Delaware Court Of Chancery Orders Buyer To Close Acquisition Of Medical Device Company After Finding Reduction In Medicare Reimbursement Rates Was Not A Material Adverse Effect
On July 9, 2021, Vice Chancellor Slights of the Delaware Court of Chancery held in a lengthy post-trial opinion that defendant Hill-Rom, Inc. (“Hillrom”) was not excused from closing its acquisition of plaintiff Bardy Diagnostics, Inc. (“Bardy”), a medical device company, due to a Material Adverse Effect (“MAE”). Bardy Diagnostics, Inc., et al. v. Hill-Rom, Inc., et al., C.A. No. 2021-0175-JRS (Del. Ch. July 9, 2021). Between signing of the merger agreement and closing, Medicare drastically reduced the rates payable for Bardy’s signature medical device. Hillrom argued that this change constituted an MAE (or, alternatively, frustration of purpose), excusing its obligation to close. The Court disagreed, finding that (i) Hillrom failed to establish that the pricing change would have a durationally significant material effect on Bardy, (ii) Bardy was not “disproportionately impacted” relative to similarly situated companies, and (iii) a Medicare rates reduction was carved out from the MAE definition. The Court deemed the doctrine of frustration of purpose inapplicable.
With respect to Hillrom’s MAE claim, the Court noted that even though the rate decrease was an “event” affecting Bardy’s “business” (as defined in the merger agreement), the effect on Bardy’s earnings potential—at the time Hillrom invoked the MAE clause—would not endure for a “durationally significant period.” This was so, according to the Court, because Bardy was a startup, where rapid growth was prioritized over profits, and in any event the evidence showed that a near-term intervention to correct reimbursement rates was likely. While the Court noted that the “analysis . . . could end here,” it “t[ook] up the remaining links of the analytical chain and conclude[d] that they too require Plaintiff’s verdict.” The Court then held that changes in Medicare reimbursement rates, which were set by an authorized contractor for the Medicaid administrator, fell under an express carve-out in the MAE provision for “any change in Law (including . . . any Health Care law).” Finally, the Court found that the new rate did not have a “materially disproportionate impact” on Bardy “compared to other similarly situated companies operating in the same industries or locations”—in terms of revenues, gross profits and other valuation metrics—such that these circumstances would be exempt from the applicable MAE carve-out.
With respect to the claim of frustration of purpose, the Court rejected Hillrom’s contention that the new rate rendered Bardy “less than worthless” as incredible because the record showed that the impact on Bardy’s revenue would only be temporary. The Court also noted that the parties had negotiated an earnout provision that allocated the risk of a reimbursement rate reduction to Bardy. For these reasons, the Court found that Hillrom’s failure to close breached the merger agreement and granted Bardy an order of specific performance and prejudgment interest on the deal price.