By Anne Sherry, J.D.
The Delaware Court of Chancery ordered specific performance of a merger between Boston Scientific and Channel Medsystems. Boston Scientific had terminated the agreement based on the intervening discovery of a Channel officer’s fraud, but the court found that the fraud did not constitute a material adverse effect given the FDA’s acceptance of Channel’s remediation plan. Furthermore, Boston Scientific’s termination constituted a breach of its contractual obligation to use commercially reasonable efforts to consummate the merger (Channel Medsystems, Inc. v. Boston Scientific Corporation, December 18, 2019, Bouchard, A.).
In December 2017, about two months after Boston Scientific and Channel entered into the merger agreement, Channel discovered that its vice president of quality had engaged in a scheme to defraud the company. The officer used shell companies and falsified invoices to steal $2.6 million over about five years. He also falsified other documents, some of which were contained in Channel’s submissions to the FDA seeking approval of its sole product, a gynecological device called Cerene. The FDA accepted Channel’s remediation plan in April 2018, a strong indicator that the fraud would not impede FDA approval. However, Boston Scientific terminated the merger agreement in May 2018. The FDA approved Cerene in March 2019, and Channel sued for specific performance of the merger.
The court concluded that although the officer’s fraud caused a number of representations in the agreement to be inaccurate, Boston Scientific failed to prove that those inaccuracies would reasonably be expected to have a material adverse effect. As is typically the case, the agreement did not define what is "material" for purposes of a material adverse effect, so the court turned to Delaware cases holding that the effect should "substantially threaten the overall earnings potential of the target in a durationally significant manner" (Akorn, Inc. v. Fresenius Kabi AG (Del. Ch. 2018)). Furthermore, it held that the relevant date for assessing whether there was a reasonable expectation of a future material adverse effect is the date on which Boston Scientific provided its notice of termination, and the relevant date on which that material adverse effect would be expected to occur is the date the parties expected to close.
Boston Scientific’s evidence of a material adverse effect fell short from both a qualitative and quantitative standpoint. The company’s main qualitative argument was that even if Cerene received FDA approval, Boston Scientific would need to remediate and retest Cerene before putting it on the market. This argument was not credible given the circumstances surrounding the decision to terminate the agreement in reliance solely on a consultant’s report without speaking with the consultant or Channel, retaining an outside consultant, quantifying the costs of remediation, or looking into Channel’s remediation efforts to date. The executive who made that decision also did not confer with a number of executives whose perspectives would have been relevant. Boston Scientific kept no written record of the meeting at which the decision was made to terminate, or any documentation at all assessing the impact of the fraud at Channel after it received the consultant’s report, and its quality expert could not identify any instance where any company, including Boston Scientific, voluntarily rebuilt a quality system and retested a device after receiving FDA approval. Furthermore, Boston Scientific’s concerns about potential products liability litigation, competitive harm, and future regulatory action were based on unsubstantiated speculation.
Boston Scientific also failed to make the quantitative case for the existence of a material adverse effect. The court did not credit its expert’s analysis because it was premised on an assumption that Boston Scientific would shelve Cerene for two to four years while it rebuilt and retested the device, a position that the court explained was not objectively reasonable. The expert also analyzed a putative change in Channel’s value that incorporated merger synergies. The chancery court consistently holds that a target should be valued as a standalone entity when determining whether a material adverse event has occurred.
Having determined that Boston Scientific’s termination of the agreement was not justified by the existence of a material adverse effect, the court held that the company breached its obligation to use commercially reasonable efforts to consummate the merger. As for the remedy, the parties expressly agreed that a failure to perform would warrant specific performance, and the equities weighed in Channel’s favor so as to make that remedy appropriate.
The case is No. 2018-0673-AGB.