M&A/PE Quarterly, September 2024

Table of Contents:

• In the Most Recent Earnout Decisions, the Court of Chancery Found the Buyers Breached Their Efforts Obligations-Auris and Alexion

• Uncertainty on Governance Rights in Stockholders Agreements Continues Pending a Decision in the Appeal of Moelis

• Chancery Holds, for the First Time, that Substantive Contract Provisions in Private Agreements Cannot be Incorporated by Reference into a Delaware Corporation's Charter

• Lessons on Law Firm Legal Opinions from Chancery's Recent Boardwalk Decision on Remand

• 2024 Proxy Season Developments

• Other Developments of Note

• Minority Investors in an LLC Should Seek to Ensure the LLC Agreement's Amendment Provision Expressly Applies to Amendments Effected by a Merger-Campus Eye

• Federal District Court Decision Presents Roadblock for Anti-ESG Movement-SIFMA v. Ashcroft

• Inadvertent HSR Violation Leads to $1M Settlement Payable by GameStop's CEO Relating to His Purchases of Less than 10% of Wells Fargo Stock

• CFIUS Assesses Its Largest Penalty to Date, and for the First Time Discloses the Name of the Target of an Enforcement Action

• Chancery Decision Offers LLC Agreement Drafting Lessons on Purchase Price Escrow and "Customary" Representations-Seva v. Octo

• Fried Frank M&A/PE Briefings Issued this Quarter

• Selected Other Fried Frank Briefings Issued this Quarter

In the Most Recent Earnout Decisions,the Court of Chancery Found the Buyers Breached Their Efforts Obligation-Auris and Alexion

In the Court of Chancery's two most recent earnout decisions-Fortis v.Johnson & Johnson ("Auris") (Sept. 4, 2024) and SRS v. Alexion (Sept. 5, 2024)-the court concluded that a buyer breached its contractual obligation to use "commercially reasonable efforts" to achieve an earnout.

In Auris, the parties had agreed to an "inward-facing" obligation, requiring that the buyer use efforts to develop the earnout product-a surgical robot-similar to the efforts it expended for its other "priority medical products." The court held that the buyer breached this obligation when it caused the earnout product to compete head-to-head with, and then to combine with, one of the buyer's competitive products. Those actions, the court found, were lesser than the efforts the buyer had made for the single comparator product and inconsistent with the priority status the buyer was required to accord to the earnout product.

In Alexion, the parties had agreed to an "outward-facing" obligation, requiring that the buyer use efforts to develop the earnout product-an antibody to treat disease-similar to the efforts of similar companies for similar products under similar circumstances. The court held that the buyer breached this obligation when it terminated the earnout product, purportedly due to concerns over new safety data and the resulting effect on the product's order of entry to the market. The court, essentially rejecting the validity of the buyer's purported business reasons for the termination, concluded that, under similar circumstances, another similar company would have gathered more safety data rather than terminating the product. The overlay to that conclusion was that the court viewed the buyer's purported reasons for the termination as pretexts, with the real reason for the termination being that the buyer was acquired during the earnout period and its acquiror wanted the product terminated to help it secure the outsized merger synergies it had publicly promised.

Key Points

• While Auris and Alexion are consistent with the court's new shift away from most often holding in favor of buyers in earnout cases, both of these cases were decided based on unusual facts and circumstances-and so do not,in our view, reflect any strong reinforcement of the new trend. In Auris, the court's result was based on unusually strong seller-friendly earnout language in the parties' merger agreement. In Alexion, the court's result was based on the particular unusual factual context involving an idiosyncratic need of a company that acquired the buyer during the earnout period. Both cases underscore, once again, that the outcome in earnout cases is based on the specific facts and circumstances, including the specific language of the earnout provisions.
  
  
• Alexion highlights that the court will interpret a provision granting a buyer sole (or complete) discretion over an earnout product in context with the buyer's efforts obligations. Based on the precise language used by the parties in their agreement, the court determined that, in making decisions about the earnout product, Alexion could consider only what actions other "typical biopharmaceutical companies" under similar circumstances would make-and could not consider its own "self-interest." The court's analysis, at a highly granular level, of the specific wording of the provisions, as compared to the language in precedential cases, underscores that the precise language the parties use in their agreement is critical to the court's result.
  
  
• Alexion also highlights that earnout parties utilizing an outward-facing efforts obligation should consider specifying whether the comparison is to actual actions taken by actual similar companies or, instead, to actions that would be expected to be taken by a hypothetical similar company. The Alexion parties did not so specify, and the court, determining that there were no exemplar companies for the first approach, applied the hypothetical approach-which led, effectively, to judicial second-guessing of the buyer's business decisions for terminating the product, and a finding that a hypothetical similar company would not have terminated the earnout product under similar circumstances. Again, we note the overlay that, under the particular facts in this case, the court viewed Alexion's purported business reasons as pretextual, with the real reason being an idiosyncratic need of the company that acquired Alexion.
  
  
• These decisions highlight that, when selecting between an inward- or outward-facing standard for the buyer's efforts obligation, the parties should: consider whether there are in fact exemplar products under each standard; and, if so, which those products are; what the buyer's efforts have been with respect to them; and whether those efforts comport with the parties' expectations for treatment of the earnout product.
  
  
• These decisions highlight other practical issues that may arise when the buyer has products that are competitive with the earnout product and when a buyer with an earnout obligation is acquired during the earnout period. Auris underscores that, where the buyer has products that are competitive with the earnout product, the parties should consider addressing in their agreement how the competing products will be treated in relation to one another with respect to the earnout. In addition, in this context, the court may be more skeptical of the buyer's motives for having acquired the product and any post-closing lack of efforts in support of it. Alexion underscores that, when a buyer is itself acquired during the earnout period, the buyer's acquiror, as part of its due diligence, should consider the buyer's efforts obligations with respect to any earnouts and whether they comport with the acquiror's own plans and objectives.
  
  
• These decisions serve as another reminder that earnouts often lead to post-closing disputes. Accordingly,while earnouts make sense in pharma or biotech cases where almost all the value of the company depends on future developments and those developments are highly uncertain, earnouts are not necessarily a favored mechanism in other cases. Not only do disputes often arise relating to earnouts, but, as the outcome involves intensive judicial analysis of the factual context and the specific language of the parties' agreement, it is often difficult for buyers to obtain dismissal of earnout claims at the pleading stage of litigation and often difficult to predict what the ultimate outcome of these cases will be. Where earnouts are used, thoughtful, clear, business-contextualized drafting of the earnout provisions is critical.

Earnout Efforts Standards

Under Delaware law, unless the parties provide otherwise, a buyer has no obligation to make efforts to achieve an earnout, but cannot act with the specific purpose of defeating the earnout. If the parties provide that a buyer must use reasonable or best efforts to support achievement of an earnout, the Delaware courts generally have defined that standard-if undefined by the parties-to mean that the buyer must take "all reasonable steps" to support achievement of the earnout.

Parties sometimes define an efforts obligation using an "inward-facing" standard-which requires the buyer to engage in a decision-making process, and to take actions to support achievement of an earnout, that are consistent with the buyer's own (or the seller's) process and actions in connection with its own similar products (or the seller's past development of the product). Alternatively, parties may define an efforts obligation using an "outward-facing" standard, which requires the buyer to engage in a decision-making process, and take actions to support achievement of an earnout, that are consistent with the practices of similarly situated companies with respect to similar products under similar circumstances. In the case of an outward-facing standard, the comparison may be to actual similar companies and their actual actions taken "in the real world" with respect to similar products under similar circumstances (the so-called "yardstick approach"), or the comparison may be to a hypothetical similarly situated company and the actions it would be expected to take with respect to similar products under similar circumstances (the so-called "hypothetical company approach").

The Auris Decision-The Buyer Breached an Inward-Facing Efforts Standard by Causing the Acquired Product to Compete, and then Combine, with Another Buyer Product

In Auris, in a post-trial decision, the court held Johnson & Johnson liable for more than $1 billion in damages to the former stockholders of Auris Health Inc. for breach of J&J's obligations, set forth in the parties' Merger Agreement, to use "commercially reasonable efforts" to achieve an earnout tied to further development of Auris's market-leading surgical robot called "iPlatform."

The Merger Agreement set forth an "inward-facing" definition of "commercially reasonable efforts," based on J&J's own "usual practices" for its "priority medical devices." The Merger Agreement further required that J&J not intentionally act to defeat the earnout, and provided that it could not take into account the cost of any earnout payments when making its decisions.

The court found that J&J breached these obligations-"most blatantly" when, soon after closing, it directed that iPlatform compete head-to-head against J&J's competing product, a surgical robot called Verb, and then directed that iPlatform combine with Verb, all of which resulted in significant disruption of iPlatform's ability to achieve the earnout milestones, as J&J knew it would, according to the court.

Background. Auris, a venture-backed startup, had developed in record time two novel, market-leading surgical robots, "Monarch" (used to diagnose lung cancer) and "iPlatform" (used for laparoscopic and endoscopic procedures). At the same time, J&J was trying to develop a surgical robot, "Verb" (for orthopedic uses), but Verb's progress was seriously stalling. J&J sought to acquire Auris "to solve its problems" with its robotics program. Auris, which was well-funded and had strong prospects, was wary of being acquired, especially by J&J because Verb was a potential competitor of iPlatform. J&J used an earnout to "put together a proposal [Auris] would not refuse." It offered to pay $3.4 billion at closing and another $2.35 billion upon the achievement of certain commercial and regulatory milestones relating to the further development of Monarch and iPlatform. The regulatory milestones were ambitious, but Monarch and iPlatform were on track to meet them. Auris accepted the offer after heavy negotiation of the efforts standard in the merger agreement.

Soon after closing, J&J decided, with respect to iPlatform, that its budget could not support the development of iPlatform and Verb in parallel, so it would have to either "combine the robots or kill one." J&J then "thrust iPlatform into a head-to-head faceoff against Verb," to determine which was "the better bet." Progress toward iPlatform's regulatory milestones ceased while it had to focus on the series of procedures J&J required for the competition with Verb. J&J ultimately decided that iPlatform was the better bet; but then, to salvage its years-long investment in Verb, J&J directed that the Verb hardware and personnel be added to iPlatform. The combination created significant disruption for iPlatform, as it had to spend "countless hours creating engineering and software workarounds" to make the combination work. The combination also led to the departure of the entire legacy iPlatform team (a "devastating loss").

iPlatform then did not meet the milestone events; and J&J did not pay the earnout. The Plaintiff brought suit on behalf of the former Auris stockholders. Vice Chancellor Lori W. Will held that J&J breached its contractual efforts obligations with respect to the earnout as it related to iPlatform (but not to Monarch).

Discussion

The inward-facing efforts obligation in the Merger Agreement was unusually seller-friendly. The Merger Agreement defined "commercially reasonable efforts" as "the expenditure of efforts and resources…consistent with the usual practice of J&J with respect to priority medical device products of similar commercial potential at a similar stage in product lifecycle to the applicable Robotics Products[.]" The court noted that the Merger Agreement provided Auris with "several layers" of protection:

• the inward-facing definition was "doubly advantageous" to Auris, as "[e]fforts to achieve the regulatory milestones [had to] be at the high level J&J-a top company in the industry-set for itself, and for 'priority' devices within J&J";
  
  
• J&J's efforts, expressly, were to be "in furtherance of achieving each of the Regulatory Milestones"-in other words, the court concluded, not in furtherance of J&J's other corporate goals;
  
  
• J&J was specifically prohibited not only from acting "with the intention of avoiding" payment of the earnout, but also from making decisions "based on taking into account the cost of making any Earnout Payment(s)"-which, the court stated, was "more restrictive" language than the typical requirement that a buyer not act "for the purpose of thwarting" an earnout; and
  
  
• the Merger Agreement did not include the typical provision stating that the buyer would have "complete discretion" over decisions relating to the acquired company's business.

The court held that causing iPlatform to compete and then combine with Verb violated J&J's efforts obligation. The court found that the head-to-head competition exercise with Verb caused delays in working toward the regulatory milestones; and that the combination with Verb (which effectively rendered iPlatform "a parts shop for Verb") caused further complications and disruptions for the development of iPlatform. Further, according to the court, J&J knew that the competition and combination with Verb would "hinder, rather than promote, the earnout." Moreover, the court concluded, "J&J viewed the resulting delays as beneficial since it could avoid making the earnout payment." The court wrote: "When J&J's actions put the first iPlatform milestone out of reach, the other milestones fell like dominos." And, the court noted, J&J's actions that impaired iPlatform's development and ability to achieve regulatory milestones "benefitted another [J&J] device-Verb-at iPlatform's expense." Causing iPlatform to compete and combine with Verb was inconsistent with the "priority" treatment the efforts standard required. Thus, causing iPlatorm to compete and combine with Verb, standing alone, was "sufficient to find that J&J breached its efforts obligation," The court wrote: "[A] 'priority' device would not have to endure a costly battle merely to remain operative," nor would it have to "have its system, technology, and team diluted to fix another device's problems."

The court found, in addition, that J&J'streatment of iPlatform was "starkly different" from its treatment of the comparator product. J&J identified only a single similar J&J product that was at the same stage of development-a surgical robot (for orthopedic procedures) called Velys. Velys had been "developed through an MVP strategy starting with simple, buildable functionality and a single indication. It lacked perfect performance statistics before receiving its first FDA clearance in January 2021 and was not superior (or even equivalent) to its market-leading rival upon launch in August 2021. Velys employees were given cash incentives to achieve rapid FDA clearance." J&J's treatment, by contrast, involved: (i) pursuing a more complex regulatory strategy than the MVP strategy (even though the MVP strategy was typically used for priority medical products; the milestones framework in the Merger Agreement appeared to have contemplated use of the MVP strategy; and iPlatform would have been more likely to be able to satisfy the MVP strategy requirements) (ii) a write-down on the books of the value of the milestones, then an announcement that the milestones were "canceled," and then a revision of the targets for iPlatform employee's bonuses to make them different from the milestones in the Merger Agreement-all of which "negatively affected employees' motivation to work towards the iPlatform…regulatory milestones"; (iii) changes to iPlatform's reporting structure, with the operational team to report to a person who had no experience with robotic surgical products; and (iv) after the combination of iPlatform and Verb, significant investment by J&J into the Verb program.

The court rejected J&J's argument that it had discretion under the Merger Agreement to make a "commercially reasonable business decision" to combine iPlatform with Verb in furtherance of its overall robotics program. The court noted that the Merger Agreement did not contain language granting J&J sole discretion over development of iPlatform. Further, the court held that the ten factors listed in the Merger Agreement that J&J could take into account when fulfilling its efforts obligation-such as safety, risks inherent in development and commercialization, likelihood and difficulty of obtaining regulatory approval, and expected profitability-did not give J&J broad discretion with respect to the development of iPlatform. Rather, the court stated, under the Merger Agreement: "J&J could consider [these] various factors in assessing the level of efforts to devote. But the end goal of those efforts was to achieve the iPlatform regulatory milestones-not to further J&J's robotics program."

The court rejected J&J's argument that its efforts devoted to iPlatform were commercially reasonable because iPlatform's funding vastly exceeded that of Velys (or any other medical device program at J&J). J&J invested "over $2.25 billion in the Auris program" over about three years, and purchased a $20 million company to buttress Auris's capabilities. The court viewed it as "an oversimplification to view these funds as furthering the achievement of the iPlatform regulatory milestones." A large proportion of the funds appeared to have been devoted to J&J's robotics program generally, for litigation expenses, and for other items not necessarily related to "furthering the achievement of the iPlatform regulatory milestones."

Other rulings of note. (i) Implied covenant of good faith. The court held that J&J also breached the implied covenant of good faith and fair dealing-on the basis that, when the FDA informed J&J that it would have to pursue a different regulatory pathway for iPlatform than the one that was then being pursued, J&J failed to devote efforts to achieve the revised regulatory pathway.(ii) Fraud. The court held that J&J committed fraud with respect to one of the milestones related to its Monarch robot. The milestone was tied to regulatory clearance by a near-term deadline using a J&J-developed catheter. J&J allegedly had told Auris that this milestone was so certain to be met that J&J viewed the associated milestone payment as upfront consideration, but had not told Auris that J&J was under a regulatory investigation because a patient in a clinical study using the catheter had recently died, which put the milestone in doubt.

Calculation of damages. The Plaintiff sought $2.35 billion in damages, which was the amount of earnout payments not made. The court instead weighted each milestone payment by the parties' estimated probability of its achievement at the time of the merger, utilizing the Plaintiff's expert's averaging of the parties' respective estimates on the probability of achievement. Notably, the court commented that, as a result of the buyer's actions, while Auris's former stockholders could be compensated with a damages award, "what remains irretrievably lost is the transformative potential of Auris's robots."

The Alexion Decision-The Buyer Breached an Outward-Facing Efforts Standard by Terminating the Earnout Product

In Alexion, in a post-trial decision, the court held that Alexion Pharmaceuticals breached its obligation in its Merger Agreement with Syntimmune, Inc. to use commercially reasonable efforts to support achievement of earnout milestones tied to further development of the monoclonal antibody known as ALXN1830 (the "Antibody") for certain illnesses (or "indications").

The Merger Agreement called for an upfront purchase price of $400 million, and an earnout of up to $800 million, payable in installments upon the completion of each of eight milestones. The Merger Agreement defined "Commercially Reasonable Efforts" using an "outward-facing" standard-with the efforts to be measured by what a similarly situated company would do under similar circumstances. The court determined that the outward-facing standard required comparison to the efforts that a hypothetical similar company would have made under similar circumstances; and concluded that such a company would not have terminated the Antibody program.

Background. When Alexion acquired Syntimmune, at least four competitors were developing therapies similar to the Antibody. Alexion believed it could distinguish the Antibody, however, including by being the first to develop a subcutaneous (rather than intravenous) means of administration. The Antibody program encountered problems, however, including contamination of its drug supply and the need to pause ongoing trials due to the COVID-19 pandemic. In April 2020, Alexion publicly announced a new project to demonstrate value to investors-called "10 by 2023," the goal was to launch ten products by 2023. Alexion reallocated a significant portion of the Antibody program's funds to other programs. The Antibody program's funding was not completely removed, but its deprioritization (the "2020 Deprioritization") meant that, a few months later, when Alexion was willing and able resume its Antibody studies (after resolution of the contamination- and pandemic-related problems), it could not do so. Alexion thereafter continued to develop the Antibody, but its development fell behind its competitors' programs.

In July 2021, AstraZeneca acquired Alexion. In connection with the acquisition, AstraZeneca publicly announced that it expected about $500M in recurring merger synergies. Soon after the acquisition, AstraZeneca launched a review of all of Alexion's programs, including the Antibody program. Also at this time, new (but inconclusive) data from an ongoing Phase 1 trial of the Antibody suggested the possibility of certain safety risks. In December 2021, Alexion terminated the Antibody program, citing the potential safety concerns and the resulting expected later entry into the market.

The Plaintiff brought suit on behalf of the former securityholders of Syntimmune, alleging that Alexion failed to use Commercially Reasonable Efforts, as defined in the Merger Agreement, to achieve the earnout milestones. Vice Chancellor Morgan T. Zurn held that Alexion breached its efforts obligation (as well its obligation to make the first milestone payment-$130 million-which, the court concluded, under the terms of the Merger Agreement, had been earned). The court stated that it will determine damages for the contractual breach with respect to the remaining seven earnout payments in a subsequent decision.

Discussion

Alexion's outward-facing efforts obligations. The Merger Agreement defined "Commercially Reasonable Efforts" as:

such efforts and resources typically used by biopharmaceutical companies similar in size and scope to [Alexion] for the development and commercialization of similar products at similar development stages taking into account, as applicable, [the Antibody's] advantages and disadvantages, efficacy, safety, regulatory authority-approved labeling and pricing, the competitiveness in the marketplace, the status as an orphan product, the patent coverage and proprietary position of [the Antibody], the likelihood of development success or Regulatory Approval, the regulatory structure involved, the anticipated profitability of [the Antibody], and other relevant scientific technical and commercial factors typically considered by biopharmaceutical companies similar in size and scope to [Alexion] in connection with such similar products.

The Merger Agreement also provided that: Alexion had "sole discretion" over the development of the Antibody, but subject to its obligation to use Commercially Reasonable Efforts to develop the Antibody; Alexion had "no obligation…to achieve any [milestone] events…that would give rise to an Earn-Out Payment"; Alexion was not required "to act in a manner which would otherwise be contrary to prudent business judgment"; and "the fact that [a milestone] objective is not actually accomplished is not dispositive evidence that [Alexion] did not in fact utilize its Commercially Reasonable Efforts in attempting to accomplish the objective."

The court applied a "hypothetical company approach" to the outward-facing efforts standard. The court acknowledged that the reference in the efforts standard to "biopharmaceutical companies" could refer to "actual existing companies and the efforts and resources they actually used in developing similar products at similar stages." But, the court wrote, "the reference to the efforts and resources the companies 'typically used,' and the 'scientific, technical and commercial factors' they 'typically considered,' call[ed] for a more abstract and aggregated industry standard." Further, the court stated, the yardstick approach was "unworkable" in this case because there were "no adequate exemplar companies, as none of Alexion's competitors operated under the same conditions as Alexion [nor even as one another]." Therefore, the court stated, "[t]he realities of applying the provision call[ed] for a hypothetical company approach." (The court recently reached that same result, for the same reason relating to inherent variation among drug development companies, in Himawan v. Cephalon (Apr. 30, 2024)-discussed briefly below.)

The court analyzed the interrelationship of the provisions in the parties' agreement granting sole discretion to Alexion with respect to the earnout product, but subject to Alexion using reasonable efforts to develop the product. In its recent Himawan decision, the court held that a buyer's sole discretion provision and outward-facing efforts obligation were best interpreted together as meaning that the buyer was obligated to develop the product if doing so was in the buyer's self-interest. In other words, the buyer could not make an uneconomic decision to terminate the product, but could terminate the product if doing so was commercially reasonable. In Alexion, the court held that Alexion's right to sole discretion with respect to development of the Antibody program and its outward-looking efforts obligation together meant that Alexion could not terminate the program based on its own self-interest, but only based on what other similar companies would do in their self-interest under similar circumstances. The court found the efforts standard in Alexion to be "more outward-facing" than the standard in Himawan. The difference, the court stated, is that, the standard in Himawan, although outward-facing, expressly permitted the buyer "to consider its own efforts and cost required for the undertaking," the standard in Alexion did not permit Alexion to consider its own self-interest, only the self-interest of other similar companies. "Alexion's efforts obligation is pegged to typical factors considered by typical companies-not Alexion's own self-interest." Alexion was permitted to "consider anticipated profitability," for example, the court stated, "only insofar as typical companies might typically consider it." Rather than considering its self-interest in determining what is commercially reasonable, Alexion can consider its self-interest only in drawing the upper bound of its commercially reasonable efforts" (because "Alexion's obligation does not require that it act in a manner which would otherwise be contrary to prudent business judgment"). The court's analysis on this important point that was pivotal to the outcome of the case underscores the critical difference that the specific language of the parties' agreement, at a very granular level, can make with respect to the court's interpretation of earnout provisions, including the efforts obligation.

The court concluded that a hypothetical similar company under similar circumstances would not have terminated the Antibody program-and that the program really was terminated due to AstraZeneca's idiosyncratic objectives. The court reviewed "holistically" the factors that Alexion asserted were the basis for the termination, and essentially rejected the validity of Alexion's purported business reasons for the termination (especially noteworthy given that the Merger Agreement granted Alexion sole discretion over development of the Antibody). With respect to Alexion's purported new safety concerns, the court determined that the record evidence showed that the new safety data was inconclusive. Under similar circumstances, the court stated, "[a] hypothetical company using commercially reasonable efforts would respond by gathering further data…-not by terminating the program." With respect to Alexion's purported concerns about the order of entry to market, the court acknowledged that, at the time of the termination, the Antibody was expected to be "fifth overall"; but, the court stressed, Alexion still expected to be first to market for two new indications it was pursuing. With respect to Alexion's consideration of "other advantages and disadvantages" of the Antibody, the court noted the Antibody's advantages in having "strong patent protection until 2036, after its competitors' would have expired"; and in not having the effect of lowering albumin (which would make it appealing to older people and people with kidney problems). Perhaps most importantly, the court also noted that, at the time of the termination, Alexion itself appeared to be still optimistic about the Antibody program and to want to continue it. The court observed that its analysis led to the question why then Alexion terminated the program. The answer, the court stated, was that the "the decision was influenced, motivated by, or driven by AstraZeneca's pursuit of merger synergies."

The court found that Alexion's 2020 Deprioritization of the Antibody program, in this case, did not itself constitute a breach of the efforts obligation. Alexion terminated the Antibody program "because [the Antibody] could not be launched quickly enough to be part of [the 10 by 2023 Goal]." That was "an idiosyncratic corporate initiative" that "[could] not satisfy an outward-facing efforts clause based on the typical efforts of similar companies," the court stated-and, indeed, at that time, Alexion's competitors all were moving forward with, and not deprioritizing, development of their products that competed with the Antibody. Nonetheless, however, the court ruled that the Plaintiff could not obtain a judgment based on the 2020 Deprioritization because it had offered no evidence to establish the extent, if any, to which the delays in development that resulted from the 2020 Deprioritization contributed to Alexion's failure to achieve the milestones (as opposed to other causes known to have caused delay, such as the pandemic).

Practice Points Arising from Auris and Alexion

• Parties should be aware that there is a broad spectrum of earnout provisions. Where the parties end up on the spectrum, in terms of protection for the seller as compared to flexibility for the buyer, in most cases will depend on the parties' respective negotiating leverage. In addition, a buyer's history with earnouts may impact the parties' negotiations.Before a seller enters into an earnout, the seller should check the buyer's history with respect to earnouts.Buyers should be mindful of potential reputational damage, in terms of their ability, in the future, to enter into earnout arrangements and/or obtain desired earnout terms, if they have a problematic history with respect to compliance with their earnout obligations.
  
  
• The court generally will interpret earnout provisions precisely as written. Earnout provisions should be drafted as bespoke provisions, tailored to the specific product, business, company, industry, and situation at hand, in a process involving lawyers and the business people who understand the specific product or business best. Careful, specific, business-contextualized consideration of potential issues that may arise relating to the earnout is critical. Also it , should be made clear how the earnout provisions relate to other provisions of the merger agreement (such as the buyer's level of discretion to run the acquired business post-closing).
  
  
• A buyer should be aware that a provision granting it "sole discretion" to develop the earnout product will generally be viewed as subject to the buyer's specified efforts obligation. The parties may wish to make clear in the agreement how they intend the discretion provision and the efforts standard to interrelate.
  
  
• A seller may want the agreement to expressly state that: (i) the buyer's efforts obligation relates to furthering achievement of the milestones for the earnout product, and not to furthering the buyer's other corporate goals; and (ii) the buyer cannot make decisions on a basis that takes into account the cost of making earnout payments. A buyer may want the contrary language. Also, the parties may wish also to specify, with respect to any list of factors the buyer can take into account in connection with an outward-looking efforts obligation, whether and how the buyer can consider its own "self-interest." For clarity, the parties may wish to specify in the agreement how they intend the efforts standard provided to be interpreted, including examples of hypothetical situations and how the standard would work in those specific circumstances.
  
  
• Parties should consider providing in their agreement any specific actions the buyer (or seller) will be required to make, will not be required to make, or will be prohibited from making, in connection with developing the earnout product. If, for example, the parties have discussed particular actions that they anticipate will have to be taken (or not taken) to ensure or maximize earnout payments, the parties should set them forth in express covenants in the agreement. If there are other specific actions the seller believes the buyer should take in furtherance of the earnout, or other specific flexibility the buyer wants to preserve-particularly with respect to issues that are the most critical to achievement of the earnout or the most likely to be subject to manipulation or dispute-the parties should consider setting them forth in express covenants in their agreement.
  
  
• In selecting between an inward- or outward-facing efforts standard, the parties should consider which comparators would be applicable under each standard-and then consider which standard provides the comparators that comport best with how the buyer intends to proceed or the seller expects the buyer to proceed, as the case may be. If an outward-looking standard is selected, the parties should specify whether the comparison is to be made using a yardstick approach or hypothetical company approach. (Notably, in Alexion and Himawan, the Court of Chancery has stated that there may be no outward-facing comparators for a company developing pharmaceuticals, given inherently unique circumstances at every drug development process company.) If an inward-facing standard is selected, the parties may wish to identify by name particular products that will be used as the comparators-rather than characterizing the comparators (for example, in Auris, "priority products"), which could lead to disputes as to which products meet that characterization.
  
  
• An inward-facing standard may offer a buyer a greater degree of flexibility than an outward-facing standard. First, under an inward-facing standard, depending on the facts and circumstances, a buyer may be able to adjust its efforts for its other products if beneficial for its efforts obligations with respect to the earnout product. Also, particularly where there is a long earnout period, an inward-facing standard may better accommodate unique corporate needs or objectives that may develop over time (i.e., needs that would not necessarily apply to other companies).
  
  
• Before taking actions with respect to, or that may affect, an earnout product, a buyer should review the agreement to determine whether the action is permitted under the efforts standard. Determining whether such actions would violate the efforts standard will require close analysis of the specific language of the earnout provisions and their interrelationship with other merger agreement provisions. As highlighted in Auris, such actions might include, for example: causing the acquired product or business to compete head-on, or to compete, with any of the buyer's existing products; failing to identify and pursue alternative regulatory strategies when others are foreclosed; revising the incentive program for, or making comments that may negatively affect the motivation of, the employees working on the acquired product; changing the reporting structure for the employees working on the acquired product or business (such as by having them report to a person without experience with the specific type of product or business); significantly decreasing the funding or other corporate support for the earnout product; and significantly increasing the investment in other businesses (perhaps, even if significant funding is still being provided for the acquired product or business). As highlighted in Alexion, such actions might include deprioritizing or terminating the acquired product or business.
  
  
• A buyer should monitor compliance with the efforts standard on an ongoing basis during the earnout period. If an inward-facing standard applies, the buyer should monitor the efforts it is making with respect to its own products or businesses that are the comparators, and benchmark its earnout efforts against those efforts. If an outward-facing standard applies, the buyer should monitor the efforts its peers (or other companies that are the comparators) are making, and benchmark its efforts against those efforts.
  
  
• Special issues may arise where the buyer has competing or potentially competing products. The parties should consider how the competing products will be treated in relation to one another with respect to the earnout-and should consider providing explicitly in their agreement how the products will compete and whether they can be combined. Before causing products to compete or combine, a buyer should carefully consider the potential impact on the earnout and whether the action would violate the agreement. In addition to issues relating to competition and/or combination (the issues in Auris), the parties should consider addressing explicitly the issue (not present in Auris) as to the allocation of revenues from the various products or businesses for purposes of any formula relating to calculation of the earnout payments.
  
  
• A post-closing acquisition of a buyer subject to an earnout obligation may create certain complications. Alexion highlights that, if the buyer is acquired, and thereafter the earnout product or business is terminated, the court may be skeptical that the termination was consistent with the earnout-buyer's efforts obligations, rather than having been due to the acquiror's self-interest (such as achieving merger synergies). In addition, an acquiror of a company with earnout obligations should consider whether the target's earnout obligations, which generally will continue to be binding on the earnout-buyer, are consistent with the acquiror's synergy goals and post-closing plans. A seller may wish to consider specifying certain consequences to the earnout in the event of certain acquisitions of the earnout-buyer, such as acceleration of the earnout.
  
  
• Sellers should be careful when commenting on the likelihood of achievement of milestones. Overstating the likelihood of achievement, particularly where the seller has negative information not shared with the buyer, can lead to fraud charges (as occurred in Auris).
  
  
• Parties should be aware that the court may use the parties' negotiating process and internal communications to interpret ambiguous earnout provisions. In Alexion, for example, in determining that the criteria for the first milestone had been satisfied, the court reviewed the full history of the parties' negotiations, as well as internal emails, to determine Alexion's own contemporaneous interpretation of the agreement language. It cannot be emphasized enough that individuals should craft carefully their planning documents and internal communications, including emails, keeping in mind that they may be subject to discovery in the event of litigation. Humor, sarcasm, playing devil's advocate (without stating as much), and ambiguous statements should be avoided, as they could later be misinterpreted.

Other Recent Earnout Decisions

We note the following additional earnout decisions issued recently:

Himawan-Earnout Claims Against a Buyer are Dismissed Based on Outward-Facing Efforts Standard. In Himawan v. Cephalon (Apr. 30, 2024), the Court of Chancery, in a post-trial decision, held that Cephalon, after buying Ception Therapeutics, did not breach its obligation to use "Commercially Reasonable Efforts" to develop Ception's single pharmaceutical product, "RSZ," for use in the treatment of a specific disease called EoE. The Merger Agreement provided for an earnout payment to be made if RSZ received regulatory approval to treat EoE. Cephalon abandoned its attempts to commercialize RSZ for EoE after testing results for its treatment of a different disease showed more promise. The earnout provisions stated that (i) Cephalon had "complete discretion" with respect to the development of RSZ; and (ii) Cephalon's discretion was subject to an obligation to use Commercially Reasonable Efforts to achieve the milestone targets. "Commercially Reasonable Efforts" was defined as "the exercise of such efforts and commitment of such resources by a company with substantially the same resources and expertise as Cephalon, with due regard to the nature of efforts and cost required for the undertaking at stake." The court interpreted the efforts definition to set an objective standard based on "similarly-situated pharmaceutical companies and their actions in the real world" in developing different drugs for EoE. The court determined, however, that this method was unworkable, as "no exemplar companies operate under the actual conditions of [Cephalon]." Rather, the circumstances of companies developing drugs, even if for the same condition, are inherently varied, the court stated. The court held that the best interpretation of the contract was that, "if a reasonable actor [when] faced with the same restraints and risks [with respect to developing RSZ] would go forward in its own self-interest, [Cephalon was] contractually obligated to do the same." The court found that Cephalon's actions were commercially reasonable, as the record at trial established that RSZ was not likely to receive regulatory approval for EoE. See hereour Briefing that discusses the decision in depth.

Beckett-Earnout Claims Against a Buyer Survive Based on Ambiguity in Provisions Relating to Acceleration of Payment and Good Faith Negotiations. In Medal v. Beckett (Aug. 22, 2024), the Court of Chancery, at the pleading stage of litigation, declined to dismiss claims that Beckett Collectibles, by failing to make certain earnout payments, breached the Stock Purchase Agreement pursuant to which it had acquired Due Dilly Trilly ("DDT"). While the decision focused on a number of procedural issues, the court's brief discussion of the substantive earnout claims provides guidance for avoiding ambiguity in provisions relating to (i) the acceleration of earnout payments under specified circumstances and (ii) a requirement that the parties negotiate in good faith to resolve earnout disputes before bringing litigation.The decision highlights that: (i) language providing for payment of "unpaid" earnout amounts under specified circumstances should be clear as to whether the provision calls for acceleration of all of the unpaid earnout payments or just for payment of earnout payments earned but not yet paid; and (ii) language requiring the parties to negotiate or cooperate in good faith to seek to resolve any disputes before bringing litigation may not be enforceable if there is insufficient detail as to how the parties can fulfill the obligation and/or there are indications that the negotiations would be futile. See hereour Briefing that discusses the decision in depth.

Philips-Earnout Claims Against a Buyer Survive Based on Ambiguous Milestone Relating to FDA Approval. In WT Representative v. Philips (Aug. 16, 2024), the Court of Chancery, at the pleading stage, declined to dismiss claims that Philips Holdings USA, which had acquired Vesper Medical, breached the parties' merger agreement when it failed to make a post-closing earnout. The earnout was contingent on Philips' obtaining FDA approval of Vesper's "DUO Venous Stent Systems." While Philips had sole discretion with respect to the FDA approval, it was subject to an "outward-facing" efforts standard and an express obligation not to act in bad faith. Although the earnout provisions included detailed definitions, the court found they were ambiguous as to whether the FDA approval that was obtained-which covered all of the numerous sizes of stents included in the definition of the Systems but one (the narrowest size, which Vesper had ceased to use before the deal with Philips)-was sufficient to trigger the earnout payment. The decision highlights that "outward-facing" post-closing efforts standards relating to achieving the earnout can present difficult practical issues. See hereour Briefing that discusses the decision in depth.

Medtronic-Earnout Claims Against a Buyer are Dismissed Based on Language Prohibiting Only Buyer Actions with the "Primary Purpose" of Defeating the Earnout. In Fortis v. Medtronic Minimed (July 29, 2024), the Court of Chancery, at the pleading stage, dismissed claims against Medtronic for, allegedly, having purposefully defeated a $100 million earnout payment. The merger agreement required that, post-closing, Medtronic not take action with the primary purpose of defeating the earnout.Delaware law generally requires only that a buyer not take action with the specific purpose of defeating an earnout, unless the parties' agreement provides otherwise. The court held that the merger agreement standard in this case imposed an even narrower obligation than under the Delaware law standard-with Medtronic permitted to take actions motivated by defeating the earnout so long as some other purpose was "more central" to Medtronic's decision. The decision thus highlights the need for particular care in drafting a buyer's post-closing obligations with respect to an earnout. In this case, use of the word "primary" rendered the merger agreement standard significantly narrower than the Delaware law standard. We note that the case was unusual in that the merger agreement set forth what the court called an "exceptionally buyer-friendly standard" for the buyer's post-closing obligations with respect to the earnout; and in that, notwithstanding that the standard depended on the buyer's "primary purpose" for its actions, in the court's view the plaintiff did not plead allegations relating to Medtronic's purpose in taking the actions that led to the earnout milestone not being met. See hereour Briefing that discusses the decision in depth.

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Uncertainty on Governance Rights in Stockholders Agreements Continues Pending a Decision in the Appeal of Moelis

Important recent Delaware developments on the issue of the facial validity of governance rights granted by corporations in stockholders agreements have included (i) the issuance by the Court of Chancery of three major decisions (all by Vice Chancellor Laster)-West Palm Beach Firefighters Pension Fund v. Moelis (Feb. 23, 2024); Wagner v. BRP Group (May 28, 2024); and Seavitt v. N-Able, Inc. (July 25, 2024); and (ii) the enactment by the Delaware legislature of amendments to the Delaware General Corporation Law, which became effective August 1, 2024 (the "Amendments").

• Moelis. In the seminal Moelis decision, the court held that extensive governance rights granted by a Delaware corporation in an internal corporate governance agreement (including a stockholders agreement), rather than granted in the corporate charter, were facially invalid, as such rights violated DGCL Section 141(a)'s mandate that the affairs of Delaware corporations be managed by the board of directors (not key stockholders) unless otherwise provided in the corporation's charter.
  
  
• DGCL Amendments. In response to (among other things) Moelis, the Delaware legislature enacted the Amendments, with the express purpose of overriding the result in Moelis, in order to conform the statute to what practitioners asserted was longstanding market practice in granting governance rights in stockholders agreements. The Amendments provide that, "notwithstanding DGCL Section 141(a)," any and all kinds of governance rights can be granted in stockholders agreements, so long as they do not violate the corporate charter nor would violate Delaware law if they were incorporated into the charter. By their terms, the Amendments are applicable prospectively and retrospectively, but they do not apply to the few cases as to which litigation already was pending (or completed) before the August 1, 2024 effective date of the Amendments.
  
  
• Wagner. The Amendments were not applicable in Wagner because the litigation was already pending before August 1, 2024. The court held that, even without the benefit of the Amendments, many of the governance rights granted in the stockholders agreement at issue did not violate DGCL Section 141(a)-because the parties had adopted a novel corporate governance mechanism that effectively returned power to the board over the corporate actions with respect to which the stockholders rights had been granted. Further, however, the court found that some of the rights, separately, violated other specific sections of the DGCL and on that basis were facially invalid.
  
  
• Seavitt. The Amendments were not applicable in Seavitt because the litigation was already pending before August 1, 2024. The court held that many of the rights granted in the stockholders agreement at issue were facially invalid as they violated DGCL Section 141(a). The court held, further, however, that many of the rights were facially invalid, separately, on the basis that they violated specific sections of the DGCL other than Section 141(a) and/or violated provisions of the corporation's charter. For example, the court held that the pre-approval right over mergers violated the "order of operations" set forth in DGCL Section 151 (which required, first, approval by the board and, then, approval by the corporation's stockholders); and the right to set the size of the board violated the authority of the board to set board size under the corporation's charter.

Key Points

• Wagner and Seavitt raise an important question about the court's potential interpretation of the Amendments going forward. The court stressed in Wagner and Seavitt that it was applying "the old law"-and not offering any opinion as to what the result would be if the Amendments had been applicable in these cases. However, the court's findings in both cases that, irrespective of the validity of certain governance rights under Section 141(a), separately, they were also invalid under other sections of the DGCL raises an important question. In future cases, where the Amendments are applicable, will the court interpret the Amendments as effectively overruling Moelis, Wagner and Seavitt-because the Amendments broadly authorize the granting of governance rights in stockholders agreements? Or, alternatively, will the court, notwithstanding the Amendments, still find certain governance rights in stockholders agreements to be facially invalid-because they violate sections of the DGCL other than Section 141(a) or violate the corporate charter, and the Amendments authorize governance rights in stockholders agreements "notwithstanding Section 141(a)" so long as they do not violate the corporate charter nor would violate Delaware law if included in the charter? Put differently, the question arises whether it would violate Delaware law to include in a corporate charter a governance right that violates a specific section of the DGCL? If so, the court may find in future cases, notwithstanding the Amendments, that many governance rights granted in stockholders agreements are facially invalid. We would note that, arguably, such result would be inapt as it would render the Amendments largely meaningless and contradict the legislative history and purpose. Further certainty awaits the decision on the pending appeal in Moelis,thepossible appeal of Wagner or Seavitt, further judicial interpretation of Wagner and Seavitt, future decisions interpreting the Amendments, and the evolution of corporate practices and norms.
  
  
• In Seavitt, the court stressed the board's "gatekeeper role" where the DGCL establishes an "order of operations" requiring board action first. Where the DGCL establishes an order of operations-requiring, for example, first, approval by the board and then approval by the corporation's stockholders-that order is "fixed," the court stated, and it establishes an important "gatekeeper role" for the board. A pre-approval right granted to key stockholders in a stockholders agreement, for example with respect to mergers, "usurps" the board's gatekeeper role by "putting [the key stockholders] at the head of the line" before the board in making a decision about a merger.
  
  
• In Seavitt, the court found that the following rights granted in the stockholders agreement at issue violated sections of the DGCL other than Section 141(a) and/or violated the corporation's charter:
  
  
  • Mergers. The court found that a pre-approval right over change-in-control transactions (including mergers) violated the order of operations set forth in Sections 251 and 272. A "two-step process" was required for approval of such transactions-"First, the board of directors must initiate the process and recommend the transaction to stockholders. Only then can the stockholders vote to approve the transaction…."
    
    
  • Voluntary liquidation or dissolution. The court found that a pre-approval right over voluntary liquidation or dissolution of the corporation violated the order of operations set forth in Sections 275(a) and (b).
    
    
  • Filling vacancies. The court found that a right to require the board to fill vacancies in seats occupied by designees of the key stockholders with other designees of the key stockholders violated Section 223(a), which provides that the board has the exclusive right to fill board vacancies.
    
    
  • Committee representation. The court found that a right to require the board to include at least one of the key stockholders' designees on each committee violated Section 141(c)(2), which empowers the board to create committees and select the members.
    
    
  • Removal of classified director. The court found that a right to remove directors from the corporation's classified board, with or without cause, so long as the key stockholders held at least 30% of the company's voting shares, violated Section 141(k), which permits removal of a director from a classified board only for cause, and only with the approval of a majority of the shares entitled to vote for directors.
    
    
  • Board size. The court found that a right to set the size of the board violated the corporation's charter, which stated that the board would determine the number of directors.
    
    
• In Wagner, the court found that the following rights granted in the stockholders agreement at issue violated sections of the DGCL other than Section 141(a) and/or violated the corporation's charter:
  
  
  • Charter amendments.The court found that a pre-approval right over charter amendments violated the order of operations set forth in Section 242.
    
    
  • Hiring or removing senior officers. The court found that a pre-approval right over actions affecting a senior officer violated Sections 142(b) and (e), which provides that officers shall be chosen and vacancies filled as set forth in the bylaws or determined by the board.

Practice Points

• A corporation granting governance rights in a stockholders agreement should carefully tailor each right to maximize the potential that the court would find it facially valid. Pending further developments on the topic, this effort will require careful analysis, with legal counsel, of (i) all potentially applicable sections of the DGCL, (ii) the company's charter and bylaw provisions, and (iii) the structure of the rights. We note that many of the rights the court found invalid in Wagner and Seavitt would have been valid, the court seemed to indicate in Wagner, if, rather than having been structured as pre-approval rights, they had required the stockholder party's approval to come after the statutorily-required approvals by the corporation's board and its stockholders. Tailoring rights granted to stockholders, to seek to ensure compliance with the DGCL, should be an ongoing process that takes into account the Amendments; the court's holdings and discussion in Wagner and Seavitt; any further judicial or legislative developments in this area; and the evolution of market practices and norms.
  
  
• Continued uncertainty is to be expected.Notwithstanding the Amendments, based on (i) Wagner and Seavitt, (ii) some arguably ambiguous drafting in the Amendments, and (iii) possible fiduciary issues, we expect continued uncertainty as to the validity of governance rights granted in stockholders agreements. Thus, a board still should consider granting any significant governance rights in the charter, or in a "golden share" of preferred stock (if blank-check preferred shares are authorized), to the extent possible.This should be readily accomplished in the context of a company about to go public. Amendment of the charter of an already-public company to provide such rights, however, presents logistical issues in terms of obtaining the necessary stockholder approval; possible fiduciary duty issues related to justifying a grant of rights in a post-IPO context; and, if changes are later desired, the need to obtain stockholder approval at that time to amend the charter. All of these considerations will be affected by the Delaware Supreme Court's decision in the Moelis appeal.
  
  
• Consider structuring governance rights as post-approval (rather than pre-approval) rights where the DGCL establishes an "order of operations" requiring approval by the board first, to be followed by approval of the stockholders. Where the DGCL sets forth an order of operations for board and stockholders' approval for an action, a company should consider, in lieu of granting key stockholders' a pre-approval right for such action, granting instead a right to approve that follows any statutorily-required board and stockholder approvals. We expect it should be permissible in this situation, and, depending on the circumstances it may be desirable, to provide also that the stockholder, if requested, would, at the outset of the process, provide to the company an indication as to whether the stockholder would intend, absent changed circumstances, to provide its consent after the board and stockholder approvals are obtained.
  
  
• Consider amending the bylaws so that governance rights granted do not conflict with them. In Wagner, the court held that a stockholder's pre-approval right for actions affecting senior corporate officers violated DGCL Section 142, which provides that certain key actions relating to officers (such as their hiring and firing) can be taken as set forth in the company's bylaws or as determined by the board. The court emphasized that the company's bylaws did not authorize a contractual counterparty to control the hiring and firing of the company's senior officers. Thus, with respect to any governance rights as to which the DGCL permits actions to be taken "as prescribed by the bylaws or determined by the board," a board should consider providing in the bylaws that such actions can be taken as set forth in any stockholders agreement the company has and/or may enter into. (We note, however, that, in Wagner, the court injected an element of doubt with respect to this approach, stating that the court was not addressing whether "the Charter or the Bylaws couldempower a contractual counterparty to control [such matters relating to senior officers], because nothing in the Charter or Bylaws [in this case] purports to allow it.")
  
  
• A charter provision opting out of the Amendments should be specific. The Amendments apply by default to all Delaware corporations, but a corporation can opt out of the applicability, either in whole or with respect to specific issues. In Seavitt, the court found that the Lead Investors' right in the Stockholders Agreement to set the size of the board was invalid because it conflicted with N-Able's charter, which stated that the board had the exclusive right to determine the size of the board. Notably, in a footnote, the court wrote: "It is interesting to ponder whether, under the [Amendments], the Charter is sufficiently specific to override Section 122(18) [(i.e., to opt out of the Amendments)] for purposes of the Size Requirement." The court stated that it could offer no viewpoint on the issue as the Amendments were not applicable in this case. The court's comment, however, indicates that, to seek to ensure that a charter provision opting out of the Amendments will be effective, it should be sufficiently specific.

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Chancery Holds, for the First Time, that Substantive Contract Provisions in Private Agreements Cannot be Incorporated by Reference into a Delaware Corporation's Charter

Corporations commonly have incorporated by reference agreements or provisions of agreements into the company's charter, relying on DGCL Section 102(d), which permits charter provisions to be "made dependent upon facts ascertainable" outside the charter. In Seavitt v. N-Able (July 25, 2024) (also discussed in the article above), the Court of Chancery, acknowledging that no previous case had addressed "whether a charter can incorporate a private contract by reference," held that it cannot.

In Seavitt, N-Able, Inc., in connection with its spin-off from SolarWinds Corporation, entered into a Stockholders Agreement granting governance rights to certain "Lead Investors." N-Able's charter included certain governance provisions that stated they were "subject to" the Lead Investors' governance rights provided in the Stockholders Agreement. The court held that the incorporation by reference was invalid.

The court acknowledged that, given the enactment of the 2024 Amendments to the DGCL (effective as of August 1, 2024), it will no longer be relevant whether governance rights granted in stockholders agreements can be incorporated by reference into a charter to satisfy DGCL Section 141(a). (See the article above.) We note that the Seavitt holding on incorporation by reference will be relevant in other contexts, however.

The court reasoned in Seavitt that "introduc[ing] the DNA of a purely private agreement into [a charter, which is] a foundational and public document" is problematic because the parties to an agreement can amend the agreement without a stockholder vote, which would then automatically amend the charter's substantive terms without the stockholders' approval that the DGCL requires for charter amendments.

The court reasoned, further, that "substantive agreement provisions" are not "facts ascertainable" because they are not "facts" within the meaning of that term as used in the DGCL. "Facts ascertainable," the court stated, refers to things like "the occurrence of any event" or "a determination or action by any person or body." Thus, the court stated, facts such as the identity of parties to a private agreement, or whether an agreement was breached, or the definition of "affiliate" under the federal securities laws, would be facts ascertainable and could be incorporated reference. However, the court stated, substantive contractual rights and obligations of parties under a private agreement should not be elevated to the status of charter provisions simply by reference to the private agreement.

The court noted that, although the DGCL does not require private agreements to be publicly available, the federal securities laws require that some private agreements be publicly filed-thus, in those cases, the terms of the agreement would be publicly available. Nonetheless, the court stated, the public filing of some agreements does not affect the court's interpretation of the DGCL as it applies to all Delaware corporations. Therefore, the court rejected excepting from its holding private agreements that are publicly available.

Pending further developments on the issue of incorporation by reference-which could include an appeal of Seavitt, future judicial interpretation of Seavitt, and/or legislation-drafters of new charters should consider carefully any references to external agreements or other sources. If incorporation by reference to a private agreement is desired, the drafter should analyze, with respect to each such reference, whether it involves a "fact ascertainable" or, instead, a "substantive provision." If the latter, the company should consider setting forth the full provision in the charter (or foregoing inclusion in the charter). Companies with existing charters that incorporate by reference provisions in private agreements should be prepared for challenges to their enforceability (and could consider amending the charter, but amendment may be impractical in many situations given the need for stockholder approval and possible fiduciary issues).

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Lessons on Law Firm Legal Opinions from Chancery's Recent Boardwalk Decision on Remand

The Court of Chancery's most recent decision in Bandera Master Fund LP v. Boardwalk Pipeline Partners LP (Sept. 9, 2024) offers important lessons for law firms and their clients with respect to the issuance of law firm legal opinions. (See "Practice Points on Legal Opinions" below.)

Background. The Partnership Agreement of a public limited partnership that owned and operated natural gas pipelines (the "Company") granted the General Partner the right (the "Call Right") to buy the Company's publicly traded limited partnership units under certain circumstances. The Company was controlled by the General Partner; the General Partner was controlled by its general partner (the "GPGP"); the GPGP (a sole member limited liability company) was controlled by its sole member (the "Sole Member"); the Sole Member was controlled by a public corporation (the "Controller").

The Partnership Agreement provided that exercise of the Call Right was subject to satisfaction of an "Opinion Condition" and an "Acceptability Condition." The "Opinion Condition" required that the General Partner receive a law firm opinion (an "Opinion of Counsel") concluding that the Company's status as a non-taxable partnership had, or would reasonably likely in the future have, a material adverse effect ("MAE") on "the maximum applicable rate that can be charged to customers." The Acceptability Condition required that the General Partner determine that the Opinion of Counsel was acceptable. The Partnership Agreement also provided that, if the General Partner reasonably relied on an expert, the General Partner would be entitled to a conclusive presumption of good faith and would be exculpated for any action taken in good faith.

The General Partner obtained an Opinion of Counsel from a well-reputed, nationally-recognized outside law firm with expertise in the pipeline industry. The law firm opined that there likely would be an MAE as stated in the Opinion Condition, based on new regulations recently proposed by the Federal Energy Regulatory Commission. The General Partner determined that the Opinion of Counsel was acceptable, following which it exercised the Call Right. The exercise, in 2018, occurred during a four-month period of substantial uncertainty about (i) whether FERC would adopt the proposed regulations or, in response to strong lobbying from the industry, would significantly change them, and (ii) what FERC would decide about how to treat accumulated deferred income tax (ADIT) (which would significantly effect rates)).

Certain limited partners of the Company brought suit claiming that the General Partner's exercise of the Call Right breached the Partnership Agreement. They claimed that the Opinion Condition was not satisfied because the Opinion of Counsel was "delivered in bad faith"; and the Acceptability Condition was not satisfied because the acceptability determination was made by "the wrong General Partner decision-maker."

The Courts' Decisions

Court of Chancery's 2021 post-trial opinion.Following trial, the Court of Chancery agreed that neither the Opinion Condition nor the Acceptability Opinion was satisfied. Vice Chancellor Laster concluded that (i) the Opinion of Counsel was delivered in bad faith, having been "contrived" by the lawyers issuing it to reach the legal conclusion the General Partner wanted; and (ii) the acceptability determination should not have been made by the GPGP's Sole Member (which was controlled by the Controller) but by the GPGP's board of directors (which included independent directors, as required under the federal securities laws). The court awarded the plaintiffs damages of $690 million.

The Delaware Supreme Court's 2022 reversal.On appeal, the Supreme Court focused on the Acceptability Condition and held that it was satisfied (as the Sole Member was an appropriate decider for the General Partner as to acceptability of the Opinion of Counsel). The Supreme Court held, further, that the General Partner properly relied on the advice of a second law firm that it was reasonable for the General Partner to rely on the Opinion of Counsel. Therefore, the Supreme Court concluded, under the terms of the Partnership Agreement, the General Partner was entitled to a conclusive presumption of good faith, which effectively exculpated it from liability for damages. The case was remanded to the Court of Chancery for further proceedings consistent with the Supreme Court's rulings. Of note, in a concurring opinion, two of the Supreme Court justices stated that they "would have gone further" and reversed the lower court's holding that the Opinion Condition was not satisfied. The concurring justices expressed concern that that holding-which they viewed as having involved a "de novo review" and judicial second-guessing of the substantive correctness of the law firm's conclusions in the Opinion of Counsel-had the potential "to fundamentally alter the legal environment in which opinions of counsel are prepared."

The Court of Chancery's Sept. 9, 2024 decision on remand.In this most recent decision, Vice Chancellor Laster dismissed the case. First, the Vice Chancellor concluded that the Supreme Court's reversal of the lower court's decision on satisfaction of the Acceptability Condition did notaffect the lower court's separate holding that the Opinion Condition was not satisfied. The Vice Chancellor then reviewed the arguments the parties made on appeal regarding the Opinion Condition-stating that the analysis might be helpful if this new decision is appealed. The Vice Chancellor concluded again that the Opinion Condition was not satisfied; and, therefore, notwithstanding the Supreme Court's decision, that the General Partner's exercise of the Call Right breached the Partnership Agreement.

Discussion

The Court of Chancery's determination that the Opinion of Counsel was delivered in bad faith involved a "holistic" analysis. The court noted the following factors ("so many factors pointing in the same direction,"the court wrote):

• Counterfactual assumptions and facts. The Opinion of Counsel included assumptions, and asserted facts, that were contrary to the "real-world facts" the law firm and its client knew of and acknowledged-which, the court stated, supported a conclusion that the law firm "could not have believed in good faith" the conclusions reached. The law firm opined that non-final actions FERC had taken likely would have an MAE on recourse rates, but, according to the court, "[in] fact, [they] knew the opposite was true: Recourse rates were unlikely to change at all, and no one could determine whether or not they would change without knowing how FERC would treat ADIT balances." The court wrote: "If a law firm can claim that a material adverse effect on recourse rates is likely when everyone knows the opposite is true, then an opinion becomes a blank check."
  
  
• Unstated interpretation of ambiguous term. The term "recourse rates" was not defined in the Opinion Condition, nor elsewhere in the Partnership Agreement or relevant statutes and regulations. The Opinion of Counsel interpreted the term as meaning the same thing as "hypothetical indicative rates." That may have been a reasonable interpretation, the court stated, but the Opinion of Counsel stated that it considered recourse rates, when it had "actually considered hypothetical indicative rates and made the unexpressed assumption that the two were the same." The court cited as a "significant factor" in its bad faith determination "the unstated counterfactual assumption [in the Opinion of Counsel] that indicative rates were the same as recourse rates."
  
  
• "Unexplained" opinion. The Opinion of Counsel was an "unexplained" (or "clean") opinion-i.e., one that sets forth legal conclusions without setting forth the legal analysis supporting the conclusions. (By contrast, an "explained" (or "reasoned") opinion sets forth the legal analysis, or a summary thereof, that supports the legal conclusions, usually, the court stated, with citations to cases or statutes.) The court stated that delivery of an unexplained opinion on "a complex and difficult issue"-at least in the context of the other negative factors relating to the opinion-ws inappropriate and "sent a negative signal about [the law firm]'s mindset," supported a conclusion that the law firm had "reached" for the legal conclusions it made. The court wrote: "All else equal, someone who has reached for a result will not want their analysis out in the open and subject to criticism."
  
  
• Additional factors. The court stated the following additional factors as supporting its bad faith finding: the law firm delivering the Opinion of Counsel was a non-Delaware law firm opining on complex issues of Delaware law that Delaware law firms had declined to address; the law firm resolved in its client's favor all of the "many issues" that needed to be resolved to reach the legal conclusion that was reached; in the court's view, the lawyers involved provided inconsistent testimony at trial, had not been "candid" with other law firms when seeking advice with respect to the Opinion of Counsel, and appeared to have succumbed to pressure from their client to reach the legal conclusion that was reached; and the lawyers departed from their own firm opinion committee's practices (such as by delivering a "Preliminary Opinion" without the firm chairman's signoff). The General Partner, in the appeal to the Supreme Court, criticized the Court of Chancery for having "impugned the integrity and good faith" of the many big-firm lawyers involved in issuing, or advising with respect to, the Opinion of Counsel. The court responded in its remand decision: "[T]op-flight lawyers at big law firms are human, just like the rest of us"; they "are subject to the same pressures and cognitive biases as other humans, and perhaps especially so"; and they "can get themselves into messes," including acting in bad faith in delivering legal opinions.

Practice Points on Legal Opinions

We note the following practice points on legal opinions, arising from the decision on remand:

• Law firms should deliver explained opinions when complex or difficult issues are involved. The court indicated that explained opinions are appropriate when dealing with "issues involving legal uncertainties due to the nature of the process (e.g., bankruptcy), conflicting authority or perhaps lack of authority." The court stressed that unexplained opinions "are inappropriate for complex and difficult issues."
  
  
• Non-Delaware law firms should not issue opinions on complex issues of Delaware law. The court acknowledged the common practice of-and had no issue with-non-Delaware law firms "thinking about or advising on issues of Delaware law" or "rendering opinions on straightforward issues of Delaware law." However, the court emphasized, non-Delaware law firms do not generally, and should not, render "formal opinions" on "complex issues of Delaware law."
  
  
• In addition, law firms issuing legal opinions should: be extra cautious about reaching legal conclusions that other firms have rejected or refused to address; not make assumptions or assert facts in the opinion that "contradict real-world facts"; and state how any ambiguous terms have been interpreted for purposes of the legal opinion. We would note, also, the court's practice in recent years of calling out, in the opinions it issues, law firms and lawyers (and others) by name and detailing the problematic conduct, even if the court determines there is no legal liability.

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2024 Proxy Season Developments

Key developments from the 2024 proxy season included the following:

• Continued increase in stockholder proposals. The number of stockholder proposals increased, with more proposals in 2024 than the record number in 2023. Almost 60% of S&P 500 companies received at least one stockholder proposal.
  
  
• Increase in no-action relief. The number of no-action requests increased significantly, and the SEC granted double the number of requests as compared to 2023.
  
  
• Continued increase in support of governance proposals. More than double the number of governance proposals received majority stockholder support in 2024 as compared to 2023. A substantial number of governance proposals related to removal of directors who had failed to receive a majority favorable vote of stockholders but still remained on the board.
  
  
• Continued low support for environmental/social proposals. Proposals on environmental and social issues continued to receive low levels of stockholder support.
  
  
• Continued momentum for the anti-ESG movement.Although anti-ESG proposals continued to receive very low levels of support from stockholders, the number of proposals increased. At the same time, substantial anti-ESG political and legislative efforts have continued.
  
  
• Focus on labor. There was an increase in activist campaigns relating to workers' rights (with labor unions heavily involved); and labor unions and institutional investors made, and saw some success with, shareholder proposals to enhance workers' rights.
  
  
• More new activists. Roughly a third of public and private activism is now being driven by first-time activists.
  
  
• Decrease in first-time directors from underrepresented minority groups; increase in female directors. The number of first-time directors from underrepresented minority groups declined from last year (36% in 2024 compared to 46% in 202 for S&P 500 companies). The percentage of companies with three or more female directors has increased significantly in recent years, however-for S&P companies, 86% of companies, up from 47% in 2018; and for Russell 3000 companies, 54% of companies, up from 18% in 2018. There has also been an increase in the percentage of first-time directors who are female-for S&P companies, 56% of first-time directors are women, up from 25% in 2013.

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Other Developments of Note

Minority Investors in an LLC Should Seek to Ensure the LLC Agreement's Amendment Provision Expressly Applies to Amendments Effected by a Merger -Campus Eye

In Campus Eye Management Holdings, LLC v. DiDonato (Aug. 30, 2024), the Court of Chancery held that an LLC Agreement amendment that was adopted in connection with a merger was valid and enforceable, notwithstanding that the LLC Agreement required a different vote to adopt amendments which was not was not attainable under the circumstances. The purpose of the amendment in this case was to remove a person as the manager of the LLC without his consent, although the LLC agreement provided that the agreement could be amended only by the manager with the members' consent.

The case involved the sale by Dr. DiDonato of a majority interest in his optometry business to a private equity buyer (the "Buyer"). As part of the sale, the business was restructured into a parent company and wholly-owned subsidiary, with DiDonato retaining a 35% in the parent and one of the three parent-level board seats, and the buyer obtaining a 65% interest in the parent and appointing the other two board members (the "Buyer Directors"). The subsidiary's LLC agreement named DiDonato as the subsidiary's initial manager. Soon after the closing, the Buyer Directors, without involving DiDonato, tried to amend the subsidiary's LLC agreement to change the subsidiary to a member-managed LLC rather than a manager-managed LLC (which would effectively remove DiDonato as manager). DiDonato brought suit; and, in an earlier decision in the case (issued Jan. 31, 2024), the Court of Chancery held that the amendment was ineffective, as the LLC agreement provided that it could be amended "by the manager with the consent of all members," but the Buyer Directors had not involved him in the amendment.

The same day that decision was issued, the Buyer Directors, pivoting to a new strategy, caused the parent to merge the subsidiary with a newly formed entity. In doing so, they amended the subsidiary's LLC agreement to make it member-managed rather than management-managed-and, as such, DiDonato was removed as manager. DiDonato contended that the Buyer Directors were not entitled to remove him as manager as a matter of contract, statute and equity. Vice Chancellor Lori W. Will held, however, that (i) the LLC Agreement did not prohibit the merger; (ii) the Delaware Limited Liability Company Act ("LLC Act") expressly permits amendment of an LLC agreement by merger unless the agreement expressly provides that amendment by merger will not be effective (which this LLC agreement did not); and (iii) DiDonato was owed no fiduciary duty to remain manager. "He must accept the bargain he struck in selling control," the court stated.

Campus Eye underscores the importance for investors in LLCs and drafters of LLC agreements to understand the default provisions of the LLC Act. As stated in Campus Eye, "If an LLC agreement lacks an applicable provision, and does not foreclose the application of a default rule, then the statutory provision fills the void and resolves the matter." The case highlights that minority investors in LLCs should seek to ensure that the amendment provision of the LLC agreement expressly states that the requirements set forth in that provision (such as requiring consent of the manager for amendments) apply to amendments accomplished in connection with a merger.

Federal District Court Decision Presents Roadblock for Anti-ESG Movement-SIFMA v. Ashcroft

On August 14, 2024, a U.S. District Court in Missouri held, in Securities Industry and Financial Markets Assn. v. Ashcroft, that "anti-ESG" rules adopted by Missouri were invalid, on the basis that they were preempted by federal law, violated the First Amendment of the U.S. Constitution, and were unconstitutionally vague. Missouri's rules were similar to those adopted by many states to regulate borker-dealers' and investment advisers' ESG-related decisions and advice-thus, the federal court's analysis (unless appealed and overruled) is likely applicable to anti-ESG rules adopted in other states. As a result, going forward, anti-ESG advocates may seek more limited state regulations and/or shift their focus to federal legislation.

The Missouri rules, which had been effective since July 2023, provided that broker dealers and investment advisers had to disclose to their customers, and use state-mandated (or substantially similar) language to obtain their customers' written consent for, any investment decisions or advice that "incorporates a social objective or other nonfinancial objective." The rules imposed significant civil and criminal penalties for violations. The District Court granted summary judgment and issued a permanent injunction barring enforcement of the Missouri rules. The decision has been appealed to the Court of Appeals for the Eighth Circuit.

Inadvertent HSR Violation Leads to $1M Settlement Payable by GameStop's CEO Relating to His Purchases of Less than 10% of Wells Fargo Stock

The FTC announced on September 18, 2024 that it had reached a settlement with Ryan Cohen, who is an investor and the CEO of GameStop, in connection with his open-market purchases of Wells Fargo shares without having filed a required notice under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.

While the HSR Act is most often thought of as requiring pre-merger notifications, it also requires a notice and waiting period before closing a proposed stock acquisition (or joint venture or certain exclusive licenses) if the applicable dollar thresholds are met and no exemptions apply. In this case, Cohen acquired Wells Fargo shares between March 2018 and September 2020 that, in the aggregate, represented less than 10% of Wells Fargo's shares, but that exceeded the HSR Act's reporting thresholds. The FTC determined that the exemption for acquisitions made "for investment purposes only" did not apply.

That exemption applies only when, at the time the purchases were made, the holder had "no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer." In finding that the exemption did not apply, the FTC noted that, around the time of the purchases, and periodically for about two years thereafter, Cohen communicated with Wells Fargo's leadership, seeking a board seat at the company and making general comments about possible improvements of the company's business. The FTC cited an email from Cohen to Wells Fargo's CEO in which Cohen touted "the contributions he could make to Wells Fargo should he become a member of the Board of Directors" and suggested "how Wells Fargo could improve its operations, such as improving its technology and mobile app."

The FTC acknowledged that Cohen's failure to make the required HSR filing was "inadvertent," and that Cohen had filed a "corrective" HSR notification. However, the FTC determined that Cohen's failure to be aware of the HSR Act's legal requirements was not "excusable negligence" because large-scale open market acquisitions, as his were, "require an acquirer to affirmatively and actively decided to acquire voting securities."

In the settlement, Cohen has agreed to pay $985,320 for a continuous violation of the HSR Act from the time of his purchases (March 2018) through the expiration of the waiting period on his corrective filing (February 2021). As the maximum civil penalty for an HSR violation at the time of his purchases was set at $43,792 per day of noncompliance, the settlement amount is far less than the maximum penalty that would have been permissible. The FTC explained that result on the basis that Cohen's failure was inadvertent and that he cooperated in reaching a settlement rather than insisting on resolution of the matter through an investigation and litigation.

The result in this case serves as a reminder of the broad reach of the HSR Act (including, potentially, purchases by an individual of shares representing less than 10% of a company's stock); the generally narrow application of the investment-only exemption (which, depending on the circumstances, is rendered inapplicable by conduct such as requests for a board seat and suggestions for improving the company); and the very high potential penalties associated with HSR non-compliance (even by individuals and unrelated to mergers or transactions raising potential competitive concerns).

CFIUS Assesses Its Largest Penalty to Date, and for the First Time Discloses the Name of the Target of an Enforcement Action

On August 14, 2024, the Committee on Foreign Investment in the US (CFIUS) disclosed that it had imposed a $60 million penalty against T-Mobile US in connection with data access issues following T-Mobile's 2020 merger with Sprint-the largest penalty by far that CFIUS has ever assessed. Also of note, this is the only penalty action by CFIUS in which it has identified the target of the action by name.

CFIUS had approved the merger, subject to a national security agreement between T-Mobile and the US government for the purpose of mitigating the perceived national security risks posed by the merger. CFIUS stated that T-Mobile violated a material provision of the agreement by failing to take appropriate measures to prevent unauthorized access to certain sensitive data and failing to report promptly to CFIUS some incidences of unauthorized access.

Chancery Decision Offers LLC Agreement Drafting Lessons on Purchase Price Escrow and "Customary" Representations -Seva v. Octo

The key issue in Seva Holdings Inc. v. Octo Platform Equity Holdings, LLC (Aug. 29, 2024) was whether Delaware's so-called "absolute litigation privilege" applies to the repurchase, pursuant to an LLC Agreement, of a member's interests in a Delaware LLC. The privilege is an affirmative defense that bars claims arising from statements made in the course of a judicial proceeding (such as, in this case, claims of disparagement that allegedly violate the non-disparagement clause set forth in a corporate officer's employment agreement). The Court of Chancery ruled that, while the protection of the privilege extends to contractual non-disparagement claims, it does not operate to nullify the repurchase of a member's interests where allegedly defamatory statements made during judicial proceedings triggered a right of the LLC, under the LLC Agreement, to repurchase the member's interests in the event he disparaged the company.

Separately-and of interest to drafters of the LLC Agreements-Seva also claimed that Octo's repurchase of the LLC interests was invalid due to Octo's alleged violation of the procedures, set out in Section 8.7 of the LLC Agreement, for effecting the repurchase right. Judge Paul R. Wallace (sitting by designation on the Court of Chancery) denied summary judgment on those claims, finding that the LLC Agreement provisions were ambiguous and holding that the most reasonable interpretation could be decided only at trial.

Whether the repurchase payment had to be made via delivery of a Repurchase Note or by cash in escrow. Section 8.7(i) provided that, at closing, after making certain offsetting and additive payments, the "Company shall pay…by delivery of a Repurchase Note for the balance of the Repurchase Price, if any." Section 8.7(iii) provided that if the "Repurchase Holder shall fail to appear at the closing…or shall otherwise fail to comply with its obligations under the [LLC Agreement], the Company may thereupon place an amount of, equal to the amount of the purchase price to be paid for the Membership interests in escrow for the applicable Repurchase Holder." Octo had placed its Repurchase Note in escrow. The plaintiff argued that, under Section 8.7(i) and (iii), that did not satisfy the payment delivery conditions, as these sections required that Octo place the amount of the purchase price in cash in escrow. The court found the provision ambiguous "at a minimum."

On the one hand, the court stated, subsections (i) and (iii) could be read to be notdisjunctive-that is, both payment methods (delivery of the Repurchase Note or cash in escrow) were acceptable means of payment. The court noted that the language under subsection (i) was mandatory ("shall pay…by delivery of a Repurchase Note"), while the language under subsection (iii) was permissive (if the Company fails to perform its obligations under the Agreement, the defendant "may thereupon place an amount of, equal to the amount of the purchase price to be paid for the Membership interests in escrow…"). Section 8.7(d)(iii) could be reasonably interpreted, the court stated, as "providing for a non-mutually exclusive option to place an equivalent amount in cash in escrow in the event [the plaintiff] fail[ed] to perform its obligations." There was no clear language clarifying whether depositing into an escrow "an equivalent amount in cash [was] the only option or whether holding onto the Repurchase Note until its execution satisfie[d] Section 8.7(d)(iii)'s so-called escrow requirement."

On the other hand, the court reasoned, these provisions also could reasonably be read to be disjunctive. "The requirement to pay by delivery of the Repurchase Note was the requirement at closing, whereas the requirement to place an amount in escrow was the requirement that governed in the event that the Repurchase Holder failed to comply with its obligations under the LLC Agreement." The court noted that, in the latter scenario, "the added benefit to Octo of treating the interests as cancelled may therefore have imposed a corresponding burden of putting the equivalent value of the Repurchase Note in escrow." The court stated that it could only be established at trial which interpretation was more reasonable.

Whether the repurchase agreement Octo provided was "customary." Seva argued that Octo had impermissibly conditioned the repurchase on a general release of claims by Seva. Section 8.7(d)(iii) provided that: "The Company shall be entitled to receive customary representations and warranties from the sellers of any securities purchased pursuant to [the Repurchase right] regarding such sale of Membership Interests…(including representations and warranties regarding good title to such Membership Interests… free and clear of any liens or encumbrances)." The Repurchase Agreement that Octo provided with its notice of exercise of the repurchase right contained a release of claims that Seva "may have or claim to have…for or by reason of any matter, circumstance, event, action, inaction, omission, cause or thing whatsoever arising out of, related to or in connection with the Repurchase Units." Seva contended that this release went beyond Octo's entitlement to receive "customary representations and warranties."

Octo asserted that the language of the LLC Agreement did not suggest that the release was not customary, and noted that releases Octo had required of other employees had been much broader. Seva argued that Octo "could only require representations and warranties limited to 'statements of fact about the condition of the Membership Units,' because the representations and warranties include those regarding 'good title….'" Both were plausible readings, the court found, noting that the parties had not defined "customary" and had not attached a form of Repurchase Agreement to the LLC Agreement. Further development at trial would be needed to resolve the ambiguity as to the parties' use of term "customary," the court held.

Practice points. Where a purchase price may be payable in whole or in part by a note, an escrow provision should make clear whether a cash amount equivalent to the purchase price must be deposited into escrow or holding the note is sufficient. Where an agreement provides for a purchase that is subject to the parties entering into a purchase agreement with customary representations and warranties or other provisions, the parties should consider the benefits of attaching a form of the agreement to be used. If the inclusion of "customary" provisions is required, the parties should consider at least providing the form of those provisions, or instead defining what is "customary." A definition might reference, for example, such agreements the company had previously entered into.

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Fried Frank M&A/PE Briefings Issued this Quarter

Earnout Decision Provides Drafting Lessons for Acceleration-of-Payment and Good-Faith-Negotiation Provisions-Beckett (See the article on Earnouts above.)

Earnout Decision Highlights Difficulty of Drafting with Sufficient Clarity to Avoid Post-Closing Disputes-Philips(See the article on Earnouts above.)

Earnout Decision Underscores Buyer's Post-Closing Obligations are Very Limited Except as Specifically Set Forth in Parties' Agreement-Fortis v. Medtronic(See the article on Earnouts above.)

Chancery Finds Deal Price is the "Least Bad" Methodology to Appraise Fair Value of an Early-Stage Company-FairXchange

In Hyde Park v. FairXchange (July 30, 2024), the petitioner sought appraisal by the Court of Chancery of its shares of FairXchange ("FairX"), a nascent securities exchange that had been acquired by Coinbase Global. Although neither party argued for reliance on the deal price to determine appraised fair value, and the court viewed the sale process as seriously flawed, the court held that reliance on the deal price was the "least bad" methodology to determine appraised fair value of an early-stage company with a plan to disrupt the market and no track record. The court emphasized that there was no "persuasive methodology" to determine fair value for this kind of company, where in just a few years it easily could be either a unicorn worth billions or a company worth zero. We note that the court's analysis would not apply to other types of early-stage companies-such as, say, pharmaceutical companies that develop new drugs, which also face risks and uncertainty, but operate within an established industry with parallel established markets that demonstrate how drugs are commercialized. We would observe, further, that for an early-stage company with a disruptive plan and no track record, the deal price, arguably, reflects almost entirely not going concern value as a stand-alone enterprise but the target's option value-that is, what the buyer was willing to pay for the chance that a company with no cash generation and no track record may be worth billions in its near-term future.

DGCL Amendments Authorizing Governance Rights in Stockholders Agreements Will Become Effective August 1^st-What YouNeed to Know

On July 17, 2024, amendments to the Delaware General Corporation Law were enacted in response to the Court of Chancery's Moelis decision (Feb. 23, 2024), which held that rights granted in stockholder agreements violate DGCL Section 141(a)'s mandate that the affairs of a corporation be managed by its board of directors except to the extent otherwise set forth in the charter. The Amendments bring the statute more in line with what practitioners have asserted is common market practice in the granting of governance rights in stockholders agreements. While the Amendments are drafted broadly to authorize granting governance rights in corporate agreements, we expect continued uncertainty as the courts interpret the Amendments, expand on Section 141(a) jurisprudence generally, and amplify the requirements of other sections of the DGCL that may relate to governance rights granted in stockholders agreements.

Chancery Finds 26.7% Stockholder (with Blocking Rights, Management Control, and Board and Management Designees) Was Not a Controller-Scianella v. AstraZeneca

In Sciannella v. AstraZeneca (July 2, 2024), the Court of Chancery, at the pleading stage, dismissed claims that AstraZeneca UK, the 26.7% owner of Viela Bio, and certain Viela Bio directors and officers, breached their fiduciary duties in connection with the arm's-length sale of Viela Bio to Horizon Therapeutics. The plaintiff contended that AstraZeneca controlled Viela Bio based on its effective blocking rights, total management control through support agreements, and board and management designees (including the CEO). The plaintiff alleged that, to facilitate securing antitrust clearance for AstraZeneca's acquisition of a different company, AstraZeneca pushed Viela Bio into a quick sale to Horizon by threatening that it would imminently terminate its support agreements. The court found that AstraZeneca was not a controller. It did not control the board (as its blocking rights did not apply to any board actions; its director-designees did not constitute a majority of the board; and that there were no well-pled allegations that the other directors were beholden to or controlled AstraZeneca or its director-designees). It did not control the transaction (as its proposal to terminate the support agreements had been ongoing since the spinoff and was not a "threat" because it included offers to assist Viela Bio in the transition). AstraZeneca therefore owed no fiduciary duties to Viela Bio and its stockholders. The court also found that Viela Bio's disclosure was adequate; therefore, any fiduciary breaches by Viela Bio directors and officers were cleansed under Corwin. We observe that the court likely was strongly influenced by the facts that: the board was comprised mostly of independent directors; the sale process included outreach to and discussions with multiple potential bidders; the board's negotiations resulted in Horizon twice raising its offer price; and the sale price reflected a high (52.8%) premium. Also of note, the court held that disclosure by Viela Bio of its earlier, more optimistic projections was not required as the update projections were reliably prepared and reflected the company's most recent information.

Court Scrutinizes Sponsor and Financial Advisor Conflicts Under Up-C Structure-Foundation Building Materials

In Firefighters' Pension v. Foundation Building Materials (May 28, 2024), the Court of Chancery, at the pleading stage, declined to dismiss claims challenging the sale of Foundation Building materials to an unrelated third part in an arm's-length merger after the company had gone public in an Up-C IPO. The court found it reasonably conceivable that the decision to sell the company was influenced by the desire of the company's private equity sponsor (which controlled the company both before and after the IPO) to receive an early termination payment (ETP) under the tax receivable agreement (TRA) it had entered into with the company in connection with the IPO. The court viewed the receipt of the ETP as a non-ratable benefit to the sponsor and applied entire fairness review. The court found, at the pleading stage, that (i) the sponsor, its board designees and the company's CEO may breached their duty of loyalty to the minority stockholders; (ii) the independent directors on the company's special committee may have breach their duty of loyalty; and (iii) the financial advisors to the company's board and special committee, respectively-whose fees were tied in part to the sponsor receiving the ETP-may have aided and abetted the fiduciary breaches. In this Briefing, we discuss the opinion and note that the court may have viewed the alleged conflicts in this case as especially problematic given a series of factors that may distinguish the case.

Chancery Dismisses Caremark Claims Against Directors Who Relied on Management to Address Compliance Problems-Centene

In Bricklayers Pension Fund v. Brinkley (July 12, 2024), the Court of Chancery, at the pleading stage, dismissed Caremark claims against the directors of Centene Corporation (a Medicaid management company for states) for alleged failure to oversee the company's compliance with Medicaid laws and regulations. The court found the board did not breach its Caremark duties although it had deferred to management to deal with the company's serious, longstanding compliance problems. Although previous cases have stressed that Caremark requires board-level oversight, and that reliance on management alone to deal with critical compliance issues is insufficient, the court indicated in Centene that the extent to which reliance on management may be sufficient for fulfillment of Caremark duties depends on the context. The board in this case accepted management's statements that the compliance risks and issues "were being handled"-which, the court stated, is different from "mak[ing] a conscious decision to violate the law." The decision reaffirms that, generally, directors will not face Caremark liability unless the factual context is extreme.

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Selected Other Fried Frank Briefings Issued this Quarter:

FCA's revamped UK Listing Rules: Will they arrest the apparent decline of the UK stock market and rekindle London's IPO glory days?

Navigating New Enforcement Scrutiny of 'AI Washing'

The EU's Foreign Subsidiary Regime-The First Year

SEC Enforcement Action: Schedule 13D Disclosure Obligations Regarding Pledges and Other Arrangements Concerning Issuer Securities

Court Strikes Down FTC's Proposed Ban on Non-Competes

FTC Fines Investor for Inadvertent First-Time Violation of the HSR Act

DOJ Unveils New Corporate Whistleblower Awards Pilot Program

ESMA Consults on Liquidity Management Tools for Open-Ended Funds

Regulatory Technical Standards Pave Way for Open-Ended ELTIFs

CFIUS Releases 2023 Annual Report

SDNY Judge Limits SEC Cybersecurity Suit Against SolarWinds and CISO

Beyond the Continuation Fund: The Next Phase of Evolution in Private Capital Liquidity Solutions

Top Five Russia Sanctions Impacting the Transport Industry

EU Significantly Strengthens Russia Sanctions

Q2 2024-European Regulatory Update for Funds

Regulation of Private Fund Advisers

Government Contracts: Fed. Cir. Narrows Task Order Protest Bar, Broadens Interested-Party Test

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