Sale of Buyer’s Equity Provides “Good Faith” Justification for Not Earning Earnout
As we have written about in the past, earnout provisions in M&A agreements are often ways to find value and bridge a buyer’s and seller’s differing expectations of the future. But they also are ripe for litigation, especially if the buyer changes the way the business is run or pursues other opportunities that may affect the earnout. Such disputes are highly fact-specific and often turn on the unique issues facing the acquired business. A recent case from the Delaware Court of Chancery illustrates an example of a buyer not having to pay an earnout when its conduct to not enter into new business with a potential customer was influenced by a simultaneous transaction to sell an equity stake in the buyer.
Words Matter: Different Definitions of “Commercially Reasonable Efforts” Lead to Different Results in Drug-Development Earnout Disputes
Acquisitions of biotech companies with development-stage drug candidates often include earnout agreements. The buyer pays the seller’s stockholders with cash or stock upfront, and the seller’s stockholders are entitled to additional payments if the drug or drugs in development reach certain milestones, often culminating in FDA approval or commercialization. Achieving those milestones can take many years and requires the buyer to make substantial investments in clinical trials and regulatory approval. Because the right to earnout payments depends to a significant degree on a buyer’s actions in developing the asset, a seller will seek a provision in the acquisition agreement requiring the buyer to use commercially reasonable efforts in drug development.
Kitchen-Sink Pleading Will Not Fly In Delaware
Vice Chancellor Glasscock recently affirmed in BV Advisory Partners, LLC v. Quantum Computing Inc., C.A. No. 2022-0719-SG, that more is not always better when it comes to pleading claims. In ruling on motions to dismiss filed by all defendants, the Court dismissed six Defendants for failure to plead personal jurisdiction under Rule 12(b)(2), and also dismissed eight of ten causes of action pled against the remaining Defendants for failure to state a claim under Rule 12(b)(6). In each of the Court’s holdings dismissing both Defendants and causes of action (summarized below), the Court identified the various ways in which Plaintiff relied to its detriment on conclusory allegations and impermissible bootstrapping. This ruling serves as a reminder to litigants that the Court of Chancery is well-equipped to strip down complaints bloated by tangential claims and theories of liability that are not sufficiently supported by alleged facts.
An Arbitration by Any Other Name Is Still an Arbitration, Unless It’s an Expert Determination: Recent Cases Apply Delaware’s Authority Test to ADR Provisions
In M&A transaction agreements, contracting parties frequently negotiate a mechanism to make post-closing adjustments to the purchase price — for example, based on calculations of the target company’s working capital at the time of closing or an “earnout” based on the performance of the company for a specified period after closing. Because parties often disagree over these adjustments, the agreement generally will include a framework for resolving disputes. Although the particulars can vary, the parties typically will agree to negotiate in good faith and, if negotiations fail, to submit any remaining disputes to an independent accountant for final resolution. (more…)
The Court of Chancery Prunes Back the Limits of Its Jurisdiction
The Delaware Court of Chancery is one of limited jurisdiction, accessible only when complete relief at law is unavailable. On March 4, 2024, in Graciano v Adobe Healthcare, Inc., Vice Chancellor Glasscock continued a trend from other recent cases toward guarding the limits of the Court of Chancery’s equitable jurisdiction, when he concluded that a claim for release of funds in escrow established through an M&A transaction was not equitable in nature—even though framed as a request for specific performance—because a declaratory judgment was the only judicial action required to afford the Plaintiff relief.
Con Ed Uncertainty: Court of Chancery Questions Enforceability of Merger Agreement Provisions Allowing Target to Seek Lost Merger Premium
In an October 31, 2023 decision sure to spook practitioners, the Court of Chancery called into doubt the enforceability of “Con Ed provisions.” Con Ed provisions, so-named for the 2005 Second Circuit decision prohibiting stockholders from pursuing a $1.2 billion merger premium damages claim, create a path for the target’s recovery of lost merger premium if the buyer breaches and a deal fails.
Magellan Health: A New North Star for Mootness Fee Disputes May Reduce Payments to Plaintiff’s Counsel
The path to a mootness fee is well-worn. A stockholder plaintiff sues alleging that a company’s disclosures or other decisions were inadequate or improper. The company responds by issuing disclosures or taking actions that moot the plaintiff’s claims. This, laudably, avoids the expense and distraction of litigation.
The Line Between Speculation and Expectation in Damages: Delaware Court of Chancery Weighs in on Damages for Fraud in M&A Transaction
In a recent decision, Vice Chancellor Will refused to award expectation damages based on a buyer’s “speculative” synergistic cash flow resulting from a merger. The opinion demonstrates the rigorous approach that the Delaware Court of Chancery takes to calculating damages related to M&A transactions even with strong evidence of fraud, and offers valuable insight to companies calculating damages from lost synergies in M&A transactions.
Beware “Lite” Reasoning: Delaware Vice Chancellor Refuses to Disturb Arbitration Ruling Despite Concerns About Flawed Reasoning and Outcome
A recent Delaware Court of Chancery decision offers an important lesson on the limits of court review of an arbitration award, particularly when parties forego a fully reasoned award. Even though Vice Chancellor Glasscock found that “[t]he arbitration proceeding and the resulting award [were] flawed,” the court refused to overturn the award that appeared to find a contractual nonparty jointly and severally liable for breaches of the representations and warranties in a purchase agreement. The risk parties sometimes take when they contract for arbitration, the court found, is “receiving an arbitral decision that is questionable under the law and facts, but that is nonetheless—not coming within the narrow window of judicial oversight—not reviewable.”
No Participation Trophy: Court of Chancery Shifts Fees For Failure To Allow Indemnifying Seller to Participate In Defense
Chancellor McCormick, of the Delaware Court of Chancery, recently was presented with the following question: If an indemnification provision in a purchase agreement clearly requires that the indemnifying party be permitted to participate in the defense of third party claims, is it a breach not to allow that participation? It turns out that, despite a bit of creative contractual interpretation, the answer is “yes.”
