(Reuters) - The global pharmaceutical company Fresenius received a rude shock in the summer of 2017 when Akorn, the generic drugmaker Fresenius had agreed to acquire for $4.75 billion, reported its quarterly financial results. The results were terrible – far worse than Fresenius’ gloomiest projection. Fresenius CEO Stephan Sturm considered the Akorn results the biggest personal embarrassment of his career. Within weeks, the company hired Paul Weiss Rifkind Wharton & Garrison to advise it could wriggle out from the deal to buy Akorn.
A few months later, after another horrendous financial report from Akorn and with the deal still unclosed, Fresenius received a whistleblower report about compliance problems at some Akorn testing facilities. It brought in Sidley Austin, a firm that touted its experience in detecting regulatory fraud. Fresenius told Akorn that Sidley would lead the investigation. Akorn’s own lawyers at Cravath Swaine & Moore would merely shadow Sidley’s work. Behind the cover of a common interest agreement, according to evidence produced in Delaware litigation over the deal, Sidley referred to Akorn as “our adversary” and intimated that Fresenius wanted to portray Akorn as “liars and cheaters.”
By early 2018, Fresenius had formed an internal working group with the informal code name of “Project Cerafa.” That name was a reference to a fungus that kills oak trees – and it’s not a coincidence that Fresenius’ code name for the Akorn acquisition was Project Oak.
Were Fresenius and its lawyers developing a record to enable Fresenius to abandon the Akorn acquisition, contravening Fresenius’ pledge in the merger agreement to do its part to complete the deal?
Not according to Vice-Chancellor Travis Laster of Delaware Chancery Court. Laster oversaw the litigation between Fresenius and Akorn after the deal went bust. On Oct. 1, in an epic 247-page opinion, the vice-chancellor rejected arguments by Akorn’s Cravath lawyers, who contended that Fresenius and its lawyers secretly undermined the agreement, in breach of Fresenius’ contractual obligations. The vice-chancellor saw instead a company with a justifiable case of buyer’s remorse that nevertheless took steps to complete the transaction.
Laster, as you surely recall, held that Fresenius was entitled to walk away from the Akorn deal because Akorn had experienced two material adverse changes (MAC) – an unforeseen and long-term plunge in its core business and a regulatory crisis that threatened the viability of its products. The vice-chancellor’s ruling marked the first time a Delaware Chancery judge has ever allowed an acquiring company to invoke a material adverse change clause to abandon a deal.
Akorn is now appealing Laster’s decision to the Delaware Supreme Court. Its opening brief, filed this week, contends the vice-chancellor misread Delaware precedent and the MAC contract provisions between Akorn and Fresenius. There was no justification, according to Akorn, for Laster to distinguish between its case and those of the meat distributor IBP and the chemical company Huntsman, which were both jilted by would-be acquiring companies citing MAC clauses. Delaware judges rejected MAC justifications in the IBP and Huntsman cases. According to Akorn, that precedent should have led Vice-Chancellor Laster to rule against Fresenius.
To me, the most interesting part of the brief, though, isn’t Cravath’s legal discussion. It’s Akorn’s account of how Paul Weiss and Sidley supposedly helped Fresenius position itself to claim Akorn had suffered a material adverse event. Akorn argues that by “endorsing” Fresenius’ strategy to kill the deal, Vice-Chancellor Laster’s opinion “created a new blueprint for remorseful buyers to exit Delaware merger agreements.”
The essence of the strategy, according to Akorn, was to leverage the investigation of Akorn’s regulatory compliance. Before the Sidley investigation began, Paul Weiss had been warning Fresenius that Akorn’s disastrous financial reports didn’t constitute a material adverse event. But once Akorn’s compliance fell under question, according to Akorn’s brief, Fresenius saw an exit and built a road to get to it.
Cravath’s account of Fresenius’ duplicity: “It assembled an advisory team to create a record for termination; executed a (common interest agreement) falsely representing that the parties had a ‘mutual interest arising under the merger agreement’ that Fresenius wanted to terminate; falsely assured Akorn that ‘this was not a litigation exercise’; instructed advisors to find a ‘smoking gun’; pressured them to ‘call these guys liars and cheaters’; dragged its feet on antitrust approval; conflicted Akorn’s FDA counsel; attempted to ‘stimulate’ FDA sanctions; and developed a secret made-for-litigation “materiality” model at litigators’ direction.”
The vice-chancellor, Akorn said, repeatedly credited Fresenius witnesses who insisted that they acted in good faith to complete the merger even as they came to regret the deal. He also faulted Akorn for making a “misleading presentation to the FDA” in the midst of Sidley’s compliance investigation. In essence, Akorn argued, Vice-Chancellor Laster excused Fresenius’ MAC scheming because he found the acquirer’s “buyer’s remorse” to have been justified by Akorn’s problems.
Akorn said that holding upends M&A expectations. “The court concluded that Fresenius had no best-efforts obligation once it experienced ‘justified’ buyer’s remorse,” the brief said. “That is not the law. Even if Fresenius believed it had a good faith reason to investigate, it still had an obligation to conduct that investigation in a way that did not deceive Akorn, stall the deal, or exacerbate any financial or regulatory challenges.”
The vice-chancellor should have required Fresenius to prove that it did not work to undermine the acquisition by stalling to obtain antitrust approval, failing to back Akorn with the FDA and searching for a regulatory excuse to back out of the deal. By approving Fresenius’ conduct, Akorn argued, Laster has invited other disgruntled acquirers to scheme with their lawyers to invoke material adverse event provisions.
I should point out that there are some serious caveats to Cravath’s arguments. First among them: Fresenius and its lawyers certainly didn’t manufacture Akorn’s financial reports or the company’s own admission that its plunge in profits was unexpected. Nor did Fresenius, Paul Weiss and Sidley create Akorn’s severe compliance problems. Those were of Akorn’s own making.
In fact, when I asked three corporate law experts about Vice-Chancellor Laster’s ruling soon after it was published, they agreed that the facts of the Akorn case were so extreme that Vice-Chancellor Laster’s opinion, however thorough, may not even be all that instructive for companies trying to figure out what exactly constitutes a material adverse event.
Vice-Chancellor Laster carefully considered Akorn’s evidence of a purported scheme engineered by Fresenius and its lawyers. He even said in his opinion that some of the evidence supported Akorn’s assertion “that Fresenius’s advisors tried to manufacture a record that would justify termination.” But in the full context of Fresenius’ post-signing conduct, Laster said, the company was “prudent” to bring in Paul Weiss and Sidley to craft a “reasonable” response to unforeseen revelations about Akorn.
“Fresenius wanted to live by the merger agreement and do what it was obligated to do, while at the same time protecting its own contractual rights and terminating the transaction if it had a valid basis for doing so,” Vice-Chancellor Laster wrote. “In my judgment, Fresenius succeeded in doing what it was obligated to do.”
There’s a line somewhere in the Akorn story for deal lawyers advising clients on material adverse events. Cravath contends Fresenius, Paul Weiss and Sidley crossed it. Vice-Chancellor Laster found they did not. Either way, it’s going to be interesting to hear what the Delaware justices have to say.
Fresenius’ brief to the state high court is due in late November.