Material Adverse Effect in M&A Transactions

One of the major deal negotiation points in mergers and acquisitions transactions is whether the buyer can walk if something happens that causes a “material adverse effect” (MAE) on in the target’s business.  The MAE closing condition shows up in deals where the buyer is locked up for a period of time between signing the agreement and closing (say, for regulatory approvals or financing).


From the buyer’s perspective, it seems logical and fair that it should be able to terminate and get its deposit back if the target’s business declines materially.  From the target’s perspective, MAE is vague and subjective – what does “materially” even mean?  Deal lawyers and well-meaning law professors have tried to solve this problem over the years by trying to tie “materiality” to objective tests, such as a specific decline in EBITDA, but even those tests are somewhat unsatisfying.  The meaning of MAE is such an unknown that even the Delaware Court of Chancery (which is, nationally, the key court for M&A law) had never found a case where the buyer was justified in terminating because of a material adverse change in the target’s business.  Until now.


On October 1, 2018, the Delaware Court of Chancery ruled in Akorn, Inc. v. Fresenius Kabi AG et al. that Fresenius properly terminated its merger agreement to acquire Akorn because of a material adverse change in Akorn’s business.  This case is noteworthy because it is the first time, after many prior cases considering the question, that the Delaware Court of Chancery has allowed a buyer to terminate an acquisition because of an MAE.  The Court makes it very clear that the MAE was very fact-specific and company-specific.  In particular, the target’s EBITDA had fallen 86% year-over-year, the stock price had plummeted, the target had materially breached its regulatory and compliance obligations, eroding value, and, after signing, the target did nothing to resolve its serious compliance problems, breaching its covenant to operate in the ordinary course of business between signing and closing.


This decision most likely will not change the deal landscape – indeed, the Delaware Court of Chancery declined to find an MAE in landmark cases coming out of the 2008 recession.  However, it will likely affect the negotiation of closing conditions in transaction documents – no longer can deal lawyers argue that “the Delaware courts have never found an MAE, so it doesn’t matter” – with MAE definitions more specifically tied to the target’s business and operations.  Akorn also serves as a reminder to targets that the pre-closing obligation to keep operating the business in the ordinary course is a real one.  Finally, this case could result in more buyers testing the limits of the Akorn decision in the courts, but, as the Delaware Court of Chancery seems to have made clear – those limits are still fairly narrow.


If you have any questions, please feel free to reach out to your GVM lawyer.

This information is only a summary and provides only general information about fiduciary duties and corporate law.  It does not constitute legal advice, and you may not and should not rely on it.

By: Marc Hauser