable efforts” to consummate the deal. When a merger fails, the parties usually end up suing each other claiming that the other side breached that duty. Recently, a powerful Delaware court fleshed out what that standard means, and what it requires. The decision is required reading for any company or attorney working in the M&A space.
A Deal, Then Fraud: Not Commercially Reasonable
The case is Channel Medsystems, Inc. v. Boston Scientific Corporation, No. 2018-0673-AGB (Del. Ch. 2019). Medical device manufacturer Boston Scientific agreed to acquire Channel, a start-up with a single product called Cerene, a device used to treat the uterine disorder endometriosis. The agreement would only close if Cerene received FDA approval by September 30, 2019. But in late December 2017, Channel discovered that a vice president had falsified expense reports and other documents as part of a scheme by which he stole $2.6 million from the company. Some of those documents were included in Channel’s FDA submission seeking approval of Cerene, calling into question whether the FDA would reject the application on that basis and whether commercially reasonable efforts to close the deal would be possible.
Channel reached out to Boston Scientific and the FDA and cooperated fully in the ensuing investigation. In April 2018, the FDA accepted Channel’s remediation plan, which strongly signaled that the fraud would not be the cause of any failure to approve Cerene. But despite this assurance, Boston Scientific backed out of the deal the following month, with more than a year to go before the deadline for Cerene to be approved. The device actually was approved in 2019, with more than a half a year to go on the original deadline.
Pulling the Rip Cord
Channel sued, and among other findings the Delaware Chancery Court made in a 119-page ruling was that Boston Scientific failed to use “commercially reasonable efforts” in consummating the merger. This phrase is found in almost every M&A agreement and is an underlying duty under Delaware law, which governs the vast majority of mergers in the United States. What’s strange is that relatively few decisions have put forward any guidelines for determining what “commercially reasonable” actually means. Instead, Delaware courts have used an ad hoc and case-by-case approach, essentially taking the position that “we’ll know it when we see it.”
The Channel Medsystems court took a different approach, laying out a few guidelines that should shape future decisions. The court noted that once the fraud came to light, Boston Scientific never took any steps to engage with Channel after it circulated a report and remediation plan, beyond an unexplained and cursory email that the report “had obvious gaps.” Boston Scientific executives never responded to repeated requests by Channel executives for a meeting to discuss the remediation plan and its findings. This was not a commercially reasonable cour of conduct. Instead, Channel got radio silence from its merger partner for more than six weeks, at which point, the court concluded, “Boston Scientific simply pulled the ripcord.”
As it turned out, internal emails provided in discovery suggested a reason for Boston Scientific’s decision that had nothing to do with concerns about fraud or FDA approval. Boston Scientific executives almost never discussed the fraud or remediation plan internally. But within weeks of signing the merger agreement, even before the fraud came to light, they were getting queasy about the deal because of growing concerns that Cerene was going to have a difficult time competing with other devices that were shortly to come on the market. In that sense, the fraud was heaven sent, providing an excuse for Boston Scientific to get out of a deal it no longer wanted. But this plan was not commercially reasonable. Not so fast, said the court, which ordered Boston Scientific to close the deal on its original terms—an unusual remedy of specific performance that was justified by Boston Scientific’s bad faith.
So what should M&A lawyers and corporate executive take from the case? Fundamentally, the duty to use commercially reasonable efforts to close a deal means, at the least, a duty to engage with your merger partner, to work together to put a deal to bed. Prior to signing an agreement, while parties are negotiating, it’s okay to seek to maximize the advantages for your side and get the best deal possible. But the duty shifts once an agreement is signed. At that point, the parties are required to work together to close the deal, and make efforts that maximize the chances that the joint goal of the parties will be achieved. Subsequent events don’t alter that duty, even if time changes some of the assumptions that made the merger look like a good deal in the first place.