CLIENT ALERT: Court of Chancery Makes Unprecedented MAE Finding
In this post-trial memorandum opinion, the Delaware Court of Chancery made an unprecedented finding that a merger target, Akorn, Inc. (“Akorn”), had experienced a material adverse effect (“MAE”) within the meaning of its merger agreement with Fresenius Kabi AG (“Fresenius”) and further held that Akorn’s breaches of a regulatory representation and ordinary course covenant permitted Fresenius to terminate the merger agreement. The opinion notes that “[t]his case is markedly different” from typical MAE claims where buyers have second thoughts about an acquisition after “cyclical trends or industrywide effects negatively impacted their own businesses, and who then filed litigation in an effort to escape their agreements without consulting with the sellers.” Here, the Court found that Fresenius responded to “a dramatic, unexpected, and company-specific downturn in Akorn’s business” and “whistleblower letters that made alarming allegations about data integrity issues at Akorn.” Moreover, while Fresenius properly conducted an investigation into Akorn’s downturn and data-integrity issues, it nevertheless continued to move forward with the merger. As the first post-trial decision of the Delaware Court of Chancery to find an MAE, this case will likely set the standard for future litigants seeking to prove the occurrence of an MAE.
The Court made three key findings in support of the conclusion that Fresenius was not required to close the merger and had properly terminated the merger agreement: First, “Fresenius validly terminated the Merger Agreement because Akorn’s representations regarding its compliance with regulatory requirements were not true and correct, and the magnitude of the inaccuracies would reasonably be expected to result in a Material Adverse Effect.” Second, “Fresenius validly terminated because Akorn materially breached its obligation to continue operating in the ordinary course of business between signing and closing.” And third, “Fresenius properly relied on the fact that Akorn has suffered a Material Adverse Effect as a basis for refusing to close.” The Court also found that Fresenius had fulfilled its own contractual obligations, a material breach of which would have prevented Fresenius from exercising its termination right.
The Court’s opinion centered on the material deterioration of Akorn’s financial condition after the parties signed the merger agreement. For example, Akorn’s financial performance declined substantially, with its EBITDA declining 86%. The Court held that the underlying causes of the decline were durationally significant and were specific to Akorn, rather than the result of industry-wide conditions. Moreover, Akorn’s regulatory compliance problems were significant because of “overwhelming evidence of widespread regulatory violations and pervasive compliance problems” that existed at signing and worsened thereafter. Significantly, the Court held that Akorn failed to use commercially reasonable efforts to operate in the ordinary course of business. The Court found that, as soon as the parties signed the Merger Agreement, Akorn cancelled regular audits, assessments, and inspections of known problems specifically because of the pending merger. Akorn also did not maintain its data integrity system and submitted regulatory filings with inaccurate data, none of which was done in the ordinary course. The Court found that these ordinary course violations were material because, among other reasons, they cost Akorn “a year of what could have been meaningful remediation efforts.”
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