Court of Chancery Decision Provides Guidance for Drafting MAE Clauses

Gail Weinstein is senior counsel, and Philip Richter and Steven Epstein are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Richter, Mr. Epstein, Brian T. Mangino, Randi Lally, and Erica Jaffe, and is part of the Delaware law series; links to other posts in the series are available here.

In Bardy Diagnostics v. Hill-Rom (July 9, 2022), the Delaware Court of Chancery followed its almost invariable pattern of finding that an event arising between signing and closing of a merger agreement did not constitute a Material Adverse Effect that permitted the buyer to terminate the deal.

The decision is noteworthy for the court’s award of the remedy of prejudgment interest, running from the time the merger would have closed. The court also ordered specific performance, but denied the target’s request for other compensatory damages. Most importantly, the decision provides insight into the court’s interpretation of the drafting of a number of MAE provisions (as discussed below).

In this case, the event was an unexpected and dramatic reduction in the Medicare reimbursement rate for the target company’s sole product (a patch used to detect heart arrhythmias and related services). The court, following Delaware’s traditional approach to evaluating whether an MAE occurred, concluded that the effects of the event did not have “durational significance”; and that, in any event, the language of the MAE provision in the merger agreement excluded this event from constituting an MAE. The court therefore ordered the buyer to close.


In January 2021, Hill-Rom, Inc. (“Hillrom”) agreed to acquire Bardy Diagnostics, Inc., a venture-backed medical device startup company, for $350 million plus contingent earnout consideration based on 2021 and 2022 revenue. The merger agreement provided that Hillrom would not have to close in the event of an MAE. MAE was defined as any event or change that “has had, or would reasonably be expected to have, a material adverse effect on…the Business of [Bardy]”—but (among other specified exclusions) excluding the effects of “any change in any Law,” unless the effect of the excluded event had “a materially disproportionate impact on [Bardy] as compared to other similarly situated companies operating in the same industries or locations, as applicable, as the Business.”

Hillrom believed that Bardy had significant growth potential, but expected that Bardy would not become profitable until several years after the closing. Bardy’s key source of revenue was through Medicare reimbursements for the medical patch, which historically had been set at about $365 for each patch. Two weeks after the merger agreement was signed, the private firm authorized by Medicare to set the reimbursement rate for the patch reduced the rate by 86%. Although (following lobbying efforts by both the target and the buyer for an increase in the rate) the rate was soon raised, the resulting increased rate was “still less than half of the historic rate.” Hillrom contended that Bardy had suffered an MAE and it therefore refused to close.

The court held that the adverse effect on Bardy did not have “durational significance.” The Delaware courts have consistently held that, to constitute an MAE, an event must have effects that are both sufficiently material and have durational significance (i.e., affect the long-term value of the company). In Bardy, the court did not decide whether the Medicare reimbursement rate reduction was sufficiently material to constitute an MAE, but held that, assuming it was, it did not have durational significance.

First, the court observed that Hillrom’s own internal projections estimated that Bardy would not become profitable until three years after the acquisition and that Hillrom had acknowledged that five or more years would be durationally significant—leaving only a two-year period potentially affected by the rate decrease for MAE purposes.

Second, the court found credible the expert testimony that the Medicare reimbursement rate likely would be revisited and meaningfully increased some time within the next two years. While Hillrom argued that there was no certainty that, if the rate were changed again it would be “meaningfully upward such that an MAE would not reasonably be expected to have occurred,” the court responded that, based on the evidence presented, it was equally possible that the rate would be increased significantly. The court noted that, when Hillrom entered in the merger agreement, it believed that the then Medicare reimbursement rate of $365 likely would be raised to something over $400. Given the opacity and recent erratic nature of the rate-setting process, the court reasoned, there was no reason for Hillrom to believe that its prior view now was wrong—that is, a meaningful upward adjustment remained possibly or even likely. The court noted that it was “insufficient to show the effect of the [decreased reimbursement rate] might be durationally significant, as a mere risk of an MAE cannot be enough.”

Third, the court stated: “Nothing about Bardy’s fundamental business or the strength of its technology has changed. Indeed, it continues to grow apace notwithstanding the challenges brought on by the [decreased rate] and this litigation.” Although Bardy’s revenue declined about 11% between the last quarter of 2020 and the first quarter of 2021, its new patch enrollments and orders for the first quarter of 2021 increased 85% year-over-year and revenue was still up 56% year-over-year.

The court concluded: “Because Hillrom has failed to prove that it reasonably would have expected that [the agency that sets the reimbursement rate] would not meaningfully increase the current Medicare reimbursement rates…, it has likewise failed to prove that the current state of those rates constitutes an MAE.”

The court held that the exclusion in the MAE definition set forth in the merger agreement for “changes in Law” encompassed the Medicare reimbursement rate change. While the court’s analysis could have ended with its conclusion that the effects of the rate decrease did not have durational significance, the court, “for the sake of completeness,” addressed whether the rate decrease was excluded under the parties’ MAE definition. The court held that the Medicare reimbursement rate reduction fell within the carveout for “changes in Law” (even though it is a private firm that determines Medicare reimbursement rates). The merger agreement defined “Law” to include “any Health Care Law”; and defined “Health Care Law” to include “any” regulation or rule promulgated by “any governmental…or regulatory body,” including “any authorized contractor engaged by any governmental…or regulatory body.”

The court held that the Medicare reimbursement rate reduction did not have a disproportionate effect on Bardy as compared to “similarly situated” companies in the industry. The court viewed the “similarly situated” language as a “narrower, more target-friendly exclusion to the MAE carve-outs” than the more typical exclusion for a disproportionate impact as compared to other companies “in the same industry.” The court observed that, under a “plain reading” of the disproportionate impact exception, “the words ‘similarly situated’ reference company characteristics related to the ‘matter’ the exception is addressing.” The Vice Chancellor stated that, in his view, “because the rate changes at issue affect specific categories of products in the ambulatory cardiology monitoring market, a comparator company’s relevant characteristics include operational scale (i.e., revenue), developmental maturity and, most importantly, product portfolio (i.e., relative product mix and sophistication).” The court emphasized: “Where the ‘matter’ or ‘event’ alleged to be an MAE is a change in a specific product’s Medicare reimbursement rates tied to particular products and related services, product mix is patently the most important factor in determining a comparator firm’s ‘situational’ position relative to Bardy.”

The court acknowledged a potential “circularity” in reading “similarly situated” as limiting the disproportionate impact exception to companies that share a similar product mix with the target company and therefore might be expected to suffer similar impacts from external events affecting the products. The court reasoned, however, that the result was intended by the parties: “As a one-product company that operates in a high-growth, heavily regulated market, it is not surprising that Bardy bargained for a narrower, more target-friendly exclusion to the MAE carve-out.”

The court found that there was only one company, iRhythm, that was “similarly situated” to Bardy for this purpose. The court noted that neither party disputed that iRhythm was similarly situated and that Hillrom had “used only iRhythm’s revenue multiples to value Bardy.” According to the court, iRhythm was the only other company in the market that, like Bardy, derived the vast majority of its revenue from a single product (a cardiac patch); and that, like Bardy, had yet to turn a profit (“signaling it also currently prioritizes growth over profitability”). While, unlike Bardy, iRhythm was publicly traded, Bardy had “healthy access to capital to fuel its expansion.” While iRhythm’s “operational scale” (i.e., revenue) was more than nine times greater than Bardy’s, “[e]ven still, iRhythm’s product mix ha[d] left it similarly dependent on (and affected by) the [Medicare rate reduction],” the court wrote.

The court rejected the target company’s argument that only “unknown” risks can constitute an MAE. Bardy had argued that the Medicare reimbursement rate reduction could not be an MAE because “the risk of a change in reimbursement rates was not ‘unknown’ at the time the parties signed the Agreement.” Bardy cited the seminal MAE decision, IBP, in which then-Vice Chancellor Strine characterized an MAE provision as being “best read as a backstop protecting the acquiror from the occurrence of unknown events.” The court, echoing the view of commentators on the subject, explained that Strine’s characterization should be read in context—given that the merger agreement in IBP did not specify exclusions to the MAE definition, Strine meant by “unknown” events or risks those events or risks that were not “specified” in the agreement. By contrast, because in Bardy the MAE definition specifically allocated risks through specified carve-outs and exclusions, there was “no room” to argue that only an “unanticipated” event could be an MAE. Rather, the MAE definition the parties bargained for would be enforced as written, the court stated. If the parties had intended to limit the events that could give rise to an MAE to only those events that were unknown to the parties at the time the merger agreement was signed, they could have drafted the MAE provision “to only include ‘unknown’ facts, events, changes, effects or conditions,” the Vice Chancellor wrote. “Instead, they chose to adopt a broadly-worded general MAE and qualify that language with a list of carve-outs.”

Practice Points

  • The court will pay close attention to the precise words the parties chose in drafting an MAE provision. In making its determinations, the court may take into consideration any changes to customarily used language, and whether the clause as drafted reflects an intention of the parties that the clause will operate to be more target- friendly or more buyer-friendly.
  • Drafting remedies language. Merger agreement parties should consider specifying in the agreement their intentions with respect to remedies in the event of litigation over an MAE. Merger agreement parties should consider specifying in the agreement what remedies will be available in the event of litigation over an MAE— including whether prejudgment interest would or would not be payable.
  • Drafting “disproportionate impact” language. Merger agreement drafters should pay careful attention to the drafting of this exception to the MAE carveouts, with the critical feature being what the reference group of companies will be for the required comparison. Consideration should be given to special features of the target company that would affect what the appropriate reference group would be. As illustrated in Bardy, a target that is an early-stage company or otherwise emphasizes growth over profitability should consider seeking to provide for the comparison group to be “similarly situated companies in the same industry” rather than the more usual “other companies in the same industry.” Consideration also should be given to whether the relevant industry should be defined.
  • Drafting “carveouts” (i.e., exclusions) to the MAE definition. Merger agreement parties should carefully consider whether there are specific events that might arise between signing and closing that should be specifically excluded from constituting an MAE or should be specifically excepted from one of the specified exclusions. For example, most merger agreements now specify whether the effects of the COVID-19 pandemic are excluded. As another example, if a buyer believed that, in light of recent political developments, there is a strong possibility of a significant increase in the corporate tax rate, that party should consider seeking to except that event from the usual, broad carve-out for changes in law.
  • A buyer should proceed diligently toward closing while it evaluates whether it has a right to terminate based on an MAE. While ultimately ruling in favor of the target company in Bardy, the court emphasized that this was not the typical case of “buyer’s remorse,” with a buyer alleging an MAE as a pretext to exit the deal for other reasons. The court noted that Hillrom asserted the MAE “in good faith,” after working with Bardy to lobby for a change in the newly announced Medicare reimbursement rate. While the court confirmed that good faith by the buyer could not excuse a breach of the agreement, we would note that the buyer’s good faith might well affect the court’s MAE-related conclusions where they were closer calls than in this case.
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