Sign Up for PublicationsCommercially Reasonable Efforts in Earnout Cases
Acquisition and license agreements in the life sciences space frequently contain earnout provisions. An earnout is a provision that makes a portion of the purchase price payable to the seller (or licensor) if/when certain post-closing performance targets (often called “milestones”) occur.
Because earnout payments depend on achievement of the targets, sellers typically prefer to maintain some measure of control in the acquired pharmaceutical product or device. Buyers (or licensees), by contrast, prefer sole discretion over development and to minimize earnout payments. Parties often resolve these competing interests by negotiating a provision requiring the buyer to devote certain efforts toward meeting the targets.
One such provision is called “commercially reasonable efforts”—requiring the buyer to devote a certain measure of efforts to develop the product and/or achieve the targets. But what level of efforts are “commercially reasonable” is left to the parties to negotiate. So-called “outward-facing” provisions, for example, judge a buyer’s efforts relative to those of similarly-situated industry participants. “Inward-facing” provisions, on the other hand, set efforts expectations based on the buyer’s typical practices with its own products.
Disputes between parties to acquisition agreements can arise when earnout targets are not met, leading to litigation regarding whether the buyer devoted the requisite level of “commercially reasonable efforts” to achieve them. Because parties often resolve such disputes privately, caselaw interpreting “commercially reasonable efforts” provisions is limited. However, two recent decisions from the Delaware Chancery Court addressed the issue head-on, and serve as a warning that damages for failing to live up to “commercially reasonable efforts” provisions can be steep.
First, in Fortis Advisors LLC v. Johnson & Johnson, 2024 WL 4048060 (Del. Ch. Sept. 4, 2024), J&J acquired Auris Health, Inc. for $3.4 billion up front and another $2.35 billion upon the achievement of various milestones tied to, among other things, the development of an Auris surgical robot called iPlatform. J&J agreed to use commercially reasonable efforts akin to its “usual practice” for a “priority medical device” in furtherance of those milestones. However, J&J ultimately shelved iPlatform, and former shareholders of Auris represented by Fortis sued for breach of contract and other causes of action.
Examining J&J’s efforts relative to its practices for another priority medical device (a J&J surgical robot called Velys), the court found that J&J failed to use commercially reasonable efforts to develop iPlatform. For example, J&J pitted iPlatform against another surgical robot called Verb to determine which to prioritize, an exercise that had no benefit for iPlatform. J&J also instituted an employee incentive program with targets different from the milestones in the merger agreement with Auris—an act the court found was designed to deprioritize the milestones themselves and was something J&J never did for Velys.
The court awarded $900 million in damages for milestone payments that would have been achieved but for J&J’s contractual breaches, weighted by the parties’ estimated probability of achievement at the time of the merger. The court reasoned that a probability-weighted measure of damages captured what Auris reasonably expected to gain prior to J&J’s breaches.
Second, in Shareholder Representative Services LLC v. Alexion Pharmaceuticals, Inc., 2024 WL 4052343 (Del. Ch. Sept. 5, 2024), Alexion acquired Syntimmune, Inc. for $400 million up front and $800 in installments tied to milestones for the development of a monoclonal antibody drug product called ALXN1830. Alexion agreed to use “commercially reasonable efforts” to achieve the milestones for seven years benchmarked by the efforts a similarly-situated company would expend on a similar product. However, after AstraZeneca plc acquired Alexion, the company paused a trial of ALXN1830 that was set to dose its first patient the following week, and ultimately terminated the ALXN1830 program entirely. Former shareholders of Syntimmune sued for breach of contract.
The court first found that one of the contractual milestones had been achieved and awarded damages in the amount of $130 million—the amount due under the contract tied to that milestone. The court next examined whether Alexion had exercised commercially reasonable efforts to achieve the remaining milestones, and found that it had not.
Because the drug product presented no safety concerns and had an advantage over competing products that other companies were developing, the court reasoned a similarly-situated company would have continued developing ALXN1830. The court concluded Alexion instead terminated the program due to AstraZeneca’s pursuit of merger synergies for its shareholders rather than out of any concern about ALXN1830 or development issues caused by COVID, as Alexion had argued.
The court awarded damages of approximately $180 million in a separate decision issued this year, 341 A.3d 513 (Del. Ch. 2025). Similar to the approach used in Fortis, the court calculated damages by weighting each milestone’s earnout payment by its probability of success, discounted to present value at the time of breach. As the court explained, “compensating for lost expected value, rather than with full value whenever earnout payments are likely and zero value whenever earnout payments are unlikely, strives to hit the mark on the parties’ reasonable expectations, rather than award windfalls for some promises and goose eggs for others.”
As these cases illustrate, failure to adhere to commercially reasonable efforts obligations tied to earnout payments can result in large damages awards—even for milestones not due to occur for years. This is because courts will endeavour to put the plaintiff in the same position it would have been absent the breach, which can be accomplished by ascertaining milestones’ expected value.