The Court of Chancery recently explained in a post-trial opinion why a post-closing adjustment claim seeking a milestone payment was rejected in light of a careful examination of the meaning of an ambiguous term in the milestone trigger provision. This opinion is helpful for those who want insights into how a Delaware court applies contract interpretation principles to extrinsic evidence to determine the meaning of a disputed term in a post-closing earn-out dispute. Shareholder Representative Services, LLC v. Gilead Sciences, Inc., C.A. No. 10537-CB (Del. Ch. Mar. 15, 2017).

Basic Background: The background facts of this case involve a merger of two pharmaceutical companies. Calistoga Pharmaceuticals, Inc. was purchased by Gilead Sciences, Inc. in 2011 pursuant to a merger agreement which included milestone payments based on certain triggers.  After considering the evidence presented at trial, the court held that Gilead is not required to pay a $50 million milestone payment under the terms of the merger agreement.  The court provided an extensive discussion of esoteric medical and pharmaceutical terms, and aspects of FDA approval for products that either ameliorate or cure a particular disease.

The core dispute in this case according to the court: “boils down to the meaning of essentially one word – – ‘indication’ – – as used in an 84-page merger agreement.”  The court explained in its 80-page opinion why Gilead’s interpretation of that word prevailed.

Key Principles and Takeaways:

In order to determine the correct meaning of the word in dispute, and the parties’ intent pursuant to the agreement, the court considered extrinsic evidence such as draft merger agreements, emails among the negotiators on opposite sides of the negotiating table, and emails among colleagues for each party, both before and after the closing, which provided an insight into how each party viewed the meaning of the disputed term.

The court includes a recitation of basic contract interpretation principles such as a reminder that Delaware follows the objective theory of contracts. Also useful to commercial litigation practitioners is the court’s discussion of what type of extrinsic evidence is allowed when provisions in an agreement are deemed ambiguous. See slip op. at 43-45.

Especially notable is a contract interpretation principle of Delaware law that is not commonly known, explained by the court as follows: There is no need for a party to convince the court that “its position is supported by every provision or collection of words in the agreement.” See footnote 175.

Although it did not play a role in its decision, the court observed that the phrase “commercially reasonable efforts” was defined in the agreement. Few Delaware opinions have authoritatively discussed commercially reasonable efforts, as explained in a Delaware decision that was highlighted on these pages.

The court explained that “in considering extrinsic evidence, the court should uphold, to the extent possible, the reasonable shared expectations of the parties at the time of contracting. In giving effect to the parties’ intentions, it is generally accepted that the parties’ conduct before any controversy has arisen is given ‘great weight’”

In addition, the court emphasized that “ascertaining the shared intent of the parties does not mandate slavish adherence to every principle of contract interpretation.” Instead, the following instruction was provided: “Contract principles that guide the court – – such as the tenet that all provisions of an agreement should be given meaning – – do not necessarily drive the outcome.  Sometimes apparently conflicting provisions can be reconciled . . ..”

Practical Guidance in Opinion:

The burden of proof that must be satisfied at trial was described, see slip op. at 42, and the decision provides practical guidance for litigators to the extent that it discusses the type of extrinsic evidence that the court found persuasive for purposes of determining the intent of the parties in their use of one word in this case that would have triggered a milestone payment.  The court observed that both parties used the word “indication” as synonymous for “disease” during their negotiations.  An interpretation of the word “indication” was the determining factor in the case.  The court described and relied on emails between the key executives for each side exchanged during the negotiations, as well as emails among executives for each party after the closing took place.

Anecdotally, I often make the observation that any merger agreement or agreement for the sale of companies that includes a post-closing adjustment or other milestone payment will almost invariably lead to litigation. This decision is good evidence supporting that anecdotal observation.  Those litigating such a case will find this opinion a helpful guide for how the court approaches these issues in a post-closing adjustment dispute.