By Rebecca Guzman and Brandon Harper
In the second of its kind in as many days, the Court of Chancery issued a post-trial opinion enforcing contingent value rights or earnout provisions in merger agreements against breaching acquirors. In a September 5, 2024, opinion in Shareholder Representatives LLC v. Alexion Pharmaceuticals, Inc., the Court found that the buyer, Alexion Pharmaceuticals, Inc. (“Alexion”), a subsidiary of AstraZeneca, owed $130 million to the seller shareholders of Syntimmune, Inc. (“Syntimmune”) for a missed earnout milestone payment in its acquisition of the drug developer.
Following a seven-day trial, the Court held that Alexion was liable to Syntimmune shareholders for the earnout payment for achieving the first of eight total milestones and failing to use commercially reasonable efforts when it halted drug development.
The case is based on a 2018 merger agreement pursuant to which Alexion acquired Syntimmune for $1.2 billion. $400 million of the total price was due and paid at closing, while $800 million was due in increments upon completion of each of eight milestones agreed to by the parties related to the development of a monoclonal antibody to treat autoimmune diseases.
At issue in the case was the first milestone, which provided for a $130 million payment upon the successful completion of a Phase 1 clinical trial. Syntimmune’s stockholders argued that the criteria for that milestone were met, and that Alexion was in breach by failing to make the required earnout payment. Separately, Syntimmune’s stockholders argued that Alexion failed to use commercially reasonable efforts to achieve each of the remaining milestones after closing.
In response, Alexion argued that the drug development process was rife with challenges and the criteria for the first milestone had not been met. Alexion was forced to pause clinical trials in early 2020 when supply was contaminated and again during the COVID-19 pandemic. Alexion took the position that that the drug never reached “successful completion” of a Phase 1 clinical trial and, as a result, the first milestone was not met.
The Court ruled in favor of the plaintiff shareholders. The Court found that all conditions that needed to be satisfied for the first milestone had been met and awarded Plaintiffs $130 million. The Court’s decision was largely based on a determination on the satisfaction of the applicable criteria necessary to achieve the milestone. The Court ultimately found that the language and criteria set forth in the merger agreement related to achievement of the milestone was ambiguous and therefore the Court looked to extrinsic evidence.
In its commercially reasonable efforts analysis, the Court found that the parties agreed to an outward-facing, objective standard under and pursuant to the language set forth in, the merger agreement. The Court determined that the commercially reasonable efforts clause required that Alexion expend the efforts and considerations a hypothetical typical company similarly situated would have expended in developing a similar product. This “hypothetical company approach” is one of two ways of giving meaning to language in a commercially reasonable efforts clause. The other way is the “yardstick approach” in which commercially reasonable efforts are compared to the efforts of a similarly situated company in the same industry and their actions in the real world.
The Court observed that the outward-facing standard prohibited Alexion from considering its own self-interest in determining what is commercially reasonable. While the Court held that under the agreed upon standard Alexion need not undertake efforts that would be contrary to prudent business judgment, the decision on the part of Alexion to halt clinical development, given that it was driven largely by a broader corporate initiative of Alexion unrelated to the drug at issue, fell short of the “hypothetical company” commercially reasonable efforts standard agreed to between the parties in the merger agreement.
This case comes shortly after another earnout decision in which the Court of Chancery awarded damages to plaintiffs. In Fortis Advisors, LLC v. Johnson & Johnson et al., C.A. No. 2020-0881-LWW, the Court found Johnson & Johnson found liable for $1 billion for milestone payments related to the development of a surgical robot.
Ultimately these cases are another reminder to contract drafting practitioners (and their clients) to ensure that the liabilities and obligations set forth in a merger agreement reflect as closely as possible the commercial arrangement and intent of the contracting parties.
In addition, when parties negotiate and agree to efforts standards, they ought to consider how the liabilities and obligations under the specified transaction agreement fit within the overall framework of their business operations and key objectives (and ensure that the commercial agreement takes into account the broader business operations and key objectives).