On 1 October 2018, the Delaware Court of Chancery issued an unprecedented decision allowing buyer Fresenius Kabi AG to terminate its merger agreement with target company Akorn, Inc. due to a "material adverse effect" or an MAE, a term generally synonymous with “material adverse change or MAC”. While this decision marks the first time that the court determined an MAE to have occurred, the court goes to great lengths in its 247 page opinion to distinguish the facts of this case from precedent. As such, in future cases, buyers will still have to satisfy a high bar in order for a court to rule that an MAE has occurred. 


 On 24 April 2017, Fresenius and Akorn entered into a merger agreement whereby Fresenius would acquire Akorn. The merger agreement contained standard representations and warranties about Akorn's business, including representations regarding Akorn's compliance with regulator requirements. Fresenius' closing obligations were conditioned on such representations and warranties being true and correct at both signing and closing except where such failure would not reasonably be expected to result in an MAE. Akorn also agreed to a standard covenant that it would continue to operate in the ordinary course of business between signing of the merger agreement and closing of the transaction contemplated by it. Immediately prior to signing the merger agreement, Akorn also re-affirmed its previously issued financial guidance for 2018.

During the second quarter of 2017, Akorn's "business performance fell off a cliff" and its financial results fell materially below the prior year's results (upon which its financial guidance for 2018 was based).  Akorn adjusted its financial guidance for 2018 and Fresenius consulted with Akorn management about the sudden decline. Akorn attributed it to unexpected competition in the market and the loss of a key contract and assured Fresenius that the downturn was temporary. Throughout the next several months, Akorn's performance continued to significantly deteriorate.  Over the course of the year after the signing of the merger agreement, Akorn's EBITDA fell by 86%.

In October 2017, Fresenius received a letter from an anonymous whistle-blower alleging that Akorn's product development process failed to comply with regulatory requirements. In November, Fresenius received a more detailed letter which also contained allegations regarding Akorn's quality compliance programs. The letters called into question the validity of Akorn's representations and warranties regarding regulatory compliance and also whether Akorn had been operating in ordinary course of business after signing the merger agreement. Fresenius delivered these letters to Akorn. While recognizing that Akorn needed to investigate the allegations described in these letters, Fresenius also informed Akorn that Fresenius would independently conduct an investigation into the allegations. Fresenius had bargained for a right of reasonable access to officers, employees and information under the merger agreement. As such, Fresenius' expert attorneys and advisers began investigating the issues raised in the letters. The investigation uncovered serious and pervasive data integrity problems that rendered Akorn's representations and warranties about its regulatory compliance inaccurate. In addition, Fresenius determined that Akorn had changed its quality control and information technology processes without Fresenius's consent. After what Fresenius felt was a misleading presentation by Akorn to Akorn's primary regulator, the United States Food and Drug Administration, Fresenius determined that Akorn was not operating in the ordinary course of business as required by the merger agreement.

On 22 April 2018, Fresenius notified Akorn that it was terminating the Merger Agreement due to inaccurate representations and warranties which resulted in the occurrence of an MAE and also citing failure of Akorn to operate in the ordinary course of business and violation of closing conditions. Akorn contended that the merger agreement was not validly terminated and sought an order of specific performance compelling Fresenius to close the merger. 


The court determined that Fresenius validly terminated the merger agreement. The court held that the "sudden and sustained drop" in Akorn's business performance constituted an MAE of Akorn itself, Akorn's regulatory compliance representations and warranties were sufficiently inaccurate that the deviation between the actual condition and the as-represented condition would reasonably be expected to result in an MAE, the operational changes to Akorn's information technology processes breached Akorn's covenant to operate in the ordinary course of business and while Fresenius had technically breached its hell-or-high-water anti-trust covenant, such breach was not material and therefore would not prohibit Fresenius from exercising its right to terminate the merger agreement.


In making its determination, the court made careful distinctions between this case and a case where buyers were suffering from "buyer's remorse" due to "short term hiccups in earnings" which would not suffice to establish the occurrence of an MAE. Rather, Fresenius responded to "dramatic, unexpected and company-specific downturns in Akron's business" that began the quarter after the merger agreement was signed, persisted through the time of the decision and showed no signs of abating. Fresenius successfully met the standard of proving that the adverse change experienced by Akorn was "consequential to the company's long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months." Moreover, the reasons for the downturn provided by Akorn's management team at Akorn could reasonably be expected to have significant effects for a long period of time.

Further, the court explicitly rejected Akorn's argument that for purposes of determining whether an MAE occurred, the change in value of Akorn should be evaluated, not in the context of Akorn as stand-alone entity, but rather in context of Fresenius as a synergistic buyer. The court noted that every prior decision looked at changes in value of Akorn as a standalone company and not as a synergistic enterprise, and implied that if synergies were to be taken into account the combined or surviving company should be referenced in the definition of MAE. The court also rejected Akorn's contention that as long as Fresenius stood to earn a profit from the acquisition, an MAE could not have occurred noting that language relating to profit was not the standard provided in the merger agreement and the court would not introduce language outside the scope of the contract.

While this case marks the first time the Delaware Court of Chancery court has ruled that an MAE has occurred, the finding of an MAE is not unusual given the extraordinary nature of the facts in this particular case. Buyers still face a very high bar in establishing the occurrence of an MAE and should carefully consider how to define and use the concept in purchase and merger agreements.

Baker Mckenzie's attorneys are available to assist with any questions regarding these issues. For further information, please contact the authors or any Baker Mckenzie attorney with whom you usually work.

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