In Akorn, Inc. v. Fresenius Kabi AG (Del. Ch. 2018 WL 4719347), the plaintiff pharmaceutical company (“Akorn”) brought suit against Fresenius seeking specific performance of its signed merger agreement. Fresenius argued it was permitted to terminate the merger agreement because Akorn’s actions, performance, and misrepresentations following execution of the agreement constituted a materially adverse effect (“MAE”) under the terms of the merger agreement and thus excused Fresenius’s obligation to perform. The court held that Fresenius legally terminated its merger agreement with Akorn because: (1) Akorn made material misrepresentations with regard to its business operations and the status of its regulatory compliance before the closing date, (2) Akorn did not materially comply with or perform its obligations under the merger agreement prior to the effective closing date, and (3) Akorn suffered a general MAE that allowed Fresenius to terminate the agreement.

On April 24, 2017, Fresenius agreed to acquire Akorn. In the merger agreement, Akorn made extensive representations regarding its regulatory compliance and that it would continue to operate in the ordinary course of business until the agreement’s closing date. The parties agreed that, subject to antitrust approval, the deal would officially close one year later on April 24, 2018. Fresenius’s obligation to close was conditioned on: (1) Akorn’s representations being true and correct, (2) Akorn having complied with the merger agreement in all material aspects, and (3) Akorn itself not suffering a MAE prior to the closing date.

In the two fiscal quarters following execution of the agreement, Akorn’s revenue declined 29% and 30%, respectively. Akorn’s operating income also declined 84% and 89% during the same period. In October 2017, Fresenius received an anonymous letter from an Akorn whistleblower-employee that levied serious allegations regarding Akorn’s failure to comply with FDA regulations. Following receipt of the letter, Fresenius notified Akorn’s executives of the content of the letter and informed them that Fresenius would need to investigate the allegations of Akorn’s malfeasance. Fresenius’ subsequent investigation uncovered widespread compliance issues and data-integrity problems that called into question the validity of Akorn’s regulatory compliance and factual representations made in the merger agreement.

Simultaneously, Akorn’s business performance declined precipitously. In the two subsequent fiscal quarters, Akorn’s operating income declined a further 292% and 134%, respectively. Weeks before the April 24 closing date, Fresenius informed Akorn that the conditions for closing were not satisfied and ultimately terminated the merger agreement. Akorn filed suit to compel performance of the merger agreement.

To terminate its merger agreement pursuant to a materially adverse effect, Fresenius was required to show either (1) Akorn made representations to Fresenius that were incorrect or misleading and these representations could “reasonably be expected” to have a MAE in the eyes of the Fresenius or (2) Akorn materially failed to comply with its obligations prior to the closing date of the agreement. Pursuant to either condition, Fresenius was legally permitted to terminate its merger agreement as long as Akorn was incapable of curing its failure by the effective date of the merger.

To refuse to close its agreement pursuant to a materially adverse effect, Fresenius was required to show that Akorn suffered a general MAE with respect to its operations before the closing date.

First, the court determined that Akorn’s representations regarding its regulatory compliance were incorrect or misleading and could be reasonably expected by Fresenius to be a MAE. The court engaged in a qualitative and quantitative analysis of Akorn’s regulatory representations, both of which suggested Akorn's representations would be expected by Fresenius to have a MAE on the company. Qualitatively, the court reasoned that Akorn’s regulatory compliance with FDA requirements was a material aspect of maintaining a profitable business. The court further reasoned that because of the inherent importance of Akorn’s regulatory compliance, its substantial failure to comply with the FDA’s requirements should be seen as having a materially adverse effect on the company. Quantitatively, the court approximated that it would cost Akorn over $900 million to remedy its failed compliance. The court reasoned that such a significant figure would reasonably be deemed by Fresenius as having a MAE on Akorn.

Next, the court held that Akorn materially failed to comply with its general course of business obligations prior to the closing date. The court determined Akorn was required to “comply in all material respects” and to use “commercially reasonable efforts” to continue to operate in the ordinary course of its business. Under this standard, the court determined that Akorn failed the ordinary course of business test in three ways: (1) Akorn ceased auditing several of its plants following the merger agreement, (2) Akorn did not maintain a data integrity system to comply with FDA requirements, and (3) Akorn submitted regulatory filings to the FDA based on fabricated data. Because Fresenius would not have entered into the merger agreement had it known of Akorn’s aforementioned failings, the court held that Akorn materially failed to comply with its general business obligations prior to the closing date.

Finally, the court determined that Akorn suffered a general MAE with respect to its operations before the closing date of the agreement. The court determined that while Fresenius retained market and other external risks, Akorn retained the “business risks” associated with its operations that were within its control. The court found that Akorn’s dramatic and repeated losses in revenue and operating income in the four consecutive quarters following the execution of the merger agreement were materially adverse. Because these losses were not attributable to events outside the control of Akorn, the court determined that Akorn’s repeated quarterly losses qualified as a general MAE and allowed Fresenius to refuse to close the merger.

In sum, the court held that Fresenius was legally justified in terminating the merger agreement with Akorn because (1) Akorn’s regulatory compliance representations to Fresenius were incorrect and misleading and were “reasonably to be expected” to have a MAE on Akorn’s valuation, and (2) Akorn materially failed to comply in material respects with its obligations prior to the closing date by ceasing auditing efforts and failing to comply with FDA regulations. The court further held that Fresenius was permitted to refuse to close the merger because Akron suffered a general MAE with respect to its dramatic and sustained quarterly losses prior to the closing date of the merger transaction.

The primary materials for this case may be found here.