November 22, 2021

Earnouts: Drafting Tips from the Del. Chancery

This Fried Frank memo takes a look at tips for drafting milestone languages in earnout provisions from the Chancery Court’s decisions in Shareholder Representative Services v. Shire, (Del. Ch.; 10/20) and Pacira Biosciences v. Fortis Advisory, (Del. Ch.; 10/21). This excerpt summarizes the key drafting lessons to be derived from the decisions:

– Based on Pacira, merger agreement parties should consider setting forth specific restrictions on selling stockholders’ post-closing efforts to facilitate achievement of an earnout. In Pacira, the buyer contended that the milestone payment was not owed, in part, because the selling stockholders, in contravention of the buyer’s contractual right to control the acquired company post-closing in its sole discretion, had taken steps to seek to influence achievement of the milestone. The court found that, as no specific restrictions on the selling stockholders were set forth in the merger agreement, no obligation to refrain from seeking to influence achievement of the earnout existed. The court held that the buyer was not excused from making the milestone payment on the basis that the selling stockholders had breached a contractual obligation.

– Based on Shire, when the phrase “as a result of” is used, the drafting should clarify whether it means “exclusively as a result of.” In Shire, the merger agreement provided that a milestone payment would be paid on a specified date even if the specified milestone event had not occurred by that date, but would not then be payable if the failure of the milestone to have occurred by that date was “as a result of” certain regulatory-related issues having arisen. The court acknowledged that such a regulatory issue had arisen, but interpreted “as a result of” to mean that the milestone payment would not be payable only if the regulatory issue had been the only reason the milestone was not achieved. The court held that the buyer was not excused from making the milestone payment as it concluded that other factors had contributed to the milestone not being achieved.

The memo elaborates on the matters addressed in this summary, and closes with the always good advice to think hard about possible alternatives before concluding that an earnout is the answer to bridging a valuation gap.

John Jenkins