Lewis R. Clayton, left, of Paul Weiss and Daniel Slifkin, right, of Cravath, Swaine & Moore.

In oral argument before the Delaware Supreme Court on Wednesday, Cravath, Swaine & Moore's litigation practice head Daniel Slifkin began with a simple question: Why did two non-Delaware companies pick Delaware law and Delaware courts to govern their merger agreement?

“Because they could get it for free?” interjected Chief Justice Leo Strine Jr., to widespread laughter.

Slifkin chuckled too, but quickly recovered. “In large part, that's right,” he said in a clipped British accent. “We get what is expected to be an outstanding body of developed law that will be stable and will be applied with predictability. That's what we expected. We got the free part, but we did not get the rest.”

Representing specialty generic pharmaceuticals company Akorn Inc., Slifkin wants what I think of as a Delaware shotgun marriage. That is, he's urging the court to force German healthcare giant Fresenius SE & Co. to go through with its deal to buy Akorn for $4.3 billion.

And normally, that's what Delaware courts do. Once you get engaged, you're tying that knot.

Instead, Vice Chancellor Travis Laster on October 1 found that Fresenius could walk away from the union because Akorn had suffered a material adverse change in its business—the first time a Delaware court has made such a finding.

(Cue jilted bride crying at the altar. And suing, because Akorn—whose stock is now trading at under $7 a share, compared to the deal price of $34—is about as likely to get another $4.3 billion offer as the ugly step-sister is to marry Prince Charming.)

Appearing on behalf of Fresenius, Paul, Weiss, Rifkind, Wharton & Garrison's Lewis Clayton offered a forceful defense of the decision, arguing that the lower court correctly applied established Delaware law to extraordinary facts.

The basic question—when can a remorseful suitor kill a transaction—has ramifications that go far beyond the two companies. Bloomberg called it “a seminal case for those seeking to get out of M&A agreements,” and the Financial Times noted it's already caused corporate lawyers and bankers to comb through Laster's 247-page opinion “searching for tips on how to draft tighter merger contracts in the future.”

But will the decision stand?

The five Delaware Supreme Court justices did little to tip their hand, but Strine pressed Slifkin hardest on Akorn's regulatory problems with the Food and Drug Administration.

A little background: Laster in his decision covered multiple reasons why Fresenius got cold feet in the months after the deal was signed but before it closed. Among them: a massive drop in Akorn's reported earnings, delayed product launch dates, disappointing new product sales, loss of a key contract and increased competition.

As I noted in my prior coverage, Fresenius also received anonymous letters last fall from a whistleblower who detailed flaws in Akorn's quality control processes and the accuracy of its representations regarding its regulatory compliance.

Fresenius investigators discovered that Akorn employees could add, delete, or modify electronic data, which undermined all of the company's drug test and production data—and found evidence of alleged data fabrication by at least four people.

Even more worrying, 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.

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.”

Slifkin argued that the FDA concerns were overblown, noting that the company won FDA approval for eight drug applications this year—four of them since Laster's opinion was issued. “The FDA hasn't shut anything down.”

Still, Strine seemed skeptical. “The lying to the FDA—the vice-chancellor [Laster] cannot take that into account, in concert with the substantial financial information [Fresenius] presented, and that kind of fairly fundamental integrity issue doesn't have any bearing on materiality?” he said.

Slifkin responded that just one person, Akorn's former head of quality, sent “misleading” information to the FDA, and that the court would be wrong if it held that “all you need is one rogue employee and you can scuttle the deal.”

Strine answered, “If senior people at the company are willing to do that—that's a fairly deep problem in terms of your regulatory compliance.”

Arguing for Fresenius, Clayton hammered the point that it all adds up to a material adverse effect. “Because of huge defects in the quality system at Akorn, all of Akorn's data during long periods of time were completely unreliable,” he said.

“Looking at this extraordinary record of intentional disregard of their responsibilities … they wanted to deceive Fresenius, because they understood that if they acted to do audits and find more problems, they endangered the transaction,” he continued. “This was intentional misconduct. … I respectfully submit that it would be an awful message to send, to say that this kind of conduct is permissible under ordinary course in Delaware or any other state.”

 

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