Material Adverse Effect: what did the court decide?
- The dispute between Akorn (target) and Fresenius Kabi (buyer)
- The dispute between Twitter (target) and Elon Musk (buyer)
- The dispute between Hexion Specialty Chemicals (buyer) and Huntsman Corp. (target)
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Let us consider several court cases in which the material adverse effect (MAE) clause served as a key argument for refusing to perform obligations under M&A transactions.
The dispute between Akorn (target) and Fresenius Kabi (buyer)
Akorn, Inc. is a US manufacturer of generic drugs, while Fresenius Kabi is a German pharmaceutical company.
Fresenius decided to withdraw from the transaction for the acquisition of Akorn, relying on the occurrence of an MAE, namely a material deterioration in Akorn’s financial and operational condition after the transaction documents had been signed.
The essence of the claimant target’s claim:
Akorn brought proceedings seeking a declaration that Fresenius’s withdrawal from the agreement was wrongful, on the basis that Akorn’s difficulties had been caused by industry-wide trends rather than internal factors.
Arguments of the other side (the buyer):
Fresenius argued that, after the signing of the transaction, Akorn’s financial performance had deteriorated sharply (an 86% fall in EBITDA, a 292% decline in operating profit, and a 300% decrease in the market price per share), and that serious breaches in the quality control system had also been identified, including falsification of data submitted to the regulator.
What did the court decide?
The Delaware court found in favour of the buyer and held that an MAE had indeed occurred. The court found that Akorn’s financial performance demonstrated an MAE, as the decline in revenue was substantial, sudden and durationally significant. In addition, certain of Akorn’s representations and warranties were untrue, which could also give rise to an MAE.
The dispute between Twitter (target) and Elon Musk (buyer)
In 2022, Elon Musk entered into an agreement to acquire Twitter for $44 billion. The binding transaction documents contained an MAE clause.
Several months later, Elon Musk notified Twitter of his intention to terminate the transaction, citing Twitter’s breach of its obligations to provide information, as well as the alleged occurrence of an MAE.
The essence of the claimant target’s claim:
In response to Musk’s actions, Twitter brought proceedings in the Delaware court seeking specific performance of the agreement, contending that Musk’s refusal to complete the transaction was wrongful and in breach of the terms of the agreement.
Arguments of the other side (the buyer):
In support of his position, Musk argued that:
- Twitter had provided inaccurate and misleading information regarding the number of bots and fake accounts, which constituted a material breach of representations and warranties and could also give rise to an MAE;
- Twitter’s financial prospects had materially deteriorated;
- Twitter had failed to provide a sufficient volume of the requested information;
- Twitter had departed from the ordinary course of business, in particular by dismissing senior executives without Elon Musk’s consent.
What did the court decide?
No substantive hearing took place because, before the commencement of trial, Elon Musk notified the court of his willingness to close the transaction on the original terms. The transaction closed on 27 October 2022.
The dispute between Hexion Specialty Chemicals (buyer) and Huntsman Corp. (target)
In July 2007, Hexion agreed to acquire Huntsman for $10.6 billion. The transaction was to be financed through debt financing.
After the agreement had been signed, Huntsman reported a decline in its financial performance, which caused Hexion to have concerns regarding Huntsman’s solvency. Hexion engaged independent experts to assess solvency, and that assessment concluded that Huntsman was insolvent.
The essence of the claimant buyer’s claim:
Hexion brought proceedings seeking:
- to establish the existence of an MAE in the form of a material decline in Huntsman’s financial performance, which would release Hexion from its obligations under the transaction; or
- to limit Hexion’s liability for termination of the agreement to $325 million.
Arguments of the other side (the target):
Huntsman denied that an MAE had occurred and maintained that Hexion had breached its obligations to assist in securing financing for the transaction, including by disseminating information that could affect the provision of financing.
What did the court decide?
The court rejected Hexion’s arguments as to the existence of an MAE, stating that the decline in Huntsman’s performance was not sufficiently material and durationally significant to support a finding that an MAE had occurred.
The court also found that Hexion had knowingly and intentionally breached the terms of the agreement by failing to use sufficient efforts to secure financing and by disseminating information that could adversely affect the bank’s provision of financing.
As a result, the court held that Hexion’s liability was not limited to $325 million, and that Huntsman was entitled to recover its losses in full. In December 2008, Hexion agreed to pay Huntsman compensation in the amount of $1 billion.
Thus, a material adverse effect (MAE) clause serves as a safeguard for both parties to a transaction. However, it is important to bear in mind that proving the existence of an MAE is rather difficult, and in many cases courts do not find that changes in circumstances are sufficiently material and adverse.
When preparing binding transaction documents, it is important for the parties to give careful consideration to the drafting of the MAE clause, including the list of carve-outs and the criteria for an MAE. Carefully drafted wording will help the parties protect their interests in the event of potential disagreements and litigation.
Authors: Irina Kuheika, Alexandra Kovalyova
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