Court of Chancery Authorizes Termination of Merger Agreement Due to Material Adverse Effect

Skadden, Arps, Slate, Meagher & Flom LLP

Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018)

In a 246-page post-trial decision, Vice Chancellor J. Travis Laster denied a seller’s request for an order directing a buyer to specifically perform its contractual obligations to close a merger, finding that the buyer validly terminated the merger agreement because, among other things, it validly relied on the fact that the buyer had suffered a material adverse effect (MAE), as defined in the merger agreement.

The litigation arose from Fresenius Kabi AG’s contemplated acquisition of Akorn, Inc. pursuant to an April 2017 merger agreement. In the second quarter of 2017, Akorn’s business performance “fell off a cliff” and continued to deteriorate. Later in 2017, Fresenius conducted an investigation that revealed Akorn had “serious and pervasive data integrity problems,” including submitting falsified product data to the Food and Drug Administration (FDA). Fresenius provided Akorn with a notice of termination of the merger agreement on the grounds that Akorn (i) breached regulatory representations and warranties that could reasonably be expected to have an MAE (the Bring-Down Condition); (ii) materially breached a covenant that it complied with or performed in all material respects its obligations (the Covenant Compliance Condition), including to operate in the ordinary course of business (the Ordinary Course Covenant); and (iii) had suffered an MAE. In response, Akorn sued for specific performance, asserting that Fresenius breached the Covenant Compliance Condition by failing to use its reasonable best efforts to consummate the merger (the Reasonable Best Efforts Covenant) and take all actions necessary to obtain antitrust approval (the Hell-or-High-Water Covenant).

First, the court found that Akorn breached the Bring-Down Condition, which required Akorn’s representations, including representations regarding regulatory compliance, to have been true at signing and closing. At the time of signing, Akorn had “widespread regulatory violations and pervasive compliance problems” and these problems “got worse, rather than better,” during the relevant time period. The court estimated that Akorn’s data integrity issues constituted a regulatory MAE because the issues would result in a valuation hit of about $900 million, or a 21 percent decline in Akorn’s implied value under the merger agreement.

Second, the court found that Akorn breached its duty to use “commercially reasonable efforts” — which the court treated as synonymous with “reasonable best efforts” — to carry on its business “in all material respects” in the ordinary course of business. The court found that Akorn’s conduct — in canceling regularly scheduled audits in favor of verification audits that would not reveal additional deficiencies, failing to devote any resources to data integrity projects, submitting regulatory filings to the FDA based on fabricated data and failing to investigate regulatory issues upon receiving whistleblower letters — constituted a material departure from reasonable best efforts to conduct the business in the ordinary course.

Third, the court found that Akorn suffered a MAE that “substantially threaten[ed its] overall earnings potential [] in a durationally-signficant manner.” From Q2 2017 through Q1 2018, Akorn’s year-over-year declines each quarter ranged from 25 percent to 34 percent for revenue, 84 percent to 292 percent for operating income and 96 percent to 300 percent for earnings per share. In contrast, over the five-year span of 2012 to 2016, Akorn grew consistently, year over year, when measured by the same metrics. Akorn’s “dramatic downturn in performance is durationally significant” because it “persisted for a full year” and showed “no signs of abating.”

By contrast, the court found that Fresenius did not breach the Reasonable Best Efforts Covenant because it “analyzed and remained committed to fulfilling its obligations under the Merger Agreement” even while it evaluated its rights, including termination rights. Fresenius did breach the Hell-or-High-Water Covenant because for one week, it embarked on a path that would have pushed obtaining regulatory approval beyond the time frame established in the merger agreement. The court, however, found that Fresenius’ breach was not material because, within one week of deviating, Fresenius reverted back to the path that would have kept obtaining regulatory approval within the merger agreement time frame.

The court therefore concluded that Fresenius had validly terminated the merger agreement. Akorn has since taken an appeal.

This summary can be found in the December 2018 issue of Inside the Courts.