On December 18, 2019, Chancellor Andre G. Bouchard of the Delaware Court of Chancery ruled that defendant Boston Scientific Corporation was not entitled to terminate its merger agreement with plaintiff Channel Medsystems, Inc. Channel Medsystems, Inc. v. Bos. Sci. Corp., C.A. No. 2018-0673-AGB (Del. Ch. Dec. 18, 2019). After the merger agreement was signed, plaintiff—a pre-approval stage medical device company with one product—discovered that its vice president of quality had falsified various documents as part of a multiyear scheme in which he stole $2.6 million from the company. According to the Court, upon discovery, plaintiff was “transparent” with the FDA and with defendant regarding the fraud finding and “acted with dispatch to address it.” Defendant nevertheless notified plaintiff that it was terminating the merger based on provisions in the agreement that permitted termination for misrepresentations that would be expected to result in a “Material Adverse Effect.” Following trial, the Court found that—notwithstanding plaintiff’s breaches of certain representations, including with respect to the accuracy of its FDA submissions—there was no reasonable expectation of a Material Adverse Effect. The Court emphasized that plaintiff did obtain FDA approval for its medical device, which demonstrated that it was “safe and effective” and undercut defendant’s claim that defendant would need to “remediate and retest” the device at great cost before marketing. The Court thus granted specific performance and directed defendant to close the merger.
Defendant’s principal argument was that it was entitled to terminate the merger under the Material Adverse Effect provisions of the merger agreement. Those provisions permitted termination if any of plaintiff’s representations were inaccurate, unless such misrepresentations “do not have and would not reasonably be expected to have a Material Adverse Effect” on plaintiff. “Material Adverse Effect” was defined as “any change or effect occurring after the Agreement Date that, when taken individually or together with all other adverse changes or effects occurring after the Agreement Date, is materially adverse to the business, results of operations, assets or financial condition of [plaintiff].” As a temporal matter, the Court interpreted the “reasonably be expected” language to mean that, as of the date it provides its notices of termination, defendant would need to have a reasonable expectation that a Material Adverse Effect would occur “as of the time of the anticipated closing.”
Specifically, defendant contended that the fraud (a) threatened plaintiff’s overall earnings “by jeopardizing its chances of obtaining FDA approval”; and (b) notwithstanding approval, defendant would still need to remediate and retest the product before marketing. However, the Court found that the FDA’s acceptance of plaintiff’s remediation plan before defendant provided its notice of termination “strongly signaled that [the employee’s] fraud would not be the cause of any failure of the FDA to provide premarket approval” of plaintiff’s medical device and ultimately the FDA did approve the device prior to trial. Moreover, according to the Court, there was no evidence that demonstrated defendant would need to remediate and engage in new testing despite FDA approval. Considering both qualitative and quantitative factors, the Court concluded that defendant did not prove that, when it terminated the merger, there was an objectively reasonable expectation that there would be a Material Adverse Effect at the time the merger was anticipated to close.
The Court also found that defendant breached its contractual obligations to use commercially reasonable efforts to complete the merger. The Court explained that instead of engaging with plaintiff as invited upon discovery of the employee’s fraud, defendant “simply pulled the ripcord.”
This opinion may indicate that the decisions by the Court of Chancery and the Delaware Supreme Court in Akorn, Inc. v. Fresenius Kabi AG (as we discussed here and here) did not dramatically alter the judicial approach to attempts to use a material adverse effect provision to avoid a merger. Distinguishing Akorn, in which remediation costs equated to 21% of the target’s standalone equity, the Court here found that defendant “failed to demonstrate any material decline in [plaintiff’s] value.”