Vice Chancellor J. Travis Laster of the Chancery Court of the State of Delaware. HANDOUT.

Delaware courts don't normally look kindly on companies that try to pull out of merger agreements. Buyer's remorse is for when you spend too much on a pair of shoes that hurt your feet—it's not a reason to bail out on a multi-billion-dollar deal.

But this case was different. A team from Paul, Weiss, Rifkind, Wharton & Garrison won an unusual victory in the Court of Chancery on Monday, when Vice Chancellor J. Travis Laster (pictured above) ruled that German healthcare giant Fresenius SE & Co. could cancel its $4.75 billion agreement to acquire Illinois-based Akorn, Inc., a specialty generic pharmaceuticals company.

It was a clash of legal titans, with Paul Weiss litigation partners Lewis Clayton, Susanna Buergel, Andrew Gordon, Moses Silverman and Stephen Lamb facing off against Cravath, Swaine & Moore's Robert Baron, Daniel Slifkin and Michael Paskin for Akorn.

The case went to trial over five days in July, and the judge went out of his way to praise both sides for their conduct.

“The parties prepared for trial during eleven weeks of highly expedited litigation,” Laster wrote in his 247-page opinion. “Despite the massive effort this entailed, the parties required assistance with only one significant discovery dispute, which involved contentious privilege issues. This case exemplifies how professionals can simultaneously advocate for their clients while cooperating as officers of the court.”

Fresenius agreed to buy Akorn on April 24, 2017. In a press release, the company said Akorn, which specializes in making injectables, eye drops, oral liquids, inhalants and nasal sprays, would add “expertise in development, manufacturing and marketing of alternate dosage forms, as well as access to new customer segments like retail, ophthalmology and veterinary practices.”

But shortly after Akorn's stockholders approved the merger, Akorn released its second quarter results. Despite earlier rosy projections, Akorn's reported revenue dropped 29 percent year-over-year. Operating income was down 84 percent, and Akorn's reported earnings of $0.02 per share represented a year-over-year decline of 96 percent.

The company blamed unexpected new market entrants and the unforeseen loss of a key contract.

Suffice to say, Fresenius leaders were not pleased.

CEO Stephan Sturm “could not understand how the parties had signed up a deal, only to have Akorn's results fall 'off the cliff,'” Laster wrote. He “asked his executive team whether they thought Fresenius 'had been defrauded.' They did not think so. Sturm 'also asked if there was a way to cancel the deal.' His team said 'not at this point.'”

Laster continued, “Although Akorn has asserted that Fresenius decided at this point to find a way to terminate the deal, I do not agree. Sturm testified credibly that he wanted 'to get myself knowledgeable about my options under the merger agreement, but also my responsibility, my fiduciary duties in serving my shareholders, and hence I was asking my colleagues on the legal side to get us appropriate legal advice.'”

That's when Fresenius hired Paul Weiss, according to Laster. (Allen & Overy did the deal work.) In-house lawyers looked into other deals gone bad, and found Abbott Laboratories' attempt in 2017 to terminate its acquisition of Alere Inc., which was represented by Paul Weiss. The deal went through, but at a lower price.

Meanwhile, Akorn continued to flail. Its third quarter results were even worse than its second quarter, and it had to push back the launch dates of multiple new products. The ones it did manage to launch netted a mere $3.3 million in sales, versus projections of $60 million. One Fresenius executive called the results “almost comical.”

“These guys are shameless,” Sturm wrote in an email. “I'm afraid we've got to build our legal case.”

Akorn lawyers argued this meant the CEO intended to manufacture legal grounds to get out of the deal, but Laster didn't see it that way. Sturm “no longer liked the deal, and he would seek to terminate it if Akorn's performance continued to deteriorate, but Fresenius also would live up to its obligations,” the judge wrote.

Plus there was no easy way out. Yes, Akorn was doing terribly, but that wasn't necessarily the same as a material adverse effect that would justify killing the deal. “Based on advice from Paul Weiss, Fresenius concluded that it did not have clear grounds for termination. Given the Delaware precedent, this was hardly surprising,” Laster wrote.

In prior cases, he noted “this court has correctly criticized buyers who agreed to acquisitions, only to have second thoughts after cyclical trends or industrywide effects negatively impacted their own businesses, and who then filed litigation in an effort to escape their agreements without consulting with the sellers. This case is markedly different.”

The game changed last fall, when Fresenius received anonymous letters from a whistleblower who detailed flaws in Akorn's quality control processes and the accuracy of its representations regarding its regulatory compliance.

Determined to close the deal, Akorn was not eager to look into the allegations.

“Akorn decided not to conduct its own investigation into the whistleblower letters because Akorn did not want to uncover anything that would jeopardize the merger,” Laster wrote. “Akorn chose to rely on its deal counsel, Cravath, Swaine & Moore. Cravath's job was not to conduct an investigation, but rather to monitor Fresenius's investigation and head off any problems.”

Fresenius, by contrast, conducted a real investigation, hiring a team from Sidley Austin led by Nathan Sheers, who specializes in FDA enforcement and compliance.

The problems that eventually came to light were bad.

Really bad.

One consultant testified that some of Akorn's data integrity failures “were so fundamental that he would not even expect to see them 'at a company that made Styrofoam cups,' let alone a pharmaceutical company manufacturing sterile injectable drugs,” Laster wrote. “He believed that the 'FDA would get extremely upset' about Akorn's lack of data integrity 'because this literally calls into question every released product [Akorn has] done for however many years it's been this way.'”

For example, any Akorn employee could add, delete, or modify electronic data, which undermined all of the test and production data—and indeed, investigators found evidence of data fabrication by at least four people.

Investigators also found Akorn submitted at least three applications to the FDA for approval to make generic drugs “based on false or misleading data,” Laster wrote.

On April 22, 2018, Fresenius gave notice that it was terminating the merger agreement.

On Monday, Laster gave them his blessing to walk away.

“Akorn's dramatic downturn in performance is durationally significant,” he wrote. “It has already persisted for a full year and shows no sign of abating.”

Laster rejected Akorn's argument that even though its earnings were in the tank, it would bring valuable synergy to Fresenius, and that “as long as Fresenius can make a profit from the acquisition, [a material adverse effect] cannot have occurred.”

Nope.

“The [material adverse effect] definition does not include any language about the profitability of the deal to the buyer; it focuses solely on the value of the seller,” Laster wrote.

Cravath lawyers also blamed Akorn's dismal performance on “industry headwinds” that have affected the generic pharmaceutical industry since 2013. But Laster found that the problems were company-specific, and that Akorn was doing much worse than others in the industry.

And then there were the regulatory problems. Those too would “reasonably be expected to result in a material adverse effect. There is overwhelming evidence of widespread regulatory violations and pervasive compliance problems at Akorn,” the judge found.

He continued, “Akorn has gone from representing itself as an FDA-compliant company with accurate and reliable submissions from compliant testing practices to a company in persistent, serious violation of FDA requirements with a disastrous culture of noncompliance.”

Akorn, whose stock plunged more than 50 percent after the decision, said, “We are disappointed by the ruling by the Delaware Chancery Court determining not to force Fresenius to close and we continue to believe Fresenius' attempt to terminate the transaction is in breach of our binding merger agreement. We intend to appeal, in an effort to vigorously enforce our rights and continue to protect the interests of our company and our shareholders.”

 

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