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Chancery Court Enforces Merger Agreement Milestone Payment Despite Time and Cost to Bring Experimental Drug to Market

In Shareholder Representative Services LLC v. Shire US Holdings, Inc. and Shire Pharmaceuticals LLC , C.A. No. 2017-0863-KSJM (Del. Ch. October 12, 2020), the Delaware Court of Chancery (the “Court”) held that Shire US Holdings, Inc.’s (together with Shire Pharmaceuticals LLC, “Shire”) failure to initiate Phase III clinical trials for an experimental drug acquired via merger was improper because said failure was due to a series of development delays routine to the pharmaceutical industry and every-day business decisions, in contravention of the language of the merger agreement.

In 2012, Shire Pharmaceuticals LLC (the predecessor-in-interest to Shire US Holdings, Inc.) acquired FerroKin Biosciences, Inc. (“FerroKin”) via merger. The merger agreement required Shire to make a $45 million milestone payment to the former equity holders of FerroKin upon the occurrence of one of the following: (i) the commencement of Phase III clinical trials for an experimental drug acquired in the merger, or (ii) December 31, 2015, regardless of Phase III trial initiation. However, Shire was not required to make the payment if its failure to commence Phase III trials before December 31, 2015 was the result of a “Fundamental Circumstance,” defined in the merger agreement as “a circumstance in which material safety or efficacy concerns made it impracticable to produce and sell or to obtain regulatory approval for the drug.”     

Post-closing, Shire developed an aggressive strategy to bring the drug to market by 2016. However, in early 2013, Shire received data indicating an increase in dosage may improve the drug’s efficacy.  Shire decided to study a higher dose regimen of the drug (the study was known as study 203), resulting in a projected delay of Phase III trials until early 2015. Additionally, in April 2013, ongoing Phase II trials revealed several adverse medical events associated with the drug, including peripheral neuropathy. Despite these findings, Shire’s Executive Safety Review Committee determined that current clinical trials would continue. However, additional studies were put on hold by Shire pending the results of study 203. Shire formed a group comprised of external neurologic experts to assist in assessing the relationship between peripheral neuropathy and the drug.

At this time, Shire expected to begin Phase III trials in February 2015. Even so, over the course of 2013, Shire executives sent several emails commenting on the expensive nature of the program attempting to develop the drug and expressing doubts about the program due to the prevalence of peripheral neuropathy in test subjects. In December 2013, the group of external neurologic experts submitted a report indicating that the higher dose regimen of the drug was linked to higher instances of peripheral neuropathy. Study 203 was therefore discontinued, resulting in further delay of Phase III trials. Finally, in February 2014, Shire was notified that tumors were discovered on the kidneys of rats tested as part of a study commenced by FerroKin prior to the merger. The Executive Safety Review Committee subsequently voted in favor of suspending dosing in the clinical studies pending investigation. The U.S. Food and Drug Administration agreed, and brought an official halt to the studies.

As a result of required follow up studies, Phase III trials for the drug were delayed until at least mid-2017. Approval of the drug was not projected to occur until mid-2020 after a generic form of a competing drug would be released, substantially lowering expected sales of the experimental drug. In February 2015, Shire decided to terminate development of the drug and send Shareholder Representative Services LLC, in its capacity as the equityholders’ representative for the former stockholders of FerroKin Biosciences, Inc., (the “plaintiff”) notice of the occurrence of a Fundamental Circumstance. The plaintiff filed suit against Shire for breach of contract.

The Court began by stating that the party seeking to enforce a contract typically bears the burden of proof.  However, where a contractual obligation is subject to a condition subsequent, the party seeking to avoid a finding of breach bears the burden of proving the condition occurred, thereby cancelling its obligation. The Court held that the Fundamental Circumstance requirement was a condition subsequent, placing the burden of proof on Shire.

According to the Court, in order to meet its burden of proof, Shire needed to demonstrate the occurrence of two events: (i) a Fundamental Circumstance and (ii) a failure to commence Phase III trials before December 31, 2015 as a result of the Fundamental Circumstance. 

Initially, Shire pointed to the tumors discovered in the rat study and the FDA clinical trial hold to satisfy the first element. However, even assuming these events represented Fundamental Circumstances, as the Court did, Shire had still failed to satisfy the second element. The trial record demonstrated that Shire’ altering of the development timeline of the drug was the true reason that Shire could not initiate Phase III trials prior to December 31, 2015. First, Shire altered the dosing regimen of the drug hoping to improve its efficacy, resulting in delay. Second, Shire decided to delay further studies of the drug while awaiting preliminary results for study 203 as it pertained to the development of peripheral neuropathy in some test subjects. The Court concluded that these decisions collectively resulted in the delay of Phase III trials until at least May 2016 according to Shire records.

In response, Shire further argued that the May 2016 date was conjectural and that, as a matter of law, even with a May 2016 Phase III trial launch projection, the occurrence of a Fundamental Circumstance before December 31, 2015 was not foreclosed. The Court answered Shire’s arguments by explaining that the evidence indicated the May 2016 trial launch date was firmer than Shire claimed and that developmental delays were relatively commonplace in the pharmaceutical industry.

For Shire’s second argument, the Court found that the question was not whether a Fundamental Circumstance could occur prior to December 31, 2015, but whether Shire failed to commence Phase III trials by December 31, 2015 specifically because of a Fundamental Circumstance. If it did, then the payment obligation was excused. If there were any other reason as to why Phase III trials were not commenced by Shire prior to that date, then the payment obligation remained. The Court found that the decisions made by Shire would have resulted in Phase III trials being delayed beyond 2015, meaning the trials would not have started on time regardless of the occurrence of a Fundamental Circumstance. Because Shire failed to meet its burden of proving a Fundamental Circumstance prevented it from initiating Phase III trials for the drug prior to the end of 2015, the Court concluded Shire must make the $45 million milestone payment in accordance with the merger agreement.

https://www.klgatesdelawaredocket.com/wp-content/uploads/2021/02/Shareholder-Representative-Services-LLC…v.-Shire-US-Holdings-Inc.-et-al.-memorandum-opinion-201012.pdf

Copyright 2021 K & L GatesNational Law Review, Volume XI, Number 46
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About this Author

Scott Waxman, Limited Liability Companies, Corporate, Attorney, KL Gates Law FIrm
Administrative Partner

Scott Waxman is a founding partner in the firm’s Wilmington, Delaware office and a member of the firm’s global Management Committee. His practice focuses on organizational and operational issues related to limited liability companies, limited and general partnerships, statutory trusts, and special purpose corporations, as well as general commercial and financial transactions, including structured financings, securitizations, mergers and acquisitions, joint ventures, private equity and hedge funds, preferred securities transactions, insurance premium financing transactions, life settlement...

302-416-7070
Zane A. Madden Associate  Corporate/M&A
Associate

Zane Madden is an associate at the firm’s Pittsburgh office. He is a member of the corporate/M&A practice group.

412-355-6222
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