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In Fortis Advisors v. Medtronic Minimed, (Del. Ch.; 7/24), the Delaware Chancery Court dismissed claims by a sellers’ representative that the buyer wrongfully deprived the target’s former stockholders of a $100 million contingent milestone payment. The Court rejected the plaintiff’s claims based on the earnout provision’s unusually buyer-friendly language concerning the buyer’s obligations with respect to the achievement of the milestone.

The merger agreement contained language stating that the parties intent was that “development, marketing, commercial exploitation and sale of the Milestone Products” could be exercised by the buyer in accordance with its business judgment and in its “sole and absolute discretion.” It went on to say that the parties acknowledged that the buyer’s ability to exercise its discretion “may have an impact on the payment of the Milestone Consideration.”

While the agreement also provided that the buyer could not “take any action intended for the primary purpose of frustrating the payment of Milestone Consideration,” it also said that the buyer would not “have any liability whatsoever to any [former target stockholder] for any claim, loss or damage of any nature that arises out of or relates in any way to any decisions or actions affecting whether or not or the extent to which the Milestone Consideration becomes payable.”

The plaintiff alleged that the buyer’s decision to defer hiring new salespeople, commencing a marketing program and refusing to pursue regulatory clearance and sales of a particular product were actions intended to frustrate payment of the Milestone Consideration. However, the Court concluded that “[d]eferring action and refusing action are functional opposites of “tak[ing]” action.”  If the buyer had covenanted to use reasonable efforts to achieve the milestone, the Court said that those omissions might carry more weight, but not with the buyer-friendly language contained in the agreement.

The Court observed that the unusual language in the contract put the plaintiff in the position of having to satisfy a pleading burden that it just could not meet:

The Court first notes the unusually heavy burden that Fortis contractually imposed on itself. This is not a case where Medtronic covenanted to use “best efforts,” “commercially reasonable efforts,” or even “good faith efforts” to achieve the First Milestone. To the contrary, in an arm’s-length transaction, Medtronic secured for itself sole discretion to take actions that Medtronic knew would frustrate the First Milestone, so long as the action had some other primary purpose. Fortis freely assented to that arrangement. The Court is not aware of any Delaware precedent applying such a buyer-friendly contingent payment scheme, and the parties cite to none.

Thus, while Fortis is correct that Delaware law imposes a “‘minimal’ and ‘plaintiff-friendly’ standard” at the pleading stage, Fortis must contend with a voluntarily undertaken contractual standard that is far from plaintiff-friendly. To meet that standard, Fortis cannot simply raise an inference that Medtronic acted in a way that had the purpose or effect of defeating the First Milestone, Fortis must plead facts that raise an inference that Medtronic acted with the primary purpose of defeating the First Milestone. Fortis fails to raise the latter inference.

While the Court dismissed the plaintiff’s claims relating to the earnout, it allowed the plaintiff to move forward with claims that the buyer wrongfully withheld amounts held in an escrow account based on the buyer’s alleged untimely assertion of indemnity claims.

– John Jenkins