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Chancery Enters Judgment for Seller On Post-Closing Milestone Payment Claim Because Buyer Failed to Establish Occurrence of Condition Subsequent

Shareholder Representative Services LLC v. Shire US Holdings, Inc., et al., C.A. No. 2017-0863 KSJM (Del. Ch. Oct. 12, 2020)
After the purchaser of a drug manufacturer failed to make a post-closing milestone payment required under the applicable merger agreement, the seller filed a two count complaint in the Court of Chancery for breach of contract and attorneys’ fees. In a post-trial opinion, Vice Chancellor Kathaleen St. Jude McCormick concluded that a condition subsequent that would have relieved the buyer of its milestone payment obligation had not, in fact, occurred. The Vice Chancellor entered judgment for the seller and awarded attorneys’ fees based upon a prevailing party provision of the merger agreement.

The target of the merger was in the process of developing a new drug when the merger agreement was executed. The merger agreement granted the buyer with the “sole and absolute discretion” to continue developing the acquired drug but required the buyer to pay a $45 million milestone payment when the “Initiation of Phase III Clinical Trial Milestone” occurred. The merger agreement further provided that this milestone would be “deemed achieved” on or before December 31, 2015 unless the failure to attain the milestone was “as a result of a Fundamental Circumstance.” A “Fundamental Circumstance” was defined as a circumstance in which material safety or efficacy concerns made it impracticable to produce and sell or to obtain regulatory approval for the drug.   

Approximately three years after the merger closed, the buyer sent seller a “Notice of Fundamental Circumstance” citing several purported safety concerns with the drug and concluded that the Initiation of the Phase III Clinical Trial Milestone shall not be deemed to have occurred by December 31, 2015. The buyer did not make the $45 million payment, and the seller filed suit.    

The parties disputed who had the burden of proof. While the party seeking to enforce the contract usually carries the burden, contracts with conditions require another layer of analysis. If the contract imposes a duty that exists unless extinguished by a specified event, the party disputing the occurrence of a breach must prove that the condition subsequent occurred relieving it of its contractual obligations. The buyer’s obligation to make the milestone payment was mandatory and would only be extinguished upon an event that constituted a Fundamental Circumstance. Accordingly, it would be a condition subsequent, which the buyer would have to prove in order to avoid the milestone payment. In so holding, the Court also drew a parallel between allocating the burden of proof for conditions precedent and subsequent and parties asserting a material adverse change, who similarly bear the burden. 

Turning to the facts at-issue, the Court ultimately determined that the defendant-buyer failed to prove that its refusal to make the milestone payment was a result of a Fundamental Circumstance. The Court determined that the failure to initiate the Phase III Clinical Trial Milestone was the result of routine drug development delays and financially motivated business decisions and not a Fundamental Circumstance. The Court rejected buyer’s claim of reliance on certain safety concerns raised during certain clinical trials as a Fundamental Circumstance, because the evidence demonstrated that the buyer decided to delay the development of the drug before it learned of the potential safety issues. The evidence at trial also revealed that the decision to delay development of the drug was part of a company-wide effort to shift spending to products in later stages of development. The Court entered judgment for the plaintiff-seller.                

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