July 18, 2022

Earnouts: Reducing the Risk of Disputes Over Milestone Payments

“Milestone” payments are a common feature of life science deals, both public & private.  Whether you’re dealing with a contingent value right in a public company acquisition, an earnout in a private company deal or a milestone payment in a licensing agreement, it’s important to draft these provisions to minimize the risk of litigation.  It’s also not easy to accomplish that objective, but this Freshfields blog provides some advice on how to do it:

The best way to reduce the risk of disputes is to define milestones so they are conditioned to objective events that the parties reasonably expect to be achieved as part of the anticipated development plan or commercialization strategy for the specific product. For example, milestones are often structured to be payable upon the initiation of a clinical trial, the regulatory approval of a product, the achievement of a minimum level of sales for the product, or other clear-cut achievements that signal value creation and/or de-risking of the asset.

Subjectively defined milestones, such as those requiring the “successful completion” of a clinical trial, as well as terms of art, should generally be avoided. When structuring milestone payments, another point to consider is whether payment should be conditioned on achievement of the triggering event by a certain date. While these types of deadlines have certain appeal, particularly for buyers and licensees, they also can raise the risk of disputes if the milestone is not achieved, as the record will be examined for any evidence that the buyer or licensee dragged their feet in an attempt to avoid making payment.

The blog also makes a point that has been recently reinforced by the Delaware Chancery Court – if you want to impose an obligation on a party to act with a particular level of diligence in achieving a milestone, you need to spell out exactly what your chosen language for the “efforts clause” means.  If you don’t, then the default path for many courts will be to shrug their shoulders and say, “these clauses all look the same to me.”

John Jenkins