September 9, 2021

Earnouts: Del. Chancery Says “Commercially Reasonable Efforts” Must be Persistent

I thought a recent Chancery Court order interpreting what a “commercially reasonable efforts” clause in an earnout provision requires was worth noting.  In Shareholder Representative Services v. Alexion Pharmaceutical, (Del. Ch.; 9/21), the Chancery Court was confronted with a buyer that had committed to use commercially reasonable efforts to enable the target to meet contractual earnout milestones, but whom the seller alleged failed to use those efforts during the first two years of the earnout period.

The buyer argued that since the contract called for a performance period of seven years, it still had five years to achieve those milestones, so the seller’s claims weren’t ripe for assertion. Vice Chancellor Zurn disagreed, and held that the seller’s claim accrued when the contractual efforts obligation was breached.  She also rejected the buyer’s claim that a breach hadn’t yet occurred:

Alexion argues that because the Commercially Reasonable Efforts period lasts seven years, it still has nearly five years to achieve the Milestone Events without breaching the Merger Agreement. In effect, Alexion argues that it can catch up and achieve the Milestone Events despite any lapse in its efforts. Alexion’s argument conflates its obligations to pay upon certain results, at any time, with its obligations to pursue those results with a certain amount of diligence for a period of time. Section 3.8(f) requires conduct (i.e., Commercially Reasonable Efforts), not results (i.e., the Milestone Events).

Alexion’s efforts obligation requires persistent efforts for the entire contractual seven-year period, as distinct from long-term results. When Alexion failed to put forward those efforts, it breached Section 3.8(f). The facts surrounding Alexion’s substandard past efforts are static, and that breach can be adjudicated now.

John Jenkins