The deal that closed — and then the real fight began
STG CORPORATE AND COMMERCIAL LAW • CLIENT INSIGHT
What the $1 Billion Johnson & Johnson / Auris Earn-Out Dispute Teaches Every Business Owner About Selling a Company
By Katarina Strandberg | STG Corporate and Commercial Law AB
Most M&A challenges and disputes might happen before closing you would think. Someone finds something in due diligence. A representation turns out to be wrong. The deal terms are heavily negotiated. Then the deal closes — or it does not — and the fight ends.
Earn-out disputes are different. The deal has already closed. The money has changed hands. You no longer own the business but you are still waiting for that ear-out to be triggered.
The Johnson & Johnson and Auris Health case is the most instructive version of that story in modern M&A and it contains lessons that apply directly to any founder, investor, or business owner who is negotiating — or has already accepted — an earn-out.
"J&J bought the company. But the real fight was about what happened after closing."
What Happened
Auris Health was a Silicon Valley surgical robotics company with a platform called Monarch — a robotic system designed to navigate bronchoscopically into the lungs for diagnostic procedures. In April 2019, Johnson & Johnson's Ethicon division acquired Auris for approximately USD 3.4 billion upfront - and with an earn-out of up to USD 2.35 billion tied to specific regulatory and commercial milestones.
The single most significant milestone — a USD 100 million payment — was contingent on Monarch achieving FDA clearance for a specific lung biopsy procedure. The merger agreement required J&J to use "commercially reasonable efforts" to achieve the earn-out milestones.
After closing, the sellers — represented by Fortis Advisors as sellers' representative — alleged that J&J had systematically deprioritised the Monarch platform. Resources were redirected from it and the srategy shifted towards other aspects of the ancillary J&J businesses. The regulatory pathway was not pursued with the commitment the sellers had expected and in their view also been promised. The sellers even alleged that they had been misled to expect other actions and a deeper committment from J&J.
The Delaware Court of Chancery agreed with the sellers. The judgment exceeded USD 1 billion in contract and fraud damages. The Delaware Supreme Court affirmed the core findings as breach by J&J of the commercially reasonable efforts obligation and fraud in relation to the Monarch milestone — while partially reversing on a separate implied covenant point.
What "Commercially Reasonable Efforts" actually means
This is a central clause in many M&A deals including in relation to how earn-outs are often structured. And it is frequently misunderstood by both sides.
"Commercially reasonable efforts" is not a disclaimer. It does not mean "the buyer may do whatever it likes and then describe whatever it did as commercially reasonable." It creates a genuine obligation to e.g. pursue the milestone with the commitment, resources, and priority that a reasonable commercial party would apply to an objective it genuinely wanted to achieve.
A buyer that systematically redirects resources away from an earn-out milestone, changes the strategy that underpins it, and then argues that the residual effort constituted "commercially reasonable efforts" is asking a court to accept that commercial reasonableness is simply whatever the buyer decides. Delaware courts have not accepted that argument.
"Commercially reasonable efforts is a binding promise. Not whatever the buyer wants it to be from time to time."
The J&J case is now the leading Delaware authority on what this standard requires — and what happens when a buyer fails to meet it.
The structural problemwith every Earn-Out
Every earn-out creates a conflict of interest between the buyer and the seller. The buyer has a financial interest in the earn-out not being triggered — every milestone payment that is not made is money it saves. It pays less (often much less) for the company it bought. The seller has the opposite interest. It wants as much as possible when selling its company.
That conflict is manageable when the buyer is genuinely committed to the acquired business. It becomes dangerous when the buyer has its own competing interests in the milestone failing to be achieved — as J&J arguably did, with its own separately developed surgical robotics programme.
The sellers' case was not just that J&J had tried and failed. It was that J&J had not tried — and had done so in a context where its own strategic interests may have been better served by the Monarch earn-out not triggering at all.
Why the fraud finding matters
The Delaware Supreme Court affirmed the fraud finding specifically in relation to the USD 100 million Monarch milestone. Fraudulent misrepresentation in this context means that J&J made representations about its commitment to pursuing the milestone — representations that were material to the sellers' decision to close. Key for a fraud conviction is that they, J&J, knew their representations were not accurately describing their true intentions.
Internal documents and communications are often the focus in earn-out disputes. If a buyer's internal discussions reflect a view of the earn-out milestone that is materially inconsistent with what it has represented to the sellers, those documents become evidence of fraudulent intent.
Kat Strandberg Comments: What This Means for Your Deal
STG — Lawyer's Take: Five Points Every Seller Must Address
Draft the operating covenant, not just the number. The headline earn-out figure is meaningless if the buyer can simply deprioritise the milestone or if they are to vague to control for the seller. The agreement should specify things like minimum budget commitments, headcount protections, required regulatory actions, product roadmap obligations, or a list of things the buyer may not do — all with the same precision as the milestone definition itself.
Name the specific efforts standard and define what it requires. "Commercially reasonable efforts" is better than nothing — the J&J case proves it has real legal content. But a definition that specifies concrete behaviours (minimum spend, regulatory submission timelines, reporting obligations) is stronger than a bare efforts standard that leaves everything to subjective assessments.
Identify and address the conflict of interest before signing. If the buyer has competing products, a competing development programme, or any financial interest in the earn-out not triggering, name it in the agreement and address it directly. Ring-fencing provisions, prohibited-action lists, and management independence covenants are all tools available to sellers who identify this risk early.
Negotiate information rights. Quarterly reporting on milestone progress, immediate notification of any material change in strategy or budget affecting the earn-out business, and the right to audit the accounting that is the base for the earn-out calculation — these provisions are what allow you to identify a problem while there is still time to act. And the often have a preventive effect on a buyer. Without them, you find out when the period expires and the payment does not arrive.
Build in a dispute mechanism. An earn-out dispute that begins while the period is running can sometimes be addressed by injunction or specific performance — compelling the buyer to act. One that begins after the period has expired is a damages claim for something that cannot be undone. Early escalation mechanisms and interim dispute procedures often matter in earn-out structures.
What buyers need to know
The J&J case is presented above primarily from the seller's perspective — because that is where the practical risk most often lies. But the case contains an equally important message for buyers.
A commercially reasonable efforts obligation is a binding commitment. A buyer that knows at signing it will not prioritise an earn-out milestone — or that its own strategic interests conflict with the milestone being achieved — faces significant legal and reputational risk if it proceeds without addressing that reality in the agreement.
The internal documents that were most damaging in the J&J proceedings were not the ones prepared for litigation. They were the routine operational communications including strategy discussions, budget allocations, resource decisions. Those documents told a different story from the external representations being made to sellers.
The Practical Checklist
Whether you are a seller negotiating an earn-out, a buyer structuring one, or an investor evaluating a deal that includes one — these are the questions that matter:
For sellers
1. What specific actions is the buyer contractually required to take to pursue each milestone?
2. What can the buyer not do during the earn-out period without your consent?
3. What information will you receive, and how often?
4. What happens if the buyer changes strategy or redirects resources?
5. How do you raise a dispute before the earn-out period expires?
For buyers
1. Do we have any competing interest in this milestone not being achieved?
2. Are our internal communications consistent with our external commitments?
3. Is it clear what you are obligated to do, and do you have the resources and the intention to genuinely pursue each milestone?
4. Have we clearly allocated responsibility for milestone pursuit within the organisation? What happens if you change strategy or reorganize - are you subject to restrictive covenants and if so can you negotiate them for more flexibility to drive the business as you see fit from time to time?
5. Does our integration plan protect the earn-out business rather than subordinate it?
Earn-outs are one of the most litigated areas of M&A law. The gap between what a seller believes they agreed to at signing and what the buyer actually delivers post-closing is where disputes are born — and where the difference between well-drafted and poorly-drafted agreement language determines the outcome. Getting the drafting right, before the deal closes, is incomparably cheaper than litigating it afterwards.
Need advice on an earn-out, M&A transaction, or commercial contract?
Contact Kat Strandberg
kat@stgcommerciallaw.com
Case reference: Fortis Advisors LLC v. Johnson & Johnson, Delaware Court of Chancery and Delaware Supreme Court. This article is written for general informational purposes and does not constitute legal advice. For advice on your specific situation, please contact STG Corporate and Commercial Law AB.