DealLawyers.com Blog

A recent Chancery Court decision, Pacira Biosciences, Inc. et al. v. Fortis Advisors LLC (Del. Ch.; 1/25), addressed a very specific life sciences earnout issue — whether the contract tied the earnout payment to a national CMS (Centers for Medicare and Medicaid) reimbursement rate or a locality-adjusted reimbursement rate. The Court held that the agreement was ambiguous on this point and looked to extrinsic evidence, finding that it “overwhelmingly” supported that the parties intended for national reimbursement rates to be used. They were the only rates referenced throughout the merger negotiations, and post-closing milestone correspondence also referred to national rates — until a consultant tried to argue for an alternative interpretation after the milestones hadn’t been met based on the national rates.

When I first read this decision, I thought this issue — the meaning of the term “CMS Reimbursement” — was too unique for broader takeaways. But, of course, the use of varied, highly customized earnout milestones is common in life sciences deals, and this Cleary alert does identify a number of broad, helpful takeaways. One is the need for close collaboration between the legal and science steams when drafting milestones in life sciences earnouts:

This case highlights how important it is for parties to a transaction to develop a clear understanding of the key drivers of earnout milestones (here, the different reimbursement codes and the differences between national and local rates). It also highlights the challenges in drafting unambiguous earnout milestone language, particularly given the incentives that litigants (and their consultants) have to identify potential ambiguities and new interpretations after the fact. Like several other recent cases, the case again calls attention to the importance of close collaboration between legal and science teams in drafting milestones in order to avoid costly litigation and potentially unpredictable outcomes.

The alert also has some takeaways related to extrinsic evidence that are even more broadly applicable:

Importance of Maintaining a Clear Record: As earnout litigation becomes increasingly common, it is of the utmost importance that parties build a clear record regarding negotiations of these provisions. While Delaware courts generally do not look outside the four corners of an agreement, they will do so in cases of ambiguity to understand the parties’ intent. In light of this risk, it is critical that parties to a transaction are appropriately informed about the technical details of earnout milestones and are sensitive to the fact that their contemporaneous communications and records of their negotiations may be determinative in a court’s interpretation of the parties’ obligations.

Agreements that Limit the Relevance of Extrinsic Evidence, While Useful, May Not Limit the Use of All Extrinsic Evidence: Myoscience and Pacira’s merger agreement contained a clause providing that prior drafts, course of performance, and course of dealing could not be used to interpret the merger agreement. The Court respected this provision and made clear that its decision did not rely on prior drafts or the parties’ course of performance (including the fact that the MyoScience security holders had accepted a separate undisputed milestone payment based on the national reimbursement rate). However, this provision did not preclude the Court from considering other extrinsic evidence of the parties’ intent, such as the negotiation history and the seller’s own after-the-fact communications, which showed that the interpretation the seller advocated in the litigation was developed retrospectively by its consultants.

– Meredith Ervine