On July 9, 2021, the Delaware Court of Chancery issued its final ruling determining whether a buyer’s attempt to invoke a material adverse effect (MAE) clause was effective in excusing the buyer’s failure to complete an acquisition of the target company as part of a signed merger. agreement. While the tribunal relied on well-mapped pathways to arrive at its determination that no EAW had in fact occurred, there are a few noteworthy takeaways, namely (a ) the apparently “unknown event” element of IBP, Inc. the theoretical foundations of the purpose of an EAW clause in general, is not a requirement inherent in the invocation of an otherwise carefully defined EAW clause, (b) the long-term importance remains a key ingredient for determine whether a significant adverse effect has occurred, (c) – withdrawals can eliminate the otherwise really significant negative effects of building an EAW and (d) the effectiveness of disproportionate effect exclusions of exclusions of the EAW depends on the industry participants who are used to make the disproportionality comparisons.
In Bardy Diagnostics, Inc. v Hill-Rom, Inc.., 2021 WL 2886188 (Del. Ch. July 9, 2021), the buyer of a target company, a medical device startup that relied heavily on the tariffs Medicare would pay for its main product, attempted to shut down its proposed merger with the target on the basis of its claim that the target company had undergone an EAW. The event that would have triggered the EAW was the reduction in Medicare reimbursement rates for the target’s primary product by approximately 86%. Although the rates were subsequently increased above the initial reduced rates, as a result of efforts by the buyer and the target to press for the change, the resulting rate increase was ” always less than half of the historical rate ”. In dismissing the buyer’s claim that an EAW had occurred due to Medicare’s reduced reimbursement rates, the court suggested a number of takeaways that are worth noting.
First, by responding to the target company’s argument that lower Medicare reimbursement rates could not be a EAW because “the risk of a change in reimbursement rates was not ‘unknown’ at the time the parties signed the agreement ”, the court recognized that in IBP, Inc., the case from which all of Delaware’s MAE law stems, then Vice-Chancellor Strine referred to an MAE clause as being “best read as a safety net protecting the acquirer from the occurrence of unknown events. “Nonetheless, echoing Professor Robert T. Miller’s argument, the court suggested that, in context, what then Vice-Chancellor Strine referred to as “unknown events” was “unspecified risks or events”. And because in Bardy diagnosis, “The parties have structured the definition of the EAW to incorporate exceptions and exclusions to spread the risk” (unlike the EAW clause in IBP, Inc.), “[t]The Accord leaves no room for [the target company’s] argument that an “event” under the EAW of the Agreement can only be an unforeseen event. In other words, by identifying the specific risks and exclusions in the definition of AEM, there was no basis for invoking “the theoretical foundations of the typical AEM regime”. Instead, the ACM definition actually negotiated would be applied “as written”. If the parties wanted to limit the events likely to give rise to a significant adverse effect to only events unknown at the time of the signing of the merger treaty, the parties should have drafted the EAW clause “include only”unknown facts, events, changes, effects or conditions[;] [i]Instead]they chose to adopt a broad general EAW and qualify this language with a list of exceptions.
Second, while the court was prepared to assume that the lower Medicare reimbursement rate “should reasonably have a material adverse effect on [the target company] at the time [the buyer] refused to complete the merger ”, the buyer failed in its efforts to prove the“ lasting significance ”of this material adverse effect because the court concluded, on the basis of expert testimony, that ‘there was a reasonable basis to assume that the repayment rate would be revised significantly upward within a commercially reasonable timeframe (i.e. over the next two years). And, “it is not enough to show the effect of [decreased Medicare reimbursement rates] strength be significant over time, because “a simple risk of ADE cannot be enough”.
Third, although the court could have completed its analysis there and ordered the buyer to close the transaction, the court further noted that the general exclusion of changes in the law (including “any law on care health care ”) specifically included Medicare reimbursement rates because they were a regulation or rule promulgated by a government agency or a“ contractor hired by a government agency ”. Therefore, even if the significant adverse effect caused by the reduced reimbursement rates had been significant over time, the exclusion of the changes in the law would have eliminated this significant adverse effect from the constitution of an EAW.
Finally, in order to determine whether the disproportionality exclusion was effective in eliminating the impact of the changes in the law, the court noted that the companies designated for comparison purposes for the purposes of the disproportionality exclusion were, according to the definition specific to the EAW fixed in the merger agreement, only the “other similarly located companies operating in the same sectors … as [the target]. “Although there were many companies operating in the same industries as the target company, only one company was operating in the same industries and was located in the same way as the target company, i.e. there was only one company that had relevant characteristics similar to those of the target company, which mostly included a ” product portfolio (ie range and relative sophistication of products) ”similar. And, compared to this one company, there was no disproportionate impact of the decline in the reimbursement rate; the impact was essentially the same.
Here, according to the court, the target company, “a one-product company that operates in a high growth and highly regulated market, … has negotiated a narrower and more targeted exclusion of AEM exclusions”. Importantly, as the court noted:
The EAW clause of the Agreement… did not delimit the scope of the “disproportionate impact” exception to companies operating in the same “market”. Rather, it required an assessment to determine whether the impact caused by “such a case” was “materially disproportionate” compared to “companies located in similar situations and operating in the same industries”. In my opinion, this language calls for a more granular analysis of the situation of a company than a simple participation in the [long-term ambulatory electrocardiogram device] market.
The English case of the MFA, Travelport Limited v. WEX Inc.,  EWHC 2670 (Comm) (Oct 12, 2020), previously alerted M&A practitioners to the importance of carefully defining the universe of comparative companies for the purpose of disproportionate exclusion. And the importance of the exact words used in an EAW clause cannot be overstated. As the court noted in Bardy diagnosis, “The words that the parties have agreed in their contact [is] the best proof of their intention.
Ultimately, proving that an EAW has occurred under Delaware law remains a heavy burden.
End Notes (↵ return to text)
- Robert T. Miller, Material Adverse Effect Clauses and the COVID-19 Pandemic (May 18, 2020), U Iowa Legal Studies Research Paper No. 2020-21, 7, at no.30, available on SSRN here; Bardy Diagnostics, 2021 WL at * 23, n. 225. Given the extent to which Professor Miller’s work has been cited by courts, including in Bardy Diagnostics, practitioners would do well to note his overall theories regarding how AEM clauses should be analyzed. See Robert T. Miller, A New Theory of Material Adverse Effects (September 1, 2020), available on SSRN here.↵
- This approach to the concept of “unknown events” is also consistent with Vice-Chancellor Laster’s approach in Akorn, Inc. v. Fresenius Kabi, AG, 2018 WL 4719347, at * 60-62, * 76-81 (Del. Ch. 2018), confirmed, 198 A.3d 724 (Del. 2018) .↵
- In Travelport, the comparison companies to determine the applicability of the disproportionality exception to the EAW exclusions were not limited to the specialist travel-related payments market in which the target companies operated. With reference to “other participants from industries in which [the target companies] function ”as a control group for comparison, a much larger group of companies is included than would have been the case if the control group had been described as participants in the same“ competitive markets ”,“ market sectors Or “companies” as the target companies. And Judge Cockerill specifically suggested that future drafters clarify what they mean by “industry” to avoid the outcome in this case. In that case, the court interpreted the clause to mean the B2B payments industry, and not just the B2B travel-related payments industry.
- This is not the first time that we have had the opportunity to analyze the language of an MAE clause. See Glenn West, The MAE Clause, Mrs. Palsgraf and Events “Arising From or Related To” MAE Exceptions, Weil’s Global Private Equity Watch, May 11, 2021, available here.↵
- See Glenn West, Richard Slack and Joshua Glasser, Just Because Something Really Bad Doesn’t Mean a Significant Adverse Effect Has Happened: Assessment of the Latest Delaware MAE Decision, Weil’s Global Private Equity Watch, December 26, 2019 , available here.↵