Delaware Courts Sharpen Focus on Earn Outs: Review of Recent Case Law and Practical Guidance for Dealmakers

Two recent Delaware decisions on earn-out disputes offer critical guidance to dealmakers and counsel for framing earn out provisions and disputes. Two 2026 decisions (the Delaware Supreme Court’s ruling in Fortis Advisors LLC v. Johnson & Johnson(J&J) and the Court of Chancery’s opinion in Fortis Advisors LLC v. Krafton, Inc. (Krafton)) address buyer interference with earn-out opportunities, but through different legal mechanisms. In J&J, the Court examined the boundaries of the implied covenant of good faith and fair dealing, while in Krafton, the court enforced express operational control provisions. Together with earlier decisions in Himawan v. Cephalon (Himawan), Shareholder Representative Services LLC v. Alexion Pharmaceuticals(Alexion), and Fortis Advisors LLC v. Medtronic Minimed (Medtronic), Delaware has illuminated the key legal principles governing earn-out structures, and the drafting practices that can help parties avoid costly litigation.

Johnson & Johnson v. Fortis Advisors: The Implied Covenant and Foreseeable Risks

Under Delaware law, every contract contains an implied covenant of good faith and fair dealing, which requires each party to refrain from conduct that would frustrate the other party from receiving the benefits of the contract.

In 2019, Johnson & Johnson (J&J) acquired Auris Health (Auris), a medical robotics company in a deal which included up to $2.35 billion in earn-out payments. The earn-outs were contingent on Auris’ landmark surgical robots achieving regulatory and sales milestones, all of which were conditioned on obtaining FDA “510(k) clearance” which was the least burdensome pathway to approval. However, after closing, the FDA determined that approval for Auris' devices required a more rigorous pathway. J&J declined to pursue the alternative pathway, so the business could not achieve the earn-out targets. The Court held that damages could not be awarded for J&J’s failure to meeting the 501(k) clearance milestone. However, the Court upheld damages for all of the subsequent milestones, finding that J&J was still responsible for using commercially reasonable efforts to pursue those remaining milestones, and that J&J fraudulently induced Auris. The opinion provides important guidance for practitioners and dealmakers:

1. The implied covenant of good faith and fair dealing cannot be used to require to buyer to pursue alternative pathways to satisfying milestone, where the acquisition agreement expressly identifies the milestones condition. The Court clarified that for the implied covenant to apply, the harm has to be both unexpected and unforeseeable. Here, the Supreme Court found the parties negotiated for, and directly allocated, regulatory risk to the sellers in specifically identifying the pathway for achieving the milestone.
2. The failure of one (seemingly threshold) milestone does not necessarily excuse the buyer from its responsibilities to achieve future milestones. The Court, looking at the full regulatory process, determined that the harder de novoclearance would still allow J&J to pursue the subsequent 501(k)-based milestones.
3. Tailored “efforts” clauses do not permit a buyer to exercise its business judgment to refrain from satisfying earn out milestones, unless the provision explicitly so permits. J&J’s obligation to pursue the milestones was subject to an “inward-facing” standard of “commercially reasonable efforts” benchmarked against the buyer’s usual practice to achieve the milestones for similar devices. The Court held the factors only applied within the context of achieving the milestones – meaning, the factors did not permit J&J to elect not to proceed with obtaining the milestones in favor of other priorities or business considerations.
4. Only a clear anti-reliance clause that unambiguously promises it has not relied on statements made outside the four-corners of the contract will bar claims of extra-contractual fraud. J&J’s CEO verbally represented the earn-out milestone was almost certain to be achieved, while also aware the FDA was then actively investigating one of J&J’s similarly-situated products – which would undoubtedly delay achievement of the milestones. On that basis, and because the transaction agreement did not include a non-reliance provision, the Court held J&J was liable for fraud.

Fortis Advisors v. Krafton: Operational Control and For-Cause Termination

In 2021, South Korean gaming conglomerate Krafton acquired Unknown Worlds Entertainment, a video game studio known for Subnautica, for $500 million upfront plus up to $250 million in contingent earn-out payments. To protect the sellers’ ability to achieve these targets, the acquisition agreement granted the company’s founders and CEO (Key Employees) “operational control” over the studio “in all material respects,” who could only be terminated “for Cause,” which required proof of intentional dishonesty, felony conviction, gross misconduct, or wrongful disclosure of trade secrets.

Krafton’s CEO, on learning the release of a highly anticipated sequel would generate enough revenue to trigger the earn-out, consulted AI regarding a “takeover” strategy, and terminated the Key Employees from their positions. The Court found that Krafton’s justifications for termination were pretextual, reinstated the CEO with full operational authority, extended the earn-out period by the duration of his termination, and restricted Krafton from using other mechanisms to circumvent the sellers’ contractual rights. The Krafton opinion is notable particularly for its remedial approach, provides important guidance for practitioners structuring earn-out protections:

1. Communications with AI are not privileged and will be evaluated as part of the broader evidentiary record.
2. Shifting grounds for a contractual position during litigation to a different, inconsistent justification is not permissible under the “mend-the-hold” doctrine. After-acquired evidence cannot be used to retroactively justify termination after the decision has already been made. Expect a court to strictly construe the definition of “for cause”, and concepts to be interpreted with precision, and according to their plain meanings.

1. The Operational control provisions will be enforced as written, and the court will give deference to specific performance and equitable remedy clauses. The parties mutually agreed a breach would cause irreparable harm and entitle the party to specific performance. Because the Key Employees were not terminated “for Cause”, the court restored the CEO’s authority and enjoined Krafton from using board resolutions or other corporate levers to circumvent the sellers’ contractual rights over product launch decisions. The court also equitably extended the earn out period to restore lost time, barring the buyer from benefitting from its interference with the earnout.

The contrast between J&J and Krafton is instructive. In J&J, the sellers lacked explicit contractual protections framing the buyer’s discretion, leaving them to rely on the implied covenant, which the Delaware courts applied narrowly. In Krafton, the sellers had bargained for specific operational control rights and for-cause termination protections, giving the court a clear contractual framework for establishing culpability.

Understanding Earn-Outs: Purpose, Structure, and Key Legal Considerations

Against this backdrop of recent caselaw, earn-outs still serve as a critical tool for bridging valuation gaps. Earn-outs allow both sides to address this disconnect by allocating the risk of uncertainty of seller’s future performance by deferring a portion of the purchase price (typically from 25% to 30% of total consideration) post-closing, with the deferred payment contingent on the business achieving certain performance targets.

Earn-outs have become increasingly important as sellers often anchor to historical peak valuations or seek to recover their investment basis, while buyers face heightened uncertainty from geopolitical tensions, rising interest rates, and limited visibility into target company operations. Earn-outs allow sophisticated parties to “meet in the middle” by tying a portion of the purchase price to actual results. In effect, earn outs require sellers to stand behind their optimistic projections with actual performance.

Key Structural Elements

When structuring an earn-out, practitioners focus on the following:

• Earn-out Period. This is the time span for evaluating performance. The market standard is typically 1 to 3 years. Buyers generally prefer shorter periods to limit post-closing operating restrictions, while sellers prefer longer periods to give the business enough time to achieve the earn out milestones. Krafton illustrates how courts will protect the sellers negotiated earn out periods.
• Performance Metrics and Milestones. The financial metrics included in the earn-out structure are often heavily negotiated. Sellers may prefer top-line metrics like revenue which is less susceptible to manipulation through cost reductions or allocation decision by the buyer. Buyers often favor metrics like EBITDA or net income which account for operational efficiency and integration costs.
• Post-Closing Covenants. These govern how the buyer must operate the acquired business during the earn-out period. Delaware courts have identified a spectrum of obligations that parties may adopt. At one end are broad discretion clauses, like that in Fortis Advisors LLC v. Medtronic Minimed, Inc., where Medtronic acquired Companion Medical with contingent milestone payment if Medtronic sold at least 85,000 units of a “smart” insulin pen at an average price of $400 during the milestone period. Unlike typical earn-out agreements that impose "commercially reasonable efforts" or "good faith" obligations on buyers, the merger agreement gave Medtronic "sole and absolute discretion" over the business, with only one limitation: Medtronic could not "take any action intended for the primary purpose of frustrating the payment of Milestone Consideration." Ultimately, the Court of Chancery dismissed Fortis's claims because, Fortis did not successfully plead that Medtronic's primary purpose was to defeat the milestone. This is an exceptionally buyer-friendly standard that requires more than showing actions that had the effect of frustrating the earn-out. At the other end are robust protections like those in Krafton, where the sellers retained “operational control” over product roadmap, launch decisions, and employee matters.

Between these extremes lie various “efforts” standards. In Himawan v. Cephalon, the Court of Chancery interpreted a “commercially reasonable efforts” clause that required the buyer to use “such efforts and commitment of such resources” as a similarly situated company would employ. The court adopted a “hypothetical company” approach, asking what a typical pharmaceutical company in the buyer’s position would do under the circumstances. The Alexion court applied a similar outward-facing standard, measuring the buyer’s conduct against “efforts and resources typically used by biopharmaceutical companies similar in size and scope.” Critically, both courts emphasized that commercially reasonable efforts clauses impose objective obligations, and buyer’s subjective intent does not control the analysis. In contrast, the J&J court used an inward facing standard, measuring the buyer’s conduct against it’s own efforts on similarly situated medical devices.

• Acceleration and Anti-Frustration Provisions. Sellers may also want to protect against buyer actions that would frustrate achievement of the earn-out without technically breaching express covenants. To do so, Seller might include acceleration clauses that trigger immediate payment upon specified events (such as a subsequent sale of the target), anti-sandbagging provisions, or specific prohibitions against conduct designed to defeat earn-out payments. The Medtronic court’s analysis of a “primary purpose” standard highlights the difficulty of proving a buyer’s subjective intent—underscoring the importance of objective, measurable obligations where possible.
• Damages and Remedies. When earn-out disputes result in breach findings, the question of damages presents complex challenges. In Shareholder Representative Services v. Alexion, Alexion acquired Syntimmune milestone payments tied to the development of an antibody drug, but after the program faced contaminated drug supply, COVID-19 disruptions, and a portfolio review, Alexion terminated the program. In a damages opinion, the Court of Chancery finding certain criteria ambiguous and resorting to extrinsic evidence of the parties’ negotiating history to determine their intent, engaged in a detailed probability analysis, applying sophisticated statistical concepts to determine whether the milestones were achievable. In contrast to this technical analysis, the Krafton court demonstrated the availability of equitable remedies, ordering specific performance to reinstate terminated employees and extending the earn-out period to account for the buyer’s wrongful interference.
• Resolving Disputes. Because earn-outs can represent a substantial portion of purchase price, robust dispute resolution mechanisms are essential. Best practice includes a specific process for resolving disputes as to the calculation of financial performance, typically by referring to neutral accounts. This earn-out dispute resolution provision is separate from the purchase agreement's general dispute provisions for indemnification, breach, and the like.

Best Practices

When crafting earn-outs, dealmakers and advisors should keep the following in mind:

• Be specific. The Alexion court’s struggle to interpret ambiguous milestone criteria underscores the importance of specificity. Define all financial terms precisely, including accounting methodologies and treatment of extraordinary items. Involve accountants and financial advisors in drafting as early as possible and include worked examples where appropriate.
• Allocate foreseeable risks expressly. As Fortis makes clear, Delaware courts will not use the implied covenant to reallocate risks that were foreseeable at signing. Parties should devote time to anticipating potential contingencies, including regulatory changes, market shifts, or integration decisions, and address them explicitly.
• Consider the spectrum of covenant protection. The contrast between Medtronic (where the buyer secured broad discretion subject only to a “primary purpose” limitation) and Krafton (where the sellers retained operational control over product decisions) illustrates the range of available approaches. Sellers should carefully assess their leverage and negotiate for the strongest protections the market will bear, recognizing that implied covenant claims are difficult to sustain.
• Negotiate for specific performance. The Krafton decision demonstrates the power of contractual specific performance provisions. Where parties stipulate that specific performance is an appropriate remedy for breach, Delaware courts will enforce that bargain, potentially ordering reinstatement of terminated employees, extension of earn-out periods, or other equitable relief. Sellers should consider including explicit specific performance language to preserve access to these powerful remedies.
• Establish robust dispute resolution mechanisms. Separate accounting dispute processes from general dispute provisions and consider fee-shifting arrangements to encourage reasonable positions. For financial metric disputes, consider binding expert determination by neutral accountants. For interpretive disputes, consider expedited arbitration with fee-shifting to discourage unreasonable positions. Clear dispute resolution frameworks can help avoid the expense and uncertainty of full-blown litigation.