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Court Gives Great Weight to Pre-Merger Negotiations in Interpreting an Ambiguous Contract

Contract interpretation is a staple of litigation in the Delaware Court of Chancery. Disputes over the meaning of commercial contracts, foundational documents such as certificates of incorporation or bylaws or agreements governing alternative entities such as limited liability companies or limited partnerships require the court to interpret language in contracts.

So too do merger, stock purchase or sale of asset agreements. With the expansion of jurisdiction under Section 111(a)(2) of the Delaware General Corporation Law (DGCL) in 2016, disputes over the interpretation of agreements arising out of stock purchase and asset sale agreements may be expected to increase the number of cases requiring the court to interpret parties' agreements. The recent case of Shareholder Representative Services v. Gilead Sciences, C. A. No. 10537-CB (March 15), illustrates the methodology the court uses to interpret a contract and provides a primer for litigants seeking guidance on how the Court of Chancery resolves contract disputes.

Background

Gilead arises from a merger by which Gilead Sciences, Inc. acquired Calistoga Pharmaceuticals, Inc. in 2011. The parties agreed to certain milestone payments based on triggers specified in their merger agreement. One drug in development at the time of the transaction was CAL-101. The parties agreed that a trigger for a milestone payment of $50 million would be "the receipt of Regulatory Approval of CAL-101 in the United States or European Union, whichever occurs first, as a first-line drug treatment (i.e., a treatment for patients that have not previously undergone systemic drug therapy therefor) for a hematologic cancer indication." The European Commission approved CAL-101 in September 2014 "for patients with chronic lymphocytic leukemia (CLL) in the presence of genetic abnormality known as 17p deletion or TP53 mutation who are immune to chemo-immunotherapy." The issue in Gilead was whether that approval triggered the milestone payment and its resolution depended on the meaning of "Indication."

The Parties Dispute What 'Indication' Means and the Court Finds that the Merger Agreement is Ambiguous

Plaintiff Shareholder Representative Services (plaintiff), on behalf of the former securityholders of Calistoga, contended that "indication" means "the approved use of a drug in a population of patients with a particular disease" while defendant Gilead contended that "indication" means disease and that the milestone at issue was triggered only by a disease-level approval. In determining that the contract was ambiguous and thus required the court to consider extrinsic evidence, the court rejected the plaintiff's argument that "hematologic cancer" is a disease and thus Gilead's interpretation would render the word "indication" surplusage. The court took judicial notice of the use of the phrase "hematologic cancer diseases" in peer-reviewed journals and also noted that one medical professional who testified at trial used at least ten times the phrase "hematologic cancer diseases" in a natural, unforced way. The court also referenced the parties' conflicting positions on the meaning of "indication" in pretrial filings.

The court then examined in detail the parties' communications and exchange of draft agreements that culminated in the merger agreement to conclude that Gilead's interpretation was correct such that the European Commission's approval of CAL-101 for use by a sub-class of patients with CLL did not trigger the milestone payment.

Court Finds that Extrinsic Evidence Supports Gilead's Interpretation

The court carefully reviewed the parties' negotiation of the merger agreement, the structure of the agreement, and the parties' initial reaction to the European Commission's approval to conclude that the approval did not trigger the milestone payment. Among other factors, the court noted the absence of any discussion by the parties in their merger negotiations over a milestone payment for approved uses for a sub-population with a disease, the inconsistency of the plaintiff's position with the structure of the agreement regarding other milestone payments, and the commercial unreasonableness of Gilead agreeing to a payment of $50 million for an approved usage that might only benefit a minute portion of the disease population. In the court's view this combination of factors overwhelmingly supported Gilead's interpretation.

Lessons Learned

A Delaware court applies an objective theory of contracts. This means that it seeks first to ascertain the parties' intent based on the language in the four corners of the agreement. If the language is reasonably susceptible to one or more interpretations or may have two or more different meanings, then the court is obligated to consider extrinsic evidence. Gilead illustrates that the court gives great weight to the parties' conduct before a dispute arises and that a party may prevail even if it cannot persuade the court that every provision or collection of words in a contract supports its interpretation. A plaintiff before bringing a breach of contract claim should evaluate whether a contract is unambiguous and if not, assess the available extrinsic evidence to determine whether the parties' behavior on a clear day supports its litigation position.

Delaware Business Court Insider | April 5, 2017