Kramer Levin Naftalis & Frankel LLP

A year after Akorn v. Fresenius (Akorn case), the first Delaware case holding that a party was entitled to terminate a merger agreement based on a material adverse effect (MAE), the Delaware Court of Chancery, in Channel Medsystems, Inc. v. Boston Scientific Corporation (Channel case), confirmed that MAE claims are required to clear a high threshold for success.

Channel Medsystems (Channel) discovered shortly after entering into a merger agreement with Boston Scientific Corp. (BSC) in November 2017 that an employee committed fraud by falsifying expenses and company documents. Some of the falsified documents were included in Channel’s application to the Food and Drug Administration (FDA) for approval of Cerene, a device intended to treat heavy menstrual bleeding. Channel conducted a thorough investigation, implemented a remediation plan and updated both BSC and the FDA. In April 2018, the FDA accepted Channel’s remediation plan. In May 2018, BSC terminated the merger agreement, claiming that the fraudulent filings constituted a breach of Channel’s representations that had or would reasonably be expected to have an MAE on Channel. In September 2018, Channel filed a suit and sought specific performance, asserting that no MAE had occurred and that BSC had failed to use commercially reasonable efforts to consummate the transaction as required by the merger agreement. In March 2019, consistent with the time frame for receiving FDA approval the parties expected when they entered into the merger agreement, the FDA approved the Cerene device.

The Court of Chancery found that BSC failed to prove that the failure of such representations to be true and accurate reasonably would be expected to have an MAE. In evaluating the existence of an MAE, the Court of Chancery considered both qualitative and quantitative factors, noting that “a mere risk of an MAE cannot be enough” and “[t]he important consideration … is whether there has been an adverse change in the target’s business that is consequential to the company’s long-term earnings power over a reasonable period, which one would expect to be measured in years rather than months.” With respect to qualitative factors, the Court of Chancery found BSC’s claim that it would need to start over and “remediate and retest the product before placing Cerene on the market” to be little more than unsubstantiated speculation for many reasons, including that BSC did not evaluate Channel’s remediation work, speak to the experts who investigated Channel’s quality systems or consult the quality control experts within BSC. With respect to quantitative factors, although the Court of Chancery explained that “[t]here is no bright-line test for determining an MAE based on quantitative considerations,” it noted that decreases in profits of 40% or more are an MAE benchmark, and in the Akorn case, a 21% decline in stand-alone equity value was sufficient to establish an MAE.

The Court of Chancery also concluded that BSC breached the merger agreement by failing in its duty to use commercially reasonable efforts to consummate the deal. The Court of Chancery noted that Delaware case law “contains little support for distinctions” between the clause “commercially reasonable efforts” and the clause “reasonably best efforts.” With respect to the evaluation of reasonable best efforts, the Court of Chancery relied on the Akorn case, according to which, “[w]hen evaluating whether a merger partner has used reasonable best efforts, [the] court has looked to whether the party subject to the clause: (i) had reasonable grounds to take the action it did; and (ii) sought to address problems with its counter party.”

The Channel case reaffirms Delaware’s high bar for establishing an MAE and confirms that a buyer asserting an MAE claim needs to demonstrate that there will be a long-term, substantial impact on the business being acquired.

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