Historic Material Adverse Effect (MAE) Ruling Illustrates Ways to Establish One

In December 2018, the Delaware Supreme Court upheld a judgement in the matter of Akron, Inc. v. Fresenius Kabi AG wherein the Court of Chancery for the first time ever found that a “Material Adverse Effect” (“MAE”) justified a buyer’s termination of a merger agreement.  Establishing a MAE has historically proven difficult, even when the buyer is able to show, inter alia, a significant decrease in target value.  The Court has often been critical of such efforts as a case of buyer’s remorse.  In this unprecedented ruling, the Court provided a relatively thorough analysis of its thought process in determining a MAE, thereby providing insights (albeit inadvertently) on how to establish a MAE generally.

The parties in this matter entered into a merger agreement in which U.S. generic drug manufacturer Akron would be bought by German pharmaceutical company Fresenius Kabi.  Under the agreement, Akron could not suffer a MAE from the time between signing and closing the deal.  The Court found that the following events during that period contributed to a MAE:

  1. Akron incurred a precipitous and sustained decline in its financial performance that was unique to Akron (versus an industry-wide decline)
  1. Akron failed to comply with the U.S. Food and Drug Administration data integrity and other regulatory requirements (which were supported by whistleblower letters to Fresenius from an Akron employee)
  1. Akron failed to take remedial action towards the above items

The severity of the above items appear to have been sufficiently compelling to generate the successful MAE ruling.  According to the Court, “Akron’s business performance fell off a cliff” after signing the deal.  Akron suffered (i) an 86% decline in EBITDA ( a key profitability metric referring to a company’s Earnings Before Interest, Taxes, Depreciation and Amortization) from the prior year, (ii) a stock price decline from $32.13 just prior to signing to between $5 and $12 after signing, and (iii) additional “unexpected” market competition that was likely to continue.

The court relied, inter alia, upon various experts’ analyses demonstrating the above results.  For example, a simple chart comparing the mean and median EBITDA of Akron and its comparable peers was effectively used to illustrate that Akron’s dismal financial performance was unique to Akron versus the industry.  In this case, the results were so dramatically different (with Akron performing so much worse than its peers) that additional analyses on this point were not needed.  Fulcrum independently confirmed the results, using the publicly-available data in this matter to test whether the difference between Akron’s EBITDA and its peers’ EBITDA was statistically significant.  Unsurprisingly, the results were highly significant at the 99% confidence level.

In many, if not most, MAE cases, the results are not as apparent and likely require further statistical analyses.  Some of the more effective analyses commonly used include (i) tests of statistical significance (as Fulcrum used above), and (ii) regression analyses that allow one to differentiate industry-wide versus company-specific effects.

Fulcrum Inquiry assists lawyers with statistical analyses and economic damages.

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