Delaware Law Alert: Chancery Court Applies Conditional Probability to Calculate Damages in Earnout Dispute

A recent Delaware Chancery Court opinion offers a significant example of how courts may apply complex probability analysis to determine the amount of damages in an earnout dispute. The case arose from Alexion Pharmaceuticals, Inc.’s 2018 acquisition of Syntimmune, Inc. Our previous Legal Update analyzed in depth the Chancery Court’s September 2024 opinion (the “Liability Opinion”),¹ in which the Court concluded, among other things, that the buyer had failed to use commercially reasonable efforts to achieve certain post-closing milestones that could have resulted in the payment of hundreds of millions of dollars to the former stockholders of the target company under the terms of the merger agreement. The Liability Opinion left undecided the amount of the damages to which the former stockholders were entitled for that breach.

The Court addressed the calculation of damages in its June 2025 opinion (the “Damages Opinion”),² where it engaged in a painstaking analysis of the former stockholders’ expectation damages based on the probability that each unachieved milestone would have been attained absent the breach, and rejected the former stockholders’ attempt to invoke the “prevention doctrine” to secure full payment of each milestone. The Damages Opinion is yet another reflection of the uncertainty that arises in agreements that have a significant earnout component extending long after the closing—as is frequently the case in life sciences M&A transactions. The challenges associated with establishing the probability of uncertain events may result in an award that sellers consider an underpayment and that buyers consider an overpayment. This Legal Update discusses these issues and provides key takeaways from the Damages Opinion.

Background

In 2018, the buyer acquired the target company pursuant to a merger agreement that contemplated payment of an earnout of up to $800 million to the former stockholders of the target company. The $800 million was to be paid in installments upon the completion of eight milestones tied to the development of an antibody used to treat certain rare diseases. The buyer agreed to use commercially reasonable efforts, measured against similarly situated companies, to achieve each milestone for seven years after closing.

Following a seven-day bench trial, the Court concluded in the Liability Opinion that the buyer had actually achieved the first milestone (a successful Phase 1 clinical trial) but had breached its obligation to pay the stockholders’ representative (on behalf of the former stockholders) the required $130 million. The Court also considered the claim of the stockholders’ representative that the buyer had breached its obligation to use commercially reasonable efforts to achieve the remaining seven milestones. As explained in more detail in our previous Legal Update, the Court undertook a detailed review of the record and the various elements of the merger agreement’s definition of commercially reasonable efforts. The Court ultimately concluded that the buyer’s decisions to first deprioritize the acquired product and to then terminate its development fell short of its obligation to use commercially reasonable efforts to achieve those seven milestones.

The Damages Opinion

In the Damages Opinion, the Court determined the damages to which the former stockholders were entitled for the buyer’s breach.

The Court Declined to Apply the “Prevention Doctrine” Because It Would Result in a Windfall.

In the Liability Opinion, the Court had not addressed the separate contention of the stockholders’ representative that the buyer had also breached the “non-avoidance” provision of the merger agreement, which prohibited the buyer from taking any action, the primary purpose of which was to avoid achievement of the earnout milestones. The Court took that issue up in the Damages Opinion because the stockholders’ representative argued that the separate breach entitled the former stockholders to recover the full amount of each remaining milestone, estimated at over $700 million in total. The Court rejected that argument, emphasizing the reluctance of Delaware courts to award perceived windfalls, even to successful litigants harmed by a breach.

The stockholders’ representative argued that the buyer’s breach of the non-avoidance provision would trigger Delaware’s “prevention doctrine.” The prevention doctrine generally prohibits a party (in this case, the buyer) from relying upon the failure of a condition precedent (in this case, achievement of a given milestone) where that party wrongfully prevented fulfillment of that condition precedent. It is based on the commonsense principle that a party should not benefit from its own wrongful acts.

However, despite reluctantly accepting for argument’s sake the contention that the non-avoidance provision of the merger agreement was a contractual codification of the prevention doctrine, the Court rejected the notion that the doctrine entitled the former stockholders to recover damages as if every milestone was in fact achieved. The Court ruled that “the prevention doctrine does not provide a plaintiff a back door to damages in excess of proven expectation damages.” In particular, the Court bristled at the prospect of awarding the former stockholders the entire amount of each milestone when their achievement was not certain, even had the buyer complied with its obligations.

The decision reflects judicial reluctance to award perceived windfalls and makes clear that expectation damages, discussed below, will generally control the quantification of damages in contract disputes, including in the earnout context.

The Court Awarded Expectation Damages Based on the Conditional Probability That a Given Milestone Would Be Achieved.

The majority of the Court’s opinion focused on calculating expectation damages. As the Court explained, “the standard remedy for breach of contract is based on the reasonable expectations of the parties that existed before or at the time of the breach,” with damages “measured by the amount of money that would put the promisee in the same position as if the promisor had performed the contract.”

In an earnout dispute—where the achievement of a particular post-closing event is uncertain—the Chancery Court recently made clear in Fortis Advisors LLC v. Johnson & Johnson (also covered in our prior Legal Update) that damages depend on the probability of achieving the various milestones.³ Likewise, the Damages Opinion notes that “[c]ompensating for lost expected value, rather than with full value whenever earnout payments are likely and zero value whenever earnout payments are unlikely, strives to hit the mark on the parties’ reasonable expectations, rather than award windfalls for some promisees and goose eggs for others.”

The Court accordingly engaged in a detailed analysis of the probability of the buyer’s achievement of each of the remaining seven milestones. The Court’s analysis was made uniquely complex, and required application of sophisticated mathematical concepts, due to the nature of the specific milestones. In a life sciences deal like the one at issue, earnout payments are often keyed to milestones that are not entirely independent. For example, in this particular deal, the outstanding milestones turned on: (1) first dosing of a patient, (2) US Food and Drug Administration (FDA) regulatory approval, and (3) regulatory approval of similar agencies in other countries—each for a first indication and a second indication. But the first dosing of a patient impacts the likelihood of regulatory approval, and FDA approval impacts the likelihood of approval elsewhere—and each must be achieved for one indication before being achieved for a second indication. The Court therefore had to apply the math of “conditional probability” to account for those overlapping features.

In deciding among competing sources of information bearing on those probabilities, the Court ultimately selected the buyer’s own contemporaneous internal predictions about the program’s clinical and regulatory success to guide its quantification of damages. Like the Fortis opinion, which relied on estimates generated by both the parties themselves near to the time of the breach, the Court held that the buyer’s estimates were “the strongest evidence” of the milestone probabilities because they were prepared by those with detailed knowledge of the program shortly before the breach. The Court rejected other sources of estimates, including those prepared by the largest former stockholder shortly after the merger closed (because the estimates were not contemporaneous with the breach and reflected different business circumstances) and those prepared by trial experts (because an open-source database used by the experts to track the likelihood of approval was not reliable).

After converting the buyer’s estimates into actual probabilities for each milestone, the Court discounted the resulting figures to reach an estimated present value for the seven remaining milestone payments totaling $180,944,915.32 before interest.

Key Takeaways

When parties to an acquisition agree to an earnout, they should anticipate that any damages for breach of the earnout will be based on the court’s determination of the probability of achieving each earnout milestone absent the breach. In such circumstances it is likely both parties will be disappointed by the outcome—sellers will find it very difficult to make the case that they deserve the full value of the earnout (contractual provisions and the prevention doctrine notwithstanding), and breaching buyers will find that any ambiguity or uncertainty in the calculation may be resolved against them.

Both the Fortis and Alexion opinions demonstrate that in circumstances where those milestones are particularly uncertain and may not occur until well into the post-closing period—as is the case in many life sciences deals—the calculation of damages is exceptionally difficult to predict in advance of litigation. Since both opinions ultimately relied on probability estimates generated by the parties themselves near the time of the alleged breach, future parties to earnouts that anticipate milestone failures will have an incentive to steer the damages calculation by documenting their estimated probabilities of success—with buyers likely tending to predict a lower likelihood of success and sellers a higher likelihood. Courts must still weigh the reliability of such estimates and, although Delaware courts may resolve doubts against a breaching buyer, the Damages Opinion in this case shows that the Court will look to whatever reliable evidence it can find. In some cases, it might make sense for parties to agree upfront to specified damage amounts (or probability estimates) in the event of a buyer’s breach of its post-closing obligations affecting achievement of the earnout.

¹ Shareholder Representative Services, LLC v. Alexion Pharmaceuticals, Inc., C.A. No. 2020-1069-MTZ (Del. Ch. September 5, 2024) (Zurn, V.C.).

² Shareholder Representative Services, LLC v. Alexion Pharmaceuticals, Inc., C.A. No. 2020-1069-MTZ (Del. Ch. June 11, 2025) (Zurn, V.C.).

³ C.A. No. 2020-0881-LWW (Del. Ch. September 4, 2024) (Will, V.C.).