A Delaware Chancery Court has allowed a buyer to cancel a deal based on a material adverse effect. The decision is believed to be the first of its kind in Delaware.

In Akorn, Inc. v. Fresenius Kabi AG, the Delaware Court of Chancery recently ruled that a buyer could terminate a merger agreement and walk from the deal because the target suffered a material adverse effect (MAE) or a material adverse change (MAC).

Mergers and acquisitions usually provide the buyer with some type of walk right for an MAE. However, the overwhelming majority of acquisition agreements offer no definition for the key term “material.” The Akorn decision provides welcome guidance regarding what constitutes an MAE or MAC.

Akorn involved the merger agreement signed in April 2017 by Fresenius Kabi AG, a German pharmaceutical company, to acquire Akorn, Inc., an American generic pharmaceutical company, for $4.75 billion.

The merger agreement conditioned the buyer’s obligation to close on Akorn’s representations being true and correct both at signing and at closing, except where the failure to be true and correct would not reasonably be expected to have a contractually defined “Material Adverse Effect.” This type of provision is known as the “bring-down condition.”

In addition, the buyer’s obligation to close was conditioned on the target not having suffered any change, event or occurrence that, individually or in the aggregate, has had or would reasonably be expected to have a Material Adverse Effect. This type of provision is often referred to as the “general MAE condition.”

A general MAE condition is not tied to a particular representation about a specific issue. The bring-down condition examines the inaccuracy of specific representations and uses as a measuring stick whether the deviation between the as-represented condition and actual condition constitutes an MAE.

Akorn provides the following guidance regarding what constitutes an MAE or MAC under Delaware law:

• In order to constitute a general MAE, the decline in business performance must be durationally significant from a long-term perspective. A short-term hiccup will not qualify. A minimum of two bad quarters, measured on a year-over-year basis, is probably required.
• In order to constitute a general MAE, the decline in business performance must be greater than 10 percent. A decline of 40 percent or more probably will be a general MAE. Although Akorn does not provide specific guidance in the intermediate range of declines for purposes of a general MAE, a loss of 20 percent of the target’s value may be the threshold. However, the Akorn court warned readers not to “fixate on a particular percentage as establishing a bright-line test.”
• In order to constitute an MAE for purposes of a bring-down condition, the breach of the representation must be both qualitatively and quantitatively significant when viewed from the longer-term perspective of a reasonable acquiror.
• In order to constitute an MAE for purposes of a bring-down condition, the difference between the as-represented condition of the company and the actual condition at closing probably must represent a decline in value equal to approximately 20 percent of the target’s equity value.

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