A biotechnology company completes a promising Phase I clinical trial. A large pharmaceutical acquirer offers USD 400 million upfront plus USD 800 million in development milestones. Three years later, the acquirer terminates the program. The milestone payments never materialize. Four years of litigation follow. The outcome turns on how the merger agreement defined "commercially reasonable efforts" (CRE), a phrase both sides assumed they understood.
This scenario, drawn from 2024–2026 Delaware earnout litigation, illustrates why earnout provisions generate disputes at rates far exceeding other contract terms. Earnouts feature in roughly three-quarters of private-target life sciences acquisitions, yet, cumulatively, only about 10% of the potential life sciences milestone dollars on offer have ever been paid.1SRS Acquiom, 2025 Life Sciences M&A Study (SRS Acquiom, September 2025). 342 of 466 transactions structured with earnouts (~73%); ~9.5% of potential life sciences milestone dollars paid (2008–2025); ~19% of biopharma milestone dollars that had come due by mid-2025 paid. The gap between headline deal values and actual payments creates inevitable tension. The contract language determines who bears it.
1. Why Do Valuation Gaps Drive Disputes?
Earnouts exist because buyers and sellers cannot agree on what a development-stage asset is worth. The seller knows what it has invested. The buyer knows what it would cost to replicate. Neither knows whether the drug will work. An earnout defers the valuation dispute: the seller accepts less upfront in exchange for contingent payments tied to future success; the buyer avoids overpaying for uncertain science.
The structure seems elegant in principle. In practice, it converts a valuation disagreement at signing into a contract dispute at milestone. Delaware courts have long recognized this dynamic: the seller trades certainty of less cash at closing for the prospect of more cash over time, but since value is frequently debatable and the cause of underperformance equally so, an earnout often converts today's disagreement over price into tomorrow's litigation.2Airborne Health Inc v Squid Soap LP, 984 A 2d 126 (Del Ch 2009).
An earnout often converts today's disagreement over price into tomorrow's litigation.
The economics explain why. When the acquirer terminates development after paying USD 200 million upfront against USD 500 million in milestone potential, the seller perceives a USD 300 million loss, even if the termination was commercially justified. The buyer who paid USD 200 million for a program requiring USD 150 million in additional investment before the first milestone may view those expectations as unrealistic.
This asymmetry is structural. After closing, the buyer controls development decisions while the seller retains only a contingent economic interest. How the contract allocates rights and obligations between these parties (through efforts standards, milestone definitions, behavioral restrictions, and dispute resolution architecture) determines the path any subsequent challenge must take.
2. What Does the Efforts Standard Actually Require?
Most biotech earnout disputes turn on a single question: did the buyer try hard enough? The answer depends on the efforts standard negotiated at signing. Delaware decisions from 2024–2025 illustrate how different formulations produce different outcomes.3See Fortis Advisors LLC v Johnson & Johnson, CA No 2020-0881-LWW (Del Ch 4 September 2024); Shareholder Representative Services LLC v Alexion Pharmaceuticals Inc, CA No 2020-1069-MTZ (Del Ch 5 September 2024).
Consider an "inward-facing" standard requiring the acquirer to use "commercially reasonable efforts" consistent with its "usual practice" for "priority products of similar commercial potential at a similar stage in the product lifecycle." This formulation measures the buyer's conduct against its own historical behavior with comparable products. In a 2024 medical device acquisition dispute, a Delaware court found that the buyer breached this standard when it forced the acquired product to compete against the buyer's own product in an internal evaluation, diverted significant personnel from milestone-related development, and ultimately combined the products in a way that undermined the earnout timeline. The resulting trial-court damages award reportedly exceeded USD 1 billion (subsequently the subject of a partial reversal on appeal; see Section 4 below).4Fortis Advisors (n 3).
Compare an "outward-facing" standard requiring the buyer to use efforts "typically used by biopharmaceutical companies similar in size and scope." In a pharmaceutical acquisition dispute decided shortly after the medical device case, a Delaware court found that the buyer's termination, driven in part by synergy targets following its own acquisition by a third party, fell short of what a hypothetical similarly situated company would have done. Both decisions found breaches, but the analytical frameworks differed: the inward-facing standard measured the buyer against its own practices, while the outward-facing standard measured against an abstract industry benchmark.
Yet the choice between standards does not determine outcomes mechanically. In an earlier 2024 decision, the Delaware Court of Chancery found that the buyer had not breached its commercially reasonable efforts obligation, even after terminating development.5Himawan v Cephalon Inc, CA No 2018-0075-SG (Del Ch 30 April 2024), aff'd (Del 24 January 2025). The merger agreement required efforts "with due regard to the nature of efforts and costs required," language the court interpreted to permit consideration of milestone payment costs. An internal email noting that the drug was "scientifically viable" but that the milestone payment "may be the killer" did not establish breach; the contract permitted exactly that calculus.
Sellers often assume that "commercially reasonable efforts" is a standard phrase with settled meaning. It is not. The definition accompanying that phrase determines the substantive obligation. A ten-word difference in drafting can mean the difference between a binding commitment and a discretionary aspiration.
Not every terminated program reflects bad faith. Clinical data may reveal safety signals not apparent at signing, competing products may alter commercial projections, and portfolio rebalancing may require difficult resource allocation choices. The question is not whether buyers sometimes have legitimate reasons to terminate programs; they do. The question is whether the contract permits those reasons to justify termination, and whether the buyer's actual decision-making process reflected those reasons rather than a desire to avoid milestone payments.
3. When Do Milestone Definitions Become Dispute Grounds?
Even when the efforts standard favors the seller, ambiguous milestone definitions create independent grounds for dispute. The question shifts from "did the buyer try?" to "was the milestone achieved?"
Consider a milestone tied to "successful completion of a Phase 1 Clinical Study." What constitutes success? If the merger agreement defines success by reference to specific pharmacokinetic or pharmacodynamic criteria, achievement becomes an objective determination: either the data satisfy the criteria or they do not. If the agreement leaves "successful" undefined, the buyer may argue that inconclusive safety signals rendered the trial unsuccessful even if the prespecified endpoints were met.
The difference between subjective and objective milestone definitions shapes litigation risk. A milestone requiring "acceptable safety and tolerability" invites argument over what "acceptable" means. A milestone specifying numerical thresholds may be satisfied or not, but whether measurable criteria are achievable, and whether they capture the outcomes the parties actually care about, are separate questions that specificity alone does not answer.
In the pharmaceutical acquisition dispute discussed above, the parties disputed whether the first milestone, defined by five technical criteria, had been achieved. The court reviewed the full negotiation history and internal communications to determine what the parties understood at signing.6SRS v Alexion (n 3). The fact that sophisticated parties required judicial interpretation of technical criteria they themselves had drafted illustrates how easily ambiguity creeps into milestone definitions.
Regulatory milestones present similar challenges. A milestone tied to "FDA 510(k) clearance" seems objective, but what if the FDA changes its pathway requirements during the earnout period? In the medical device dispute, the Delaware Supreme Court held that the contract allocated the risk of regulatory pathway unavailability and did not create an implied obligation to pursue alternatives.7Johnson & Johnson v Fortis Advisors LLC, No 490, 2024, 2026 WL 89452 (Del 12 January 2026).
The question is whether milestone definitions can survive the unexpected. Each ambiguity (in clinical trial design changes, evolving regulatory guidance, or competitive market shifts) creates a potential dispute. Whether any definition can anticipate every contingency, and whether the attempt to do so creates its own rigidities, remains contested.
4. How Do Behavioral Restrictions Constrain Buyers?
Efforts standards address how hard the buyer must try. Behavioral restrictions address what the buyer cannot do. The distinction matters. A buyer might satisfy a commercially reasonable efforts standard while simultaneously taking actions that undermine milestone achievement through means the efforts clause does not contemplate.
In the medical device acquisition dispute, the merger agreement prohibited the buyer from "tak[ing] into account the cost of milestone payments in making any commercially reasonable development decisions."8Fortis Advisors (n 3). This anti-milestone-consideration clause was intended to prevent the buyer from deprioritizing development simply because success would trigger a large payment. The court found that internal communications demonstrated the buyer had, in fact, considered the earnout cost when deciding to combine the acquired product with its own, and that this consideration violated the contractual prohibition.
Behavioral restrictions range from anti-shelving provisions that require documented scientific or commercial justification before terminating development, through budget and headcount floors that prevent resource starvation, to pathway-specific obligations that constrain the buyer's discretion over regulatory strategy. The specific restrictions negotiated reflect the seller's assessment of how the buyer is most likely to deprioritize the acquired program post-closing.
Each restriction limits the buyer's operational flexibility. Buyers naturally resist constraints that interfere with post-closing integration. But sellers have legitimate concerns that, absent restrictions, the buyer might acquire the technology to eliminate a competitor rather than to develop it. The case law suggests that courts will enforce negotiated restrictions according to their terms, even when those terms impose commercially burdensome obligations on the buyer.
Calibration recurs as the structural tension: broad restrictions risk deterring buyers or creating unworkable post-closing obligations, while narrow restrictions risk failing to capture the specific conduct that derails milestone achievement.
The medical device litigation also illustrates the interaction between behavioral restrictions and anti-reliance provisions. The merger agreement contained only a one-way anti-reliance provision favoring the seller, meaning the buyer could not escape liability for its own pre-signing representations about milestone achievability. The court found that the buyer's representation that a key regulatory milestone was effectively a done deal, made while it withheld known information that cut against that claim, constituted actionable fraud.9Fortis Advisors (n 3).
The Delaware Supreme Court's partial reversal, limited to the implied covenant theory for the first regulatory milestone while the express commercially reasonable efforts breach finding for the remaining milestones and the fraud finding were affirmed, adds a further dimension. The Supreme Court held that the implied covenant of good faith cannot impose obligations the contract was free to include but did not; specifically, it cannot require a buyer to pursue alternative regulatory pathways when the specified pathway became unavailable.10Johnson & Johnson v Fortis Advisors (n 7); Dunlap v State Farm Fire & Casualty Co, 878 A 2d 434 (Del 2005). Swiss law offers a structural parallel in Art. 2 ZGB, but unlike Delaware's implied covenant, Art. 2 ZGB operates as an overarching principle that may, in extreme cases, modify the application of even express contractual provisions.11Art. 2 ZGB. The choice between Swiss and Delaware governing law thus carries substantive implications for the scope of gap-filling obligations the buyer assumes.
5. How Does Dispute Resolution Architecture Shape Costs?
When milestone disputes arise, the contract's dispute resolution provisions determine how, and how expensively, they are resolved. The medical device litigation discussed above required a ten-day trial, testimony from over twenty fact witnesses and nearly ten experts, dozens of deposition transcripts, and thousands of exhibits.12Fortis Advisors (n 3). Four years elapsed between the complaint and the post-trial damages award. This is the cost of unstructured earnout litigation.
Expert determination provisions (Schiedsgutachten) can refer technical disputes (whether a clinical endpoint was met, whether a regulatory criterion was satisfied) to independent experts rather than courts. Swiss M&A practice commonly employs such mechanisms: under the revised Art. 189 ZPO (in force since 1 January 2025), an expert determination binds the court as to the facts it establishes, provided the parties may freely dispose of the matter, no ground for recusal affected the expert, and the determination neither favours a party nor is manifestly incorrect.13Art. 189 ZPO; Art. 189(3)(c) ZPO. For cross-border transactions, institutional arbitration under the ICC Rules or the Swiss Rules provides procedural predictability that ad hoc arbitration may lack.14International Chamber of Commerce, ICC Arbitration Rules (2021), Art. 24; Swiss Arbitration Centre, Swiss Rules (2021), Art. 19. The challenge is matching mechanism to dispute type: a disagreement over pharmacokinetic data may be suited to expert determination, while a dispute over commercially reasonable efforts, fact-intensive and legally complex, requires arbitral or judicial resolution. Hybrid provisions that route different dispute types to different mechanisms add complexity but may better match form to function.
That binding force attaches to the determination's factual findings, not to questions of law; and a Swiss court will set even those findings aside only where the determination is arbitrary, grossly erroneous, or manifestly contrary to equity.15Bundesgericht (Swiss Federal Tribunal), BGE 129 III 535, E. 2.
6. What Strategic Choices Shape Earnout Design?
The 2024–2026 Delaware decisions reshaped negotiation dynamics in life sciences M&A. Buyers who might previously have accepted broadly worded efforts standards insist on more buyer-friendly formulations, including provisions granting sole discretion over development decisions subject only to prohibitions on acting with the primary purpose of avoiding milestone payments. Sellers who might previously have accepted milestone-heavy deal structures demand larger upfront payments, accepting lower headline valuations in exchange for greater certainty.16SRS Acquiom (n 1).
Swiss law would approach efforts obligations differently. Swiss contract law has no direct equivalent to "commercially reasonable efforts"; the nearest functional analogues are the duty of care under Art. 398(2) OR (where mandate-type duties apply) and the general regime for breach of contract under Art. 97 OR. Ambiguous milestone definitions would also be construed differently: where a Delaware court reaches for negotiation history to resolve a contested term (Section 3 above), a Swiss court would first ask what the parties actually and commonly intended, and only failing that interpret the clause objectively, as a reasonable counterparty would have understood it in good faith (Art. 18 OR).17Art. 18 OR; Art. 398(2) OR; Art. 97 OR. Swiss courts would evaluate buyer conduct through Art. 2 ZGB and the doctrine of venire contra factum proprium, which prohibits inconsistent conduct. An acquirer that publicly committed to pursuing milestone development but internally deprioritized the program could face liability regardless of the contractual efforts formulation (for the broader Swiss contractual risk allocation framework, see Pharma R&D Partnerships: Contractual Risk Allocation).
Alternative structures may avoid some of these tensions. Contingent Value Rights (CVRs) provide milestone economics without the same contractual entanglement, though CVR holders typically lack the litigation rights that earnout provisions provide. Royalty arrangements tie payments to commercial success rather than development milestones, aligning incentives more closely with observable outcomes (for an analysis of milestone and royalty structures in the licensing context, see Biotech Licensing: Hidden Contractual Pitfalls). Larger upfront payments may be preferable to milestone structures where the buyer's post-closing discretion makes achievement uncertain. No structure eliminates the fundamental problem that buyers control post-closing decisions affecting sellers' economic interests; each structure merely allocates that risk differently.18SRS Acquiom (n 1).
Credit risk further complicates earnout structures. Milestone payments are typically structured as unsecured contractual obligations of the buyer.19ABA M&A Committee, Model Merger Agreement for the Acquisition of a Public Company (ABA, 2011); SRS Acquiom (n 1). If the buyer becomes insolvent or is itself acquired during the earnout period, the seller's contingent claim is exposed to ordinary creditor risk, with no preferential standing arising from the merger agreement itself. The prevalence of unsecured earnout structures, combined with the industry's high rate of sequential acquisitions, means that sellers bear not only milestone risk but also counterparty risk that the contract's substantive protections cannot address. Sellers can soften that exposure only by bargaining for it at signing, through protections that the efforts and milestone clauses themselves do not supply (escrow or set-off against deferred consideration, a parent or affiliate guarantee, security over the relevant assets, or express survival of the milestone obligations on any assignment or change of control). These interdependencies (among efforts standards, milestone definitions, behavioral restrictions, dispute resolution, and credit exposure) do not yield to generic analysis; they require evaluation tailored to the specific transaction, the specific products, and the specific parties involved.20ABA M&A Committee, Private Target Mergers & Acquisitions Deal Points Study (ABA, 2023); SRS Acquiom (n 1).