Ambiguity in Earnout in Merger Leads to Delaware Litigation

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Earnouts – the right to receive additional consideration from the sale of a business after the closing based on achieving future milestones – remain common in M&A transactions, but carry significant risks. One of the major challenges for the seller and purchaser is to adequately define the future event that triggers the payment. Seemingly straightforward, the recent case of Shareholders Representative Services LLC v. Gilead Services, Inc., Delaware Court of Chancery (March 15, 2017) illustrates the difficulties. In Gilead, a $50 million milestone earnout payment to the seller of a pharmaceutical company boiled down to the meaning of the word “indication” as used in the phrase “Hematologic Cancer Indication.” The court found that the term was ambiguous in the merger agreement, and used external evidence to determine that “indication” meant “disease,” which did not trigger the milestone payment.

What can be learned from Gilead?

  • Use as much precision as possible when defining technical terms in earnouts. Using experts to clarify that “indication” meant “disease” and reflecting that definition in the merger agreement could have avoided the litigation.
  • Where financial milestones are part of the earnout, work closely with accountants and other financial advisors to draft the earnout provisions.
  • Use examples to clarify the events that are meant to trigger the earnout.