The Delaware Court of Chancery ruled in an October 1, 2018, post-trial opinion that a buyer could terminate the parties’ merger agreement due to a material adverse effect (MAE) suffered by the seller between signing and closing. Akorn, Inc. v. Fresenius Kabi AG1 is the first Delaware case to have found that a buyer was justified in terminating an acquisition agreement on the basis of a claimed MAE.

Background

In April 2017, Fresenius Kabi AG (the buyer), a German pharmaceutical company, signed a merger agreement committing to purchase Akorn, Inc. (the seller), a generic pharmaceuticals manufacturer. Shortly after signing, Akorn’s financial performance drastically declined. Akorn reported that year-over-year second quarter revenue declined 29 percent, operating income declined 84 percent, and earnings per share declined 96 percent. Akorn’s financial results continued to significantly decline for the remainder of the year. Compounding those financial difficulties, Fresenius received whistleblower letters in fall 2017 alleging deficiencies in Akorn’s compliance with Food and Drug Administration (FDA) rules and regulations. Further, Fresenius learned that Akorn had provided misleading information to the FDA. Fresenius conducted a lengthy investigation and ultimately decided to exercise its contractual right to terminate the agreement and not close the transaction. Akorn filed suit in response to Fresenius’s actions, seeking specific performance of Fresenius’s obligations under the merger agreement.

Chancery Court opinion

The Chancery Court stated that Akorn failed to satisfy three closing conditions: the General MAE Condition, the Bring-Down Condition, and the Covenant Compliance Condition. The Chancery Court found that Akorn experienced a general MAE due to the material decline in Akorn’s financial performance in the period between signing and closing. The Chancery Court held that the underlying causes of Akorn’s financial decline were “durationally significant” and disproportionate to Akorn relative to its industry peers. Additionally, the Chancery Court determined that Akorn breached specific representations regarding its regulatory compliance obligations that gave rise to a separate MAE, and that Akorn also materially breached its covenant to use commercially reasonable efforts to operate in the ordinary course of business. Significantly, the Chancery Court eschewed a bright-line test for finding an MAE and emphasized the need to consider the facts on a case-by-case basis. The Chancery Court also differentiated this case from prior MAE cases in which buyers sought to terminate an acquisition agreement because of  “buyer’s remorse.” The opinion noted that in this case, Fresenius’s “remorse was justified” because of the magnitude of the problems faced by Akorn. The Chancery Court noted that, while Fresenius also breached its pre-closing covenants, such breaches were not sufficiently material to undermine Fresenius’s contractual rights. The Chancery Court also rejected Akorn’s argument that the assessment of the decline in Akorn’s value should take into account its value to Fresenius as a synergistic buyer, and instead confirmed that the decline should be measured on a standalone basis, and that if the parties had intended to take synergies into account, the MAE definition would have referred to the combined company.

In addition, the Chancery Court highlighted other areas of Delaware contract law. The Chancery Court reinforced the idea that Delaware courts view “commercially reasonable efforts” and “reasonable best efforts” as equivalent, and the court therefore applied that same standard of efforts to both the buyer and the seller. Furthermore, the opinion generally reinforces Delaware courts’ prior pro-sandbagging rulings.

Conclusion

This decision represents the first time that a Delaware court has permitted a buyer to terminate an acquisition agreement as a result of a Material Adverse Effect. The Chancery Court cautioned that the finding of a Material Adverse Effect is not a bright-line test, and instead focused on the unusual facts pertaining to Akorn and the fact that the resulting decline in Akorn’s performance was durationally significant. This decision is currently being appealed, and we will continue to monitor the developments in this case and provide further alerts as appropriate.