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(Article from Securities Law Alert, December 2018) 

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On December 7, 2018, the Delaware Supreme Court affirmed the Delaware Chancery Court’s decision in Akorn v. Fresenius Kabi, 2018 WL 4719347 (Del. Ch. 2018) (Laster, V.C.), which held that a buyer was justified in terminating a public company merger agreement on the basis that  a Material Adverse Effect (“MAE”) had occurred. Akorn v. Fresenius Kabi, 2018 WL 6427137 (Del. 2018) (Strine, Jr., C.J.). An MAE, one of the key terms in an acquisition agreement, essentially defines when a buyer does not have to complete an agreed-upon acquisition as a result of an adverse change to a target’s business during the period between signing and closing.

Delaware courts to consider this issue have found that an MAE requires that “unknown events” threaten earnings potential in a “durationally-significant manner.” IBP v. Tyson Foods, 789 A.2d 14 (Del. Ch. 2001). In Akorn, the buyer terminated the merger agreement on the grounds that (1) significant declines in the target’s performance amounted to an MAE (and therefore, a failure of the standalone MAE condition), and (2) serious FDA compliance failures breached the target’s regulatory compliance representations in a manner that constituted an MAE (and therefore, a failure of the target’s ability to “bring-down” its representations and warranties at closing).[1]

In a brief decision, the Delaware Supreme Court held that “[t]he factual record adequately supports the Court of Chancery’s determination, based on its application of precedent such as [IBP] . . . that [the target] had suffered a material adverse effect . . . that excused any obligation on [the buyer’s] part to close.” The Delaware Chancery Court further held that “[t]he record adequately supports the Court of Chancery’s declaration that [the buyer] properly terminated the merger . . . because [the target’s] breach of its regulatory representations and warranties gave rise to an MAE and [the buyer] had not itself engaged in a prior, material breach of a covenant that would have prevented [the buyer] from exercising its immediate termination rights under the Merger Agreement.”