On October 1, 2018, the Delaware Court of Chancery determined for the first time that a seller had suffered a "Material Adverse Effect" ("MAE") following the execution of a merger agreement. The determination entitled the buyer to terminate the acquisition transaction. As described more fully in a Cadwalader Memorandum, this decision offers insight into the interpretation of the term "Material Adverse Effect," as well as other provisions commonly used in M&A agreements.

The case, Akorn, Inc. v. Fresenius Kabi AG, et al., concerns a merger agreement that the companies entered into in 2017. After entering the agreement, Fresenius received several whistleblower letters and later launched an investigation into Akorn that found "serious and pervasive data integrity problems," which "rendered Akorn's representations about its regulatory compliance sufficiently inaccurate." On April 22, 2018, Fresenius notified Akorn that it intended to terminate the merger agreement based on (i) untrue and incorrect regulatory representations by Akorn, (ii) Akorn's failure to "use its commercially reasonable efforts . . . to carry on its business in all material respects in the ordinary course of business" following execution of the merger agreement, and (iii) a general MAE suffered by Akorn following the execution of the merger agreement.

After a five-day trial, the Court determined that Fresenius's termination was valid because of (i) Akorn's financial performance following the execution of the merger agreement, (ii) Akorn's breach of regulatory compliance representations and (iii) Akorn's failure to maintain adequate data integrity procedures and its improper response to the data integrity issues alleged in the whistleblower letters.

Cadwalader attorneys noted several key takeaways from this decision:

  • a "material adverse effect" must be substantial and durationally significant;
  • sellers should not overreact because proving an MAE still requires evidence of substantial performance deterioration or other significant effects;
  • the court's analysis may be different under certain circumstances for a financial buyer;
  • an MAE may be deemed to occur even if the buyer had known or contemplated the risks that could lead to the MAE;
  • the court will consider "quantitative and qualitative aspects" in determining whether an issue "would reasonably be expected to result in an MAE";
  • knowledge of a potential risk does not restrict a buyer from terminating a merger agreement for breach of a representation that is based on the manifestation of such risk;
  • buyers seeking to terminate a merger agreement based on an MAE should be mindful of the evidentiary record; and
  • the decision provides insight into how the court interprets the phrases "in all material respects" and "commercially reasonable efforts."

The memorandum was authored by Joshua Apfelroth, Jason Halper, William Mills and Marianna Wonder.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.