DealLawyers.com Blog

Yesterday, the Delaware Chancery Court issued its post-trial memorandum opinion in Fortis Advisors v. Johnson & Johnson (Del. Ch.; 9/24) finding that J&J violated its earnout obligations in the merger agreement to acquire Auris Health. As John blogged at the motion to dismiss stage, the Chancery Court hears a lot of earnout cases, but very few have financial stakes as large as this. The facts may remind readers of Robot Wars (corporate America’s version):

Auris Health, Inc. was a venture-backed startup … Auris had developed two novel surgical robots in record time: Monarch and iPlatform. … Johnson & Johnson was attempting to develop its own surgical robot called Verb. … Verb was falling increasingly behind the schedule [and] J&J looked to Auris as a solution.

[Auris] was wary of an acquisition, especially by J&J since Verb was a potential competitor of iPlatform. J&J understood Auris’s hesitations and put together a proposal it would not refuse. J&J offered to pay $3.4 billion up front and another $2.35 billion upon the achievement of two commercial and eight regulatory milestones … The regulatory milestones were ambitious, but corresponded to approvals for procedures that the Auris robots were on track to complete. Auris agreed to an earnout component after securing J&J’s commitment to devote commercially reasonable efforts befitting a “priority medical device” in furtherance of the milestones.

But things did not go as Auris had hoped (and negotiated for):

Instead of providing efforts and resources to achieve the regulatory milestones, J&J thrust iPlatform into a head-to-head faceoff against Verb called “Project Manhattan.” Verb and iPlatform were forced to complete a series of procedures to be ranked against one another. Both robots successfully completed the assigned procedures. J&J decided that iPlatform was the better bet. But for iPlatform, winning Project Manhattan was losing. To salvage its years of investment in Verb, J&J directed that Verb’s hardware and team be added to iPlatform. The iPlatform robot effectively became a parts shop for Verb.

J&J knew Project Manhattan would hinder, rather than promote, iPlatform’s achievement of the regulatory milestones. It also knew that combining iPlatform and Verb would cause further complications. But J&J viewed the resulting delays as beneficial since it could avoid making the earnout payment. When J&J’s actions put the first iPlatform milestone out of reach, the other milestones fell like dominos.

Auris’s former stockholders sued for breach of contract, breach of the implied covenant of good faith and fair dealing and fraud. J&J argued that it had discretion under the merger agreement to use the Auris products to advance its overall robotics strategy without regard to the milestones and that the missed milestones were due to iPlatform’s technical problems. VC Will disagreed on both counts:

After weighing an abundance of evidence, I find that J&J breached its contractual obligations. The bespoke earnout provision negotiated by the parties required J&J to treat iPlatform as a priority device, to provide efforts in support of the regulatory milestones, and to avoid making decisions based on the contingent payment. J&J violated each obligation—most blatantly when iPlatform was made to compete against and combine with Verb. J&J also breached the implied covenant of good faith and fair dealing when it failed to devote efforts to achieve the revised regulatory pathway.

VC Will noted: “Damages with interest exceed $1 billion, which compensates Auris’s former stockholders for the earnout payment they would have received absent J&J’s failed efforts and fraud. What remains irretrievably lost is the transformative potential of Auris’s robots.”

The earnout language at issue here is in stark contrast to another recent Chancery Court decision John blogged about in early August. Fortis Advisors v. Medtronic Minimed, (Del. Ch.; 7/24) involved unusually buyer-friendly language concerning the buyer’s obligations with respect to the achievement of the milestone. Together, the decisions reinforce that the Delaware Chancery Court will enforce bespoke earnout provisions as written.

– Meredith Ervine