(Reuters) - In a landmark 247-page opinion issued Monday, Vice Chancellor Travis Laster of Delaware Chancery Court concluded that the German healthcare company Fresenius can walk away from its $4.75 billion deal to acquire the U.S. generic drugmaker Akorn because Akorn’s business experienced a material adverse effect after the agreement was signed. The vice chancellor’s ruling is apparently the first time that a Delaware judge has allowed an acquiring company to invoke an MAE clause to tank a deal. (The provisions are alternatively called MAC clauses, for material adverse change. MAC is catchier than MAE, so even though the Fresenius/Akorn contract used MAE, I’m going with MAC.)
Laster found Akorn experienced two different kinds of material adverse events. The generics company’s business “dropped off a cliff” after the Fresenius deal was announced. Akorn ran into what it called unexpected competition in the market for some of its mainstay products, in addition to challenges facing the entire generics industry. The results Akorn reported in the quarters after its agreement with Fresenius were way below its rosy projections – and even way below Fresenius’ gloomiest forecasts.
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Chancery Court judges have previously held, in 2001’s IPB, Inc. v. Tyson Foods and 2008’s Hexion v. Huntsman that even double-digit drops in quarterly results are not sufficient to trigger a MAC. But Vice Chancellor Laster said Fresenius showed the change in Akorn’s prospects wasn’t just a short-term fluctuation or, as Akorn argued, the consequence of industrywide headwinds that Fresenius should have known about.
“Fresenius carried its heavy burden and showed that the decline in Akorn’s performance is material when viewed from the longer-term perspective of a reasonable acquirer, which is measured in years,” Laster wrote. “Fresenius also showed that Akorn’s poor performance resulted from company-specific problems, rather than industry-wide conditions. Nevertheless, assuming for the sake of argument that the results could be attributed to industry-wide conditions, those conditions affected Akorn disproportionately.”
In addition, the Delaware judge found that “systemic” quality control problems at Akorn constituted a second, regulatory MAC. After announcing the Akorn acquisition, Fresenius received whistleblower reports about Akorn’s alleged failures to comply with regulatory requirements for product development and quality control. Fresenius ended up hiring regulatory lawyers to investigate Akorn’s practices. They turned up evidence, according to Vice Chancellor Laster, of such serious, fundamental flaws in Akorn’s data management that the Food and Drug Administration would have grounds to question the accuracy of the company’s representations. (Akorn’s expert said similar problems are common across the industry – and even afflict Fresenius.)
The judge estimated that it would cost nearly $1 billion to fix Akorn’s quality control problems. Considering that Akorn had pushed Fresenius hard on the original, $4.5 billion deal price, Vice Chancellor Laster said, an unexpected billion-dollar markup should be considered material.
“Akorn understandably has tried to cast Fresenius in the mold of the buyers in IBP and Hexion by accusing Fresenius of having ‘buyer’s remorse,’” the judge wrote. “In my view, the difference between this case and its forebearers is that the remorse was justified. In both IBP and Hexion, the buyers had second thoughts because of problems with their own businesses spurred by broader economic factors. In this case, by contrast, Fresenius responded after Akorn suffered a general MAE and after a legitimate investigation uncovered pervasive regulatory compliance failures.”
Those are the basic conclusions from Laster’s epic, fascinating opinion. I’m not being facetious – there are compelling subplots, for instance, about Akorn’s lawyers from Cravath Swaine & Moore shadowing Fresenius regulatory counsel from Sidley Austin as they investigated Akorn’s data control and about Akorn’s allegation that Fresenius tried to blow the deal by failing to obtain antitrust clearance. Vice Chancellor Laster also provides many pages of discussion of the academic and practitioner scholarship on MACs, which function as a vehicle for buyers and sellers to allocate the risk of unforeseen post-announcement, pre-closing risk. If deal-contract drafting is not your specialty, I can attest that you will learn a lot from reading the entire opinion.
But the big question is whether the vice chancellor’s analysis in Akorn v. Fresenius will affect the way deal lawyers and their clients think about MACs. Before Monday, after all, an acquirer had never successfully involved a MAC clause in Delaware Chancery Court to escape from a deal. Now one has.
I asked three law profs – Brian Quinn of Boston College, John Coates of Harvard and Albert Choi of the University of Virginia - for their early thoughts on the implications of Vice Chancellor Laster’s decision. Their consensus is that the Akorn case was different from Chancery Court’s previous high-profile MAC cases. Choi, whose MAC scholarship was cited by Laster, said Akorn’s plunge in business prospects was not only more severe than the downturns in the Hexion and IBP cases but also a more reliable indicator of long-lasting problems. The court, Choi said in an email, was persuaded that unexpected competition and the loss of a key contract affected Akorn in a “durationally significant manner.”
That’s important: Even though Vice Chancellor Laster found a material adverse change in Akorn’s general business prospects, it wasn’t based just on a quarter or two of bad results but on a long-term and unforeseen shift in its market. That’s a high bar.
And perhaps more significantly, according to Coates and Quinn, the vice chancellor’s MAC analysis took place in the context of allegations of systemic regulatory problems at Akorn. To be clear, Laster found both general and regulatory material adverse effects. He analyzed the two issues separately and, according to Choi, it seems as though, from Laster’s discussion, Fresenius could have ended the deal under the stand-alone MAC after the deadline came and went for Akorn to solve its problems.
But Coates and Quinn said Laster’s view of the deal had to have been shaped by both the general business and regulatory problems Fresenius alleged. The facts in the Akorn dispute, Quinn said, make it an outlier. “Prior to this case, the thinking was, there might be a line for MAC,” he said. “This case is so far over the line that if it weren’t a MAC you should not even write the provision into agreements.”
Coates pointed out that after Akorn’s first distressing quarterly report, Fresenius brought in lawyers from Paul Weiss Rifkind Wharton & Garrison to consult on the possibility of invoking the MAC clause to get out of the deal. As Vice Chancellor Laster described, Paul Weiss advised Fresenius that Akorn’s bad quarter did not amount to a material adverse change. The law firm continued to downplay the MAC option until Akorn’s regulatory problems had emerged. Coates told me that Paul Weiss was probably wise to base its case on both Akorn’s diminished prospects and its regulatory exposure.
Similarly, Coates said, Fresenius improved its own MAC case by continuing to take steps to get the deal done, even as top executives said they regretted the agreement. The company was also able to show a good-faith due diligence effort, even though its diligence team didn’t turn up the regulatory issues that surfaced later. “It all runs together,” Coates said. “Judges are always looking for motives.”
Coates said that most target companies faced with the prospect of their acquirer invoking a MAC provision have agreed to renegotiations rather than engaging in litigation over the clause. (He also said buyers are usually better off focusing on contractual representations and warranties instead of MAC clauses.) The extreme facts of the Akorn case, he said, will probably mean MAC invocation is a rare exception, not the rule.
Nevertheless, he said, the precedent is now out there. “We always thought there would be one and now here it is,” Coates said.
I emailed Akorn counsel Robert Baron and Daniel Slifkin of Cravath but didn’t hear back.
The views expressed in this article are not those of Reuters News.