Chancery Court Denies Motion to Dismiss Claim for Breach of Merger Agreement Earn-Out Efforts Provision
In Himawan, et al. v. Cephalon, Inc., et al., C.A. No. 2018-0075-SG (Del. Ch. Dec. 28, 2018), the Delaware Court of Chancery in a Memorandum Opinion denied a motion to dismiss a breach of contract claim brought against defendants Cephalon, Inc. (“Cephalon”), Teva Pharmaceutical Industries Ltd. (“Teva”) and Teva’s affiliate Teva Pharmaceuticals USA, Inc. (“Teva USA”) by former shareholders of Ception, Inc. (“Ception”), a biotech company acquired by Cephalon in a merger transaction. The case concerns a dispute over the phrase “commercially reasonable efforts” as used in an earn-out provision in the merger agreement. The decision highlights pleadings requirements for supporting an initial claim for breach of an objective contractual standard.
In the mid- to late 2000s, Ception licensed and developed an antibody to fight human diseases. After Ception developed clinical trials for the antibody, Cephalon acquired Ception pursuant to merger terms and conditions that provided for a potential $550 million in contingent earn-out payments to Ception’s former stockholders. The earn-out milestones were primarily related to Cephalon’s continued development and commercialization of the antibody. Specifically contemplating two conditions for which treatments might be developed, $400 million of the earn-out payments were tied to Cephalon’s obtaining regulatory approvals authorizing the use of the antibody to treat each condition. The merger agreement required Cephalon to use “commercially reasonable efforts” to develop the treatments. “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.”
Just over one year after Cephalon acquired Ception, in 2011 Teva acquired Cephalon as a wholly owned subsidiary. Following Teva’s acquisition of Cephalon, Teva and Cephalon continued to develop and commercialize the antibody for one of the identified conditions. Upon obtaining the relevant regulatory approvals, Teva made milestone payments to Ception’s former stockholders totaling $200 million. Teva and Cephalon abandoned development and commercialization efforts for the other identified condition, foreclosing the possibility of Ception’s former stockholders receiving an additional $200 million in milestone payments.
Ception’s former shareholders filed suit, alleging (1) breach of contract against Cephalon; (2) breach of implied covenant of good faith and fair dealing against Cephalon; and (3) tortious interference with contract against Teva and Teva USA. In response, Cephalon, Teva and Teva USA filed motions to dismiss for failure to state a claim and Teva filed a motion to dismiss for lack of personal jurisdiction.
Vice Chancellor Glasscock denied Cephalon’s motion to dismiss the breach of contract claim, recognizing in the decision that the merger agreement’s “commercially reasonable efforts” provision created an objective standard for evaluating Cephalon’s conduct. While indicating that potential alternative reasonable interpretations may be considered in construing Cephalon’s specific obligations under this standard, the court determined that this provision should not be held to be meaningless for purposes of ruling on a motion to dismiss for failure to state a claim. The Court found that Ception’s former shareholders had sufficiently pled that Cephalon failed to comply with its obligations under this provision by alleging that similarly situated companies were pursuing treatments for the other identified condition. On the basis of this finding, the Court held that dismissing the breach of contract claim would be inappropriate.
The Court dismissed the claims alleging breach of implied covenant of good faith and fair dealing and tortious interference. In its reasoning for these determinations the court addressed that the absence of a “gap” for an implied term precluded reading one into the agreement. Broadly speaking, the implied covenant of good faith and fair dealing can be used to fill “gaps” in agreements to match the contracting parties’ reasonable expectations at the time of contracting. Since the implied covenant is, by definition, implied, a court will not consider it when a contract specifically addresses the subject at issue. Here, the Court reasoned that the objective standard set forth by the “commercially reasonable efforts” provision foreclosed the existence of a “gap” for an implied term in evaluating Cephalon’s conduct. Accordingly, the implied covenant was deemed inapplicable. The Court also found that the claims of tortious interference were conclusory and that dismissal of the claims of tortious interference necessarily required dismissing the motion for lack of personal jurisdiction.
Greyson Blue contributed to this piece.