Delaware Chancery Court Focuses On Negotiation History In Denying Former Securityholders A Milestone Payment Based On The Interpretation Of An Ambiguous Merger Agreement

by Shearman & Sterling LLP

On March 15, 2017, Chancellor Andre G. Bouchard of the Delaware Court of Chancery decided, post-trial, that a biopharmaceutical company was not required to pay a $50 million “milestone payment” under the terms of a merger agreement.  Shareholder Representative Services LLC v. Gilead Sciences Inc. et al., C.A. No. 10537-CB (Del. Ch. Mar. 15, 2017).  As noted by the Court, this case turned on the interpretation of one word—“indication”—as it was used in a merger agreement.  Finding the term “ambiguous when construed within the four corners of the merger agreement,” the Court relied on extrinsic evidence—primarily related to the negotiation history—to determine that the limited approval of a drug to treat a narrow subpopulation of blood cancer patients did not constitute the requisite approval for a specified “indication” that would trigger the contractual milestone payment.

In 2011, Gilead Sciences, Inc. acquired Calistoga Pharmaceuticals, Inc.  In addition to a $375 million up-front payment to Castiloga’s securityholders, the merger agreement required Gilead to pay a series of three “milestone payments” if Calistoga’s primary cancer drug compound (now marketed as Zydelig) obtained certain regulatory approvals.  Under the terms of the merger agreement, plaintiff Shareholder Representative Services LLC was appointed as the agent for the former securityholders for the purpose of enforcing the terms of the merger agreement.

Gilead made the first two milestone payments totaling $175 million as it obtained certain regulatory approvals for the drug.  Under the merger agreement, the third milestone payment of $50 million was to become due upon regulatory approval in the U.S. or European Union “as a first-line drug treatment . . . for a Hematologic Cancer Indication.”  When the drug was approved in 2014 by the European Commission as a “first line treatment” for patients with chronic lymphocytic leukemia (“CLL,” a hematologic cancer), but only those with a specified genetic mutation, the parties disputed whether the final milestone payment was triggered. 

The Court found the term “indication” ambiguous as used in the merger agreement.  As a result, the Court evaluated the extrinsic evidence, “in particular the negotiation history concerning the [m]erger [a]greement.”  In doing so, the Court found that “the overwhelming weight of the evidence demonstrates in my opinion that the parties mutually understood when they entered into the [m]erger [a]greement that the term ‘indication’ meant ‘a disease.’”  For example, “the parties were discussing disease-level regulatory approvals throughout their negotiations over the milestones.”  Moreover, “[n]o evidence was presented suggesting that [the parties] discussed approvals for subpopulations of disease sufferers when negotiating the milestones.”  The Court thus held that the approval of the drug for the limited subpopulation of CLL patients did not trigger the final milestone payment under the merger agreement.

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