Akorn, Inc., v. Fresenius Kabi AG, et al., C.A. No. 2018-0300-JTL (Del. Ch. October 1, 2018) (Laster, V.C.)
In this 246-page post-trial opinion, the Court denied a request for specific performance by Akorn, Inc. (“Akorn”) to compel Fresenius Kabi AG (“Fresenius”) to close on Fresenius’s acquisition of Akorn, finding that Fresenius validly refused to close and terminated the parties’ merger agreement (the “Merger Agreement”) because Akorn had experienced a dramatic financial downturn and serious regulatory compliance issues that constituted material adverse effects within the meaning of the Merger Agreement, and because Akorn materially breached its obligation to continue operating in the ordinary course of business between signing and closing.
Pursuant to the Merger Agreement, Fresenius, a pharmaceutical company based in Germany, agreed to acquire Akorn, a generic pharmaceutical company, for $4.75 billion. Fresenius’s obligation to close was subject to certain conditions, including that Akorn not suffer a Material Adverse Effect (“MAE”) between signing and closing (the “General MAE Condition”). The Merger Agreement defined MAE in part to include an effect, change, or event that had a material adverse effect on Akorn’s business, results of operations, or financial condition, excluding effects, changes, or events resulting from systematic risks related to Akorn’s industry, the economy, acts of war, or other force majeure-type events. Pursuant to its agreement to this definition of MAE, Akorn assumed the risk of an MAE resulting from what the Court referred to as the “business risks,” such as those arising from the ordinary operations of the business.
In addition to closing conditions, the Merger Agreement provided Fresenius the right to terminate under certain circumstances, including if Akorn’s representations in the Merger Agreement were not true and correct both at signing and closing, except where the failure to be true and correct would not reasonably be expected to result in an MAE (the “Reps MAE Condition”). Fresenius could also terminate if Akorn failed to comply with its obligations under the Merger Agreement, including its obligation to operate the business in the ordinary course in all material respects (the “Ordinary Course Condition”). To exercise its termination rights under the Merger Agreement, Fresenius could not be in material breach of its own obligations under the agreement.
After signing, Akorn’s financial performance deteriorated significantly, with its EBITDA declining 86%. Also after signing, Fresenius received several whistleblower letters reporting serious issues with Akorn’s compliance with U.S. Food and Drug Administration regulations for product development and quality control. Fresenius provided the whistleblower letters to Akorn and conducted its own investigation into the allegations, relying on its contractual right to reasonable access to Akorn’s officers, employees, and information to assess Akorn’s contractual compliance. Fresenius’s investigation uncovered fundamental and pervasive flaws in Akorn’s regulatory compliance that called into question whether Akorn’s representations in the Merger Agreement regarding regulatory compliance were accurate and whether Akorn had been operating in the ordinary course of business post-signing. Fresenius relied on the General MAE Condition, the Reps MAE Condition, and the Ordinary Course Condition to terminate the Merger Agreement and not close. Akorn commenced litigation seeking to compel specific performance of the Merger Agreement.
The Court found that the financial downturn Akorn experienced post-signing was an MAE within the meaning of the General MAE Condition. Beginning immediately after closing and through the following year, Akorn’s financial performance declined significantly, with a 25% decrease in year-over-year revenue, a 105% decrease in operating incoming, and a 113% decrease in earnings per share. This financial downturn resulted from unexpected competition in the market for some of Akorn’s mainstay products, the loss of a key contract, and other challenges. The Court determined that the downturn had “already persisted for a full year and show[ed] no sign of abating,” that Akorn’s problems were expected to have long-term effects, and that analyst estimates about the company’s prospects and value had dramatically changed. As such, the Court concluded that the changes at Akorn were company-specific and “durationally significant,” consistent with Delaware case law’s guidance on the standard for an MAE. Because Akorn experienced an MAE, Fresenius was not required to close by reason of the General MAE Condition and Akorn was not entitled to specific performance.
The Court also found that Akorn’s representations about its regulatory compliance in the Merger Agreement were not true and correct and the magnitude of the inaccuracies would reasonably be expected to result in an MAE, triggering the Reps MAE Condition. In measuring the impact of the MAE caused by Akorn’s breach of the regulatory compliance representations, the Court considered qualitative and quantitative factors. The Court found that Akorn’s regulatory compliance problems were qualitatively significant because Fresenius provided “overwhelming evidence of widespread regulatory violations and pervasive compliance problems at Akorn” that existed at signing and worsened thereafter. Akorn’s regulatory compliance problems were also quantitatively significant, with the Court estimating that remediating the problems would require direct outlays, disruption, and delay that, in turn, would effect an approximately 21% reduction in Akorn’s standalone valuation. The Court found the estimated reduction in value to be material.
The Court also concluded that Akorn failed to use commercially reasonable efforts to operate in the ordinary course of business. The Court found that, as soon as the Merger Agreement was signed and specifically because of the pending merger, Akorn canceled regular audits at four of its sites and canceled assessments and inspections of known problems at others. The Court also found that Akorn failed to comply with the Ordinary Course Condition by failing to properly investigate the whistleblower letters, not maintaining and remediating problems with its data integrity systems, and submitting regulatory filings with fabricated data. The Court found that these ordinary course violations were material because they cost Akorn “a year of what could have been meaningful remediation efforts” and led to the further deterioration of numerous existing shortcomings.
Having found that Akorn breached the Reps MAE Condition and Ordinary Course Condition, the Court considered whether Fresenius had materially breached its own contractual obligations, in which case it would not be permitted to terminate the Merger Agreement under either of those provisions. At trial and through its briefing, Akorn attempted to show that Fresenius had breached provisions in the Merger Agreement that required Fresenius to (1) exercise reasonable best efforts to cause the closing conditions to be satisfied (the “Reasonable Best Efforts Covenant”) and (2) take all actions necessary to secure antitrust approval (“Antitrust Approval Covenant”). While the record showed that Fresenius considered and evaluated its right to terminate or not close under the Merger Agreement in light of Akorn’s troubles post-signing, the Court found that Fresenius did not breach the Reasonable Best Efforts Covenant, stating that such covenants “d[o] not require either side of the deal to sacrifice its own contractual rights for the benefit of its counterparty.” And, because of the MAEs Akorn had experienced, Fresenius had “good cause to evaluate its rights and obligations under the Merger Agreement.” Moreover, even though Fresenius was evaluating its contractual rights through counsel, the Court concluded that it was “also working hard to figure out how the deal could still work” in satisfaction of its contractual obligations.
The Court next considered Fresenius’s compliance with the Antitrust Approval Covenant, finding that Fresenius diligently pursued antitrust approvals during the first six months after the signing of the Merger Agreement but that, for approximately one week in February 2018, Fresenius contemplated adopting a strategy that it knew would delay antitrust approval by two months or more. While the Court held that Fresenius technically breached the Antitrust Approval Covenant by briefly pursuing such a strategy, Akorn ultimately failed to prove that Fresenius’s breach was material because Fresenius had the exclusive right to control antitrust strategy and ultimately chose a strategy that would have resulted in antitrust clearance well within the timeframe permitted by the Merger Agreement.
Having found that Fresenius did not materially breach its contractual obligations under the Merger Agreement, the Court concluded that Fresenius properly terminated the Merger Agreement pursuant to the Reps MAE Condition and Ordinary Course Condition.