The Delaware Court of Chancery holds that the buyer of the medical device used “good faith” and “commercially best efforts” to commercialize the sellers’ medical device.
M&A Stories
September 29, 2022
Introduction
In a recent case, the Delaware Court of Chancery made a decision regarding the earnout claim made by medical device sellers. The court ruled in favor of the buyer, stating that they had acted in good faith and made significant efforts to commercialize the sellers’ medical device.
Background
Deal Details: The case involved the acquisition of a start-up company that was developing a clip applier product for minimally invasive surgeries. To manage the risk associated with the device’s development, the parties structured the deal to include a contingent payment structure. The buyer agreed to an initial payment of $1.25 million to the sellers, with additional milestone payments of up to $10.25 million upon the device meeting specific development objectives. Furthermore, the sellers were entitled to earn-out payments of $2 million upon the first sale, as well as 10% of the net sales for five years after the initial sale.
Buyer’s Efforts: Considering that most of the payment was contingent on the device’s development and financial performance after the acquisition, the sellers negotiated for the buyer to use commercially best efforts to maximize milestone and earn-out payments. They also secured the right to demand accelerated payments if the buyer discontinued the development or sale of the clip applier, except for specified reasons such as patient safety concerns.
Product Development Challenges: Prior to finalizing the stock purchase agreement, the buyer identified design-related safety issues in the clip applier. They negotiated the right to implement design changes to address these concerns, which were documented in a schedule to the agreement. After closing the agreement, the buyer invested significant resources, including $10 million and 15,000 engineering hours, into implementing the design changes, conducting animal lab studies, and obtaining FDA clearance. By October 2015, the buyer had made $9 million in payments to the sellers, including the up-front payment and three milestone payments.
Discontinuation of Development: However, the buyer faced ongoing challenges with the device’s development, including safety features outlined in the schedule. In early 2016, a newly acquired and experienced development team recommended abandoning the product entirely and focusing on developing a new clip applier. The buyer notified the sellers of the risk of patient injury associated with the current device and expressed doubts about its further development. Eventually, the buyer’s board decided to discontinue the product’s development.
Legal Dispute and Verdict
Following the buyer’s decision, the sellers demanded accelerated payments. When the buyer refused, the sellers filed a lawsuit. After a trial, the court ruled in favor of the buyer, determining that they had acted in good faith and used commercially best efforts to commercialize the device. The court concluded that the buyer’s decision to discontinue development was based on the device posing a risk of injury to patients.
See Menn v. Conmed Corporation And Endodynamix, Inc., C.A. No. 2017-0137-KSJM, Court of Chancery of Delaware, (Submitted: March 14, 2022, June 30, 2022).
Comment
Considering the buyer’s actions, the sellers had a weak position in their claim. The court found that the buyer had provided the sellers with a reasonable chance of receiving the full earnout.
By John McCauley: I write about recent legal problems of buyer and sellers of small businesses.
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