Akorn v Fresenius

Akorn, Inc. v Fresenius Kabi AG, Quercus Acquisition, Inc. and Fresenius SE & Co KGaA, C.A. No. 2018-0300-JTL, 2018 WL 4719347, Delaware Court of Chancery, decided 1 October 2018, Vice Chancellor J. Travis Laster. The judgment was affirmed by the Supreme Court of Delaware in Akorn, Inc. v Fresenius Kabi AG, No. 535, 2018, decided 7 December 2018, before Strine C.J., Valihura, Vaughn, Seitz and Traynor JJ.

Introduction

In Akorn v Fresenius,[1] the Delaware M&A case involved whether the buyer had the right to terminate the merger agreement on account of a Material Adverse Effect (MAE), breach of regulatory representations and associated pre-closing requirements. The dispute arose from Fresenius’s purchase of Akorn, but after signing, Akorn’s financial performance fell “off a cliff,” and Fresenius’s investigation into whistleblower claims revealed significant data-integrity issues affecting Akorn’s representations.[2] The case is important because the Court of Chancery ruled in favour of Fresenius, holding that termination was valid, including because Akorn had suffered an MAE.[3] It was the first Delaware Court of Chancery decision in which a buyer successfully terminated on that basis.[4]

Case Facts

On 24 April 2017, Germany-based pharmaceutical company Fresenius Kabi AG entered into an agreement to merge with Akorn, Inc., a NASDAQ-listed specialty generic pharmaceutical company. In the event of the merger, each common stock of Akorn would have the right to convert into $34 per share. [5]

As per the terms of the merger agreement, Akorn made representations concerning compliance with applicable regulatory requirements and agreed to use commercially reasonable efforts to carry out its business in the ordinary course. Both parties agreed to use reasonable best efforts to complete, whereas Fresenius agreed to obtain antitrust approvals. The initial Outside Date was 24 April 2018, extendible to 24 July 2018 if antitrust approvals were the only outstanding conditions. [6]

Completion of the merger by Fresenius was conditioned upon satisfaction of three material conditions. Firstly, Akorn’s representations had to be true and correct both at signing and completion, except those inaccuracies which would not reasonably be anticipated to have an MAE. Secondly, Akorn had to perform all its obligations in all material respects. Thirdly, Akorn had not suffered an MAE. [7]

Following signing, in the second quarter of 2017, Akorn’s performance experienced a steep fall-off and materially under-performed its prior-year performance. Fresenius approached Akorn regarding the matter. Akorn attributed its poor performance to unexpected competition and loss of an important contract. Within one year since signing, Akorn’s EBITDA fell by 86%.[8]

During October and November 2017, Fresenius received anonymous whistleblower letters regarding alleged failures by Akorn in its product development and quality control process. Following its access provisions in the agreement, Fresenius investigated. During this investigation, the most significant finding was that Akorn had serious data integrity issues related to its representations concerning regulatory compliance. Additionally, Akorn did not provide transparency to the FDA. [9]

On 22 April 2018, Fresenius gave notice of its termination to Akorn based on an alleged inaccuracy of Akorn’s representations, failure to conduct business in the ordinary course, and Akorn suffering an MAE. Akorn sought declaratory relief for the invalidation of the notice of termination and specific performance of the obligation to close. [10]

Legal Issues

Issue 1: Whether Akorn has an MAE under s.6.02(c), which relieves Fresenius from having to close the deal.

Issue 2: Whether Akorn’s representations regarding regulations are false, in a manner which is likely to result in an MAE under s.7.01(c)(i). Whether any previous material breach by Fresenius prevents termination of the agreement under s.7.01(c)(ii).

Issue 3: Whether Akorn breached its ordinary course obligation under s.5.01(a).

Arguments Presented

Akorn’s Arguments

Akorn contended that Fresenius’s termination was invalid and sought specific performance compelling Fresenius to close. Its central argument was that Fresenius had buyer’s remorse and was attempting to escape a commercially disadvantageous deal. Akorn relied on s.7.01(c)(i), which prohibited Fresenius from terminating if Fresenius was itself in material breach. It argued that Fresenius breached the Reasonable Best Efforts Covenant and the Hell-or-High-Water Covenant.[11]

Akorn also opposed Fresenius’s use of the MAE provisions. It argued that its poor performance resulted from industry challenges such as competition, pricing pressure and regulation, allocated to Fresenius under the MAE carve-outs. It relied on In re IBP, Inc. Shareholders Litigation[12] to argue that MAE provisions protect against unknown events, not risks allegedly known or discoverable before signing. Finally, Akorn argued that Akorn should not be assessed only on a standalone basis because Fresenius expected synergies.[13]

Fresenius’s Arguments

Fresenius argued that termination was a proper exercise of its contractual rights, relying first on s.6.02(c), the General MAE Condition. Under IBP and Hexion Specialty Chemicals, Inc. v Huntsman Corp.,[14] Fresenius argued that Akorn’s decline substantially threatened its long-term earnings potential.[15] Secondly, Fresenius relied on s.7.01(c)(i), read with s.6.02(a), arguing that Akorn’s regulatory representations under s.3.18 were untrue and would reasonably be expected to result in an MAE. Thirdly, it relied on s.5.01(a), the Ordinary Course Covenant, arguing that Akorn failed to remediate data-integrity problems, changed quality-control practices and submitted fabricated data to the FDA. Fresenius finally argued that any temporary breach of its antitrust obligations was not material. [16]

Court’s Reasoning and Analysis

The Court adopted a contractual approach. It assessed whether the closing and termination conditions had been fulfilled. The Court considered s.6.02(c), the General MAE Condition; s.6.02(a), the representations bring-down condition; s.7.01(c)(i), Fresenius’s termination right; and s.5.01(a), Akorn’s Ordinary Course Covenant.[17]

First, the Court concluded that Akorn had experienced a general MAE under s.6.02(c). It relied on Delaware precedents including In re IBP, Inc. Shareholders Litigation and Hexion Specialty Chemicals, Inc. v Huntsman Corp. Under Delaware law, a temporary fall in earnings does not qualify as an MAE; the adverse change must affect future earnings power in a durationally significant manner, measured in years rather than months. The Court accepted that Akorn’s decline was sudden, severe and sustained. It dismissed Akorn’s argument that the decline was caused only by industry conditions, because many factors were company-specific, including new competitors and loss of a key contract. It also dismissed the argument that expected synergies should prevent an MAE finding, because the MAE clause concerned Akorn and its subsidiaries separately, not the combined company.[18]

Secondly, the Court assessed Akorn’s regulatory representations. Section 7.01(c)(i), together with s.6.02(a), allowed Fresenius to terminate if Akorn’s representations were inaccurate, the inaccuracy caused the bring-down condition to fail and could not be cured by the Outside Date. [19] The Court found that Akorn’s regulatory compliance representations were inaccurate. This mattered because Akorn was a generic pharmaceutical company and FDA compliance was critical to its business. FDA data-integrity requirements ensure the safety, efficacy and quality of drugs. [20] Fresenius’s investigation revealed serious data-integrity problems, so the Court accepted that the difference between Akorn’s represented and real condition could cause an MAE. [21]

Thirdly, the Court held that Akorn breached the Ordinary Course Covenant under s.5.01(a). It interpreted this provision as requiring Akorn to use commercially reasonable efforts to conduct ordinary regulatory compliance activities. Akorn’s failure was not minor: it provided false data to the FDA, was not fully transparent with the agency and failed to fix data-integrity problems in time. The Court said no reasonable acquirer would agree that Akorn could suspend audits, ignore data-integrity problems and provide false data to the FDA during the pre-closing period. [22]

Fourthly, the Court dismissed Akorn’s argument that Fresenius was barred from termination due to its own breaches. Applying the reasonable best efforts standard, including Williams,[23] the Court held that Fresenius did not breach its Reasonable Best Efforts Covenant. Although Fresenius temporarily breached the Hell-or-High-Water Covenant, that breach was not material.[24]

Judgment and Ratio Decidendi

The Delaware Court of Chancery decided in favour of Fresenius. On the first issue, it found that Akorn had suffered an MAE, so Fresenius could refuse to close. On the second issue, it held that Fresenius could terminate because Akorn’s regulatory representations were not true and correct and the inaccuracies would reasonably be expected to lead to an MAE. On the third issue, it held that Akorn materially breached its obligation to operate in the ordinary course.[25]

Akorn’s requested relief was denied. It sought a declaration that Fresenius’s termination was invalid and specific performance compelling Fresenius to close. Instead, the Court found for Fresenius and the merger agreement was treated as terminated on 22 April 2018.[26]

Akorn appealed to the Delaware Supreme Court. The appeal failed. The Supreme Court affirmed the Court of Chancery’s judgment of 17 October 2018 dismissing Akorn’s claims. It found that Akorn had suffered an MAE under s.6.02(c), relieving Fresenius of closing. It also found that Fresenius properly terminated under s.7.01(c)(i) because Akorn’s breach of regulatory representations and warranties gave rise to an MAE and Fresenius had not committed any prior material breach precluding termination.[27]

The ratio decidendi is that a buyer is relieved of closing if the target suffers a serious, durationally significant and company-specific adverse effect constituting an MAE. Where the target’s representations are inaccurate in a way that would reasonably lead to an MAE and the buyer has not committed a prior material breach, the buyer may terminate under the relevant contractual provision. A temporary technical breach by the buyer does not bar termination if it is not material.[28]

Although the Court of Chancery found that Akorn breached the ordinary course covenant under s.5.01(a), the Supreme Court noted that it did not have to decide that issue on appeal.[29]

Significance of the Decision

The significance of Akorn is not that it made MAE clauses easy to invoke, but that it established that they can be enforced in exceptional circumstances. The decision is a “seminal development in M&A litigation” because this was the first such successful MAE-based termination.[30] However, the Court set the “goalposts” for future MAE findings to require similarly egregious facts.[31] Therefore, the judgment clarifies rather than changes Delaware law. There is also no fixed percentage threshold for an MAE; the analysis is factual. [32]

Implications and Impact

The implications are significant for M&A practitioners, buyers, sellers and regulated businesses. Buyers will appreciate the value of detailed representations, access rights and termination provisions. For Fresenius, its investigation mattered because it had bargained for access rights to assess Akorn’s compliance and the closing conditions.[33] Sellers will realise that interim covenants are active obligations. A target must behave reasonably when facing serious problems, particularly in a regulated industry.[34]  Operating in the ordinary course means more than maintaining the status quo.[35]

The strength of the reasoning lies in its rigorous contractual interpretation. The Court did not let Fresenius escape simply because the transaction had become less attractive. It considered the risk allocation between the parties, Akorn’s deterioration, the regulatory evidence and Fresenius’s behaviour. This protects deal certainty while enforcing negotiated termination rights. The judgment was “markedly different” from previous buyer’s remorse cases involving ordinary cyclical or industry-wide effects.[36]

A possible criticism is that Akorn may encourage buyers to investigate vigorously after signing if the target underperforms. However, the judgment mitigates this concern by emphasising that Fresenius continued pursuing the transaction while investigating its rights, and that its concerns were reasonable in light of unforeseen events. [37] The Supreme Court’s affirmance reinforces the decision, but its order was limited and did not address every ground.

Conclusion

Akorn v Fresenius is a ground-breaking M&A decision since it proves that an MAE clause may provide grounds for terminating a merger deal after its signing, provided that the contractual and factual requirements are fulfilled. According to the Court of Chancery, Akorn experienced a general MAE, its representations regarding regulatory compliance were not made in accordance with facts, and the deviation between Akorn’s represented and real position could be reasonably predicted to result in an MAE.[38]  The decision was upheld by the Delaware Supreme Court, which concluded that Akorn experienced an MAE as per s.6.02(c), releasing Fresenius from further closing obligations, and also stated that termination of the deal pursuant to s.7.01(c)(i) by Fresenius was reasonable due to the existence of an MAE triggered by Akorn’s breach of regulatory representations.[39]

The key takeaway here is that an adverse event should be a serious and durationally significant one, related directly to the company’s business operations, rather than some temporary problem or industry-wide issue.[40] This court decision will have both theoretical and practical implications: it stresses the significance of proper MAE provision drafting, regulatory diligence, access rights, interim covenants and prudent buyer behaviour. Akorn v Fresenius will be viewed as the rare case when an MAE clause can work.

Bibliography:

Cases

• Akorn, Inc v Fresenius Kabi AG CA No 2018-0300-JTL, 2018 WL 4719347 (Del Ch, 1 October 2018)
• Akorn, Inc v Fresenius Kabi AG No 535, 2018 (Del, 7 December 2018)
• Hexion Specialty Chemicals, Inc v Huntsman Corp 965 A 2d 715 (Del Ch, 2008)
• In re IBP, Inc Shareholders Litigation 789 A 2d 14 (Del Ch, 2001)

Primary Sources

• ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ https://courts.delaware.gov/Opinions/Download.aspx?id=279250
• ‘IN the SUPREME COURT of the STATE of DELAWARE’ https://www.skadden.com/-/media/files/publications/2018/12/delaware-supreme-court-affirms-akorn/akorn-inc-vs-fresenius-kabi-ag-supreme-court-order.pdf

Secondary Sources

• ‘Akorn v. Fresenius: Important Practical Lessons from First-Ever…’ (Fenwick24 October 2018) https://www.fenwick.com/insights/publications/akorn-v-fresenius-important-practical-lessons-from-first-ever-material-adverse-effect
• Becker B and others, ‘Akorn v. Fresenius: Delaware Chancery Court Upholds MAE-Based Termination’ (2018) 12 https://www.gibsondunn.com/wp-content/uploads/2018/11/Becker-Chapman-Glover-Director-Herman-Muzumdar-Offenhartz-Alterbaum-Akorn-v.-Fresenius-Delaware-Chancery-Court-Upholds-MAE-Based-Termination-Deal-Lawyers-November-December-2018.pdf
• Leinwand D, ‘Akorn v. Fresenius: A MAC in Delaware’ (Cleary M&A and Corporate Governance Watch11 October 2018) https://www.clearymawatch.com/2018/10/akorn-v-fresenius-mac-delaware/

[1] Akorn, Inc v Fresenius Kabi AG, 2018 WL 4719347 (Del Ch, 1 October 2018)

[2] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 1-5

[3] Ibid 5-7

[4] Barbara Becker and others, ‘Akorn v. Fresenius: Delaware Chancery Court Upholds MAE-Based Termination’ (2018) 12 <https://www.gibsondunn.com/wp-content/uploads/2018/11/Becker-Chapman-Glover-Director-Herman-Muzumdar-Offenhartz-Alterbaum-Akorn-v.-Fresenius-Delaware-Chancery-Court-Upholds-MAE-Based-Termination-Deal-Lawyers-November-December-2018.pdf> 1

[5] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 1-2, 8-12

[6] Ibid 1-2

[7] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 1-3

[8] Barbara Becker (n 4) 1-2

[9]  ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 3-5

[10] Ibid 4-6

[11] Ibid 1-7

[12] In re IBP, Inc Shareholders Litigation, 789 A 2d 14 (Del Ch, 2001).

[13] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 143-150

[14] Hexion Specialty Chemicals, Inc v Huntsman Corp, 965 A 2d 715 (Del Ch, 2008).

[15] ‘IN the SUPREME COURT of the STATE of DELAWARE’ <https://www.skadden.com/-/media/files/publications/2018/12/delaware-supreme-court-affirms-akorn/akorn-inc-vs-fresenius-kabi-ag-supreme-court-order.pdf> 1-2

[16] Ibid 2-3

[17] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 1-7

[18] Barbara Becker (n 4) 3

[19] ‘IN the SUPREME COURT of the STATE of DELAWARE’ <https://www.skadden.com/-/media/files/publications/2018/12/delaware-supreme-court-affirms-akorn/akorn-inc-vs-fresenius-kabi-ag-supreme-court-order.pdf> 2-3

[20] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250>12-18

[21] Ibid 3-6

[22] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 221-224

[23] Williams Cos v Energy Transfer Equity LP, 159 A 3d 264 (Del, 2017).

[24] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 224-225

[25] Ibid 5-7

[26] Ibid 4-8

[27] ‘IN the SUPREME COURT of the STATE of DELAWARE’ <https://www.skadden.com/-/media/files/publications/2018/12/delaware-supreme-court-affirms-akorn/akorn-inc-vs-fresenius-kabi-ag-supreme-court-order.pdf> 1-3

[28] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 5-8

[29] ‘IN the SUPREME COURT of the STATE of DELAWARE’ <https://www.skadden.com/-/media/files/publications/2018/12/delaware-supreme-court-affirms-akorn/akorn-inc-vs-fresenius-kabi-ag-supreme-court-order.pdf> 3

[30] Barbara Becker (n 4) 1

[31] Ibid

[32] Barbara Becker (n 4) 4

[33] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 3-4

[34] David Leinwand, ‘Akorn v. Fresenius: A MAC in Delaware’ (Cleary M&A and Corporate Governance Watch11 October 2018) <https://www.clearymawatch.com/2018/10/akorn-v-fresenius-mac-delaware/>.

[35] ‘Akorn v. Fresenius: Important Practical Lessons from First-Ever…’ (Fenwick 24 October 2018) <https://www.fenwick.com/insights/publications/akorn-v-fresenius-important-practical-lessons-from-first-ever-material-adverse-effect>.

[36] ‘IN the COURT of CHANCERY of the STATE of DELAWARE’ <https://courts.delaware.gov/Opinions/Download.aspx?id=279250> 5-7

[37] Ibid

[38] Ibid

[39] ‘IN the SUPREME COURT of the STATE of DELAWARE’ <https://www.skadden.com/-/media/files/publications/2018/12/delaware-supreme-court-affirms-akorn/akorn-inc-vs-fresenius-kabi-ag-supreme-court-order.pdf> 1-3

[40] Barbara Becker (n 4) 3-4