Channel Medsystems, Inc. v. Boston Scientific Corp., et al., C.A. No. 2018-0673-AGB (Del. Ch. December 18, 2019) (Bouchard, C.)
In this post-trial opinion, the Delaware Court of Chancery found that Boston Scientific Corporation (“Boston Scientific”) was not entitled to terminate its merger agreement (the “Merger Agreement”) with Channel Medsystems, Inc. (“Channel”), finding that, although fraud by an employee of Channel caused a series of contractual representations to be inaccurate as of the date of the Merger Agreement, Boston Scientific failed to prove that these misrepresentations had a material adverse effect (“MAE”) on the value of Channel. The Court found that Boston Scientific breached its contractual obligation to use commercially reasonable efforts to consummate the merger, and that Boston Scientific failed to prove a claim for fraudulent inducement. Accordingly, the Court held that Channel is entitled to an order of specific performance requiring Boston Scientific to close the merger.
On November 1, 2017, Boston Scientific, a medical technology company, agreed to acquire Channel, a developer of Cerene, a medical device used to treat menstrual bleeding. Boston Scientific had the right to terminate the Merger Agreement under certain conditions, including: (i) Channel’s failure to obtain FDA approval for Cerene by September 30, 2019, and (ii) an MAE resulting from the failure of Channel’s representations and warranties to be true and accurate as of the date of the Merger Agreement.
In late December 2017, Channel first discovered that its Vice President of Quality Assurance, Dinesh Shankar (“Shankar”), falsified expense reports and other documents as part of a fraudulent scheme by which he stole approximately $2.6 million from Channel. Unbeknownst to Channel, some of the documents Shankar falsified were contained in Channel’s prior submissions to the FDA seeking approval of Cerene. Promptly after learning of Shankar’s fraud, Channel notified the FDA and Boston Scientific. Channel then commenced a thorough internal investigation and submitted a remediation plan to the FDA, which the FDA accepted in April 2018. Boston Scientific sent Channel a notice of termination pursuant to the MAE clause of the Merger Agreement on May 11, 2018 (the “Termination Date”).
Channel filed suit seeking an order of specific performance requiring Boston Scientific to close the merger. Additionally, Channel sought a declaratory judgment that Channel did not breach any representations or warranties that had, or would reasonably be expected to have, an MAE on Channel, and that Boston Scientific breached its contractual obligation to use commercially reasonable efforts to consummate the merger. Boston Scientific counterclaimed seeking rescission of the Merger Agreement, alleging that Channel’s breaches of representations and warranties constituted an MAE pursuant to the Merger Agreement. Boston Scientific also asserted a counterclaim for fraud in the inducement based on alleged misrepresentations and omissions regarding Shankar and Channel’s quality control systems.
After a four-day trial, the Court ruled that Shankar’s fraud rendered a number of Channel’s contractual representations materially inaccurate as of the date of the Merger Agreement. First, the Court found that the falsified reports submitted to the FDA would alter the total mix of information available to a reasonable acquirer by calling into question Channel’s ability to secure FDA approval for Cerene. The Court reached the same conclusion with respect to Channel’s representations regarding compliance with design control requirements set forth by the FDA. The Court, however, found Channel made no material misrepresentations regarding whether the Cerene device itself was defective.
The Court then addressed Boston Scientific’s contention that Channel’s misrepresentations constituted an MAE pursuant to the Merger Agreement. Noting that the Merger Agreement did not define what “material” meant with respect to the MAE clause, the Court applied the analysis set forth in Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), which held that “material” in the context of an MAE means an effect that would substantially threaten the overall earnings potential of a target company in a durationally-significant manner.
Here, the Court found that Boston Scientific failed to prove that Channel’s misrepresentations had, or would reasonably be expected to have, an MAE on Channel as of the Termination Date. First, the FDA’s acceptance of Channel’s remediation plan on April 18, 2018 strongly signaled that Shankar’s fraud would not cause the FDA to decline to provide premarket approval of the Cerene device. The Court noted that the FDA eventually approved the Cerene device on March 28, 2019 – six months ahead of the deadline set forth in the Merger Agreement. Additionally, the Court found that FDA approval of Cerene, which appeared likely by the Termination Date, undercut Boston Scientific’s assertion that it would need to keep Cerene off the market while engaging in its own remediation efforts.
Next, the Court addressed Boston Scientific’s contention that, even with FDA approval, Shankar’s fraud would reasonably be expected to have an MAE to the extent the merger would expose Boston Scientific to products liability litigation, competitive harm, and regulatory action. The Court rejected this argument, noting the lack of a “single scrap of paper” demonstrating that Boston Scientific considered the foregoing risks before the Termination Date. Further, the Court rejected the opinion proffered by Boston Scientific’s expert witness, who estimated that Channel’s value to Boston Scientific decreased by 24% to 54% due to the remediation costs associated with Shankar’s fraud. The Court found that the evidentiary record did not support the expert’s underlying assumption that Boston Scientific would need two to four years to rebuild Channel’s quality systems and undertake a new clinical trial for Cerene.
Further, the Court held that Boston Scientific breached the Merger Agreement by failing to use commercially reasonable efforts to consummate the merger. Boston Scientific made no meaningful attempt to engage with Channel to keep the deal on track after Channel promptly informed Boston Scientific of Shankar’s fraud. By way of example, Boston Scientific attempted to terminate the merger without first communicating with Channel about its decision or engaging its own outside experts to analyze Channel’s data and quality control systems.
Accordingly, the Court granted Channel’s request for specific performance requiring Boston Scientific to consummate the merger. The Court held that the equities weighed in Channel’s favor, noting that Channel itself was a victim of Shankar’s fraud and acted in good faith by promptly notifying Boston Scientific of the fraud. Additionally, the Court concluded that Boston Scientific would obtain the essence of what it bargained for by closing on the merger: an FDA-approved Cerene device.
Finally, the Court rejected Boston Scientific’s fraudulent inducement claim, finding Boston Scientific failed to prove that Channel knew that certain statements it made about Shankar’s work experience were false. The Court declined to impute Shankar’s fraud to Channel, concluding that Shankar’s fraud was for his own benefit and to the detriment of Channel.