Earnout Milestones Cannot Be Rewritten via the Implied Covenant; Exclusive-Remedy Clauses Do Not Bar Extra-Contractual Fraud Without a Buyer-Side Anti-Reliance

Introduction

Johnson & Johnson v. Fortis Advisors LLC is a major Delaware earnout decision at the intersection of (i) post-closing “efforts” covenants tied to regulatory milestones, (ii) the implied covenant of good faith and fair dealing when regulators change the rules midstream, and (iii) the enforceability of exclusive-remedy clauses against extra-contractual fraud claims.

Johnson & Johnson (“J&J”) acquired Auris Health, Inc. (“Auris”), a medical robotics company, under a Merger Agreement that included up to $2.35 billion in contingent earnouts. Many earnout triggers required FDA “510(k) premarket notification” for specified devices and indications. Fortis Advisors LLC (“Fortis”), as the former stockholders’ representative, sued when no milestones were achieved—alleging (a) breach of an express “commercially reasonable efforts” obligation to pursue iPlatform regulatory milestones, (b) conduct intended to avoid earnout payments, and (c) fraudulent inducement relating to a $100 million Monarch lung-ablation milestone.

After trial, the Court of Chancery largely ruled for Fortis, including by using the implied covenant to treat a “De Novo” pathway approval as the functional equivalent of the contractually specified 510(k) clearance for the first iPlatform milestone after the FDA closed the 510(k) route for first-generation robotic-assisted surgical devices. The Delaware Supreme Court reversed that implied-covenant rewrite, but otherwise affirmed the breach-of-contract and fraud findings and remanded to recalculate the judgment excluding the Milestone 1 payment.

Summary of the Opinion

  • Implied covenant: Reversed. There was “no genuine contractual gap” permitting the implied covenant to substitute De Novo for an expressly required “510(k) premarket notification.” The agreement repeatedly conditioned regulatory earnouts on 510(k) and allocated to stockholders the risk that FDA “developments” might affect route/timing/cost.
  • Commercially reasonable efforts (iPlatform milestones other than Milestone 1): Affirmed. The Court adopted the Court of Chancery’s reading of the inward-facing efforts clause requiring efforts consistent with J&J’s “usual practice” for “priority medical device products.” The ten listed factors could inform calibration within that baseline, not swallow the baseline itself.
  • Fraud (Monarch Soft Tissue Ablation Milestone): Affirmed. J&J’s CEO’s “high certainty / effective up front” pitch, without disclosing a patient death and FDA for-cause investigation undermining the milestone’s achievability, supported findings of active concealment and scienter.
  • Exclusive remedy clause: Did not bar the fraud claim. In the absence of an express anti-reliance provision running against Auris, an exclusive-remedy provision could not eliminate Auris’s extra-contractual fraud claim.
  • Disposition: AFFIRMED in part, REVERSED in part, and REMANDED to recalculate damages/interest excluding Milestone 1.

Analysis

Precedents Cited

The Court’s reasoning is best understood as a careful reapplication of Delaware’s modern implied-covenant and anti-reliance jurisprudence, with an emphasis on sophisticated-party contracting in heavily regulated industries.

1) Implied covenant as a narrow “gap-filler” (and not a rewrite tool)

  • Dunlap v. State Farm Fire & Cas. Co. and Nemec v. Shrader anchor the core principle that the implied covenant is a limited, extraordinary remedy. In Nemec v. Shrader, the Court refused to rebalance a “bad deal” in hindsight when the disputed outcome was within the range of foreseeable developments and the contract spoke to the disputed right.
  • Gerber v. Enter. Prods. Hldgs., LLC and Dieckman v. Regency GP LP illustrate where the implied covenant properly operates: to prevent a party from undermining contractual mechanisms in ways the parties would not have countenanced at signing (often involving discretion and process-based protections).
  • Oxbow Carbon & Mins. Hldgs., Inc. v. Crestview-Oxbow Acq., LLC is central to the Court’s “no gap” conclusion: even if the precise scenario was not predicted, the contract’s structure can show the parties anticipated the category of risk and allocated it.
  • Glaxo Grp. Ltd. v. DRIT LP supplies the Court’s crisp rule: the implied covenant “cannot be invoked when the contract addresses the conduct at issue.” Where a definition or condition expressly contemplates the relevant possibility, there is nothing to fill.
  • Cincinnati SMSA Ltd. P'ship v. Cincinnati Bell Cellular Sys. Co. provides the closest regulatory-change analogy: the Court refused to expand a contractual restriction to cover a later-arising regulatory category because the parties had anchored their bargain to a defined regulatory construct.

2) Contract interpretation and “commercially reasonable efforts”

  • The Court applied ordinary whole-contract principles (citing Chi. Bridge & Iron Co. N.V. v. Westinghouse Elec. Co. LLC, among others): avoid readings that render negotiated language surplusage, and read defined terms and subsections together.
  • It emphasized that the “priority medical device” comparator baseline could not be nullified by the clause allowing J&J to “take into account” ten factors. The factors calibrate effort; they do not invert the obligation to pursue the milestones.

3) Anti-reliance and extra-contractual fraud vs. exclusive-remedy clauses

  • The Court treated Abry P'rs V, L.P. v. F & W Acq. LLC as the “lodestar” for contractual limits on fraud claims, reaffirming that to bar extra-contractual fraud a contract must contain clear anti-reliance language by the party asserting reliance.
  • It relied on the same anti-reliance line reflected in FdG Logistics LLC v. A&R Logistics Hldgs., Inc. and Kronenberg v. Katz: Delaware’s policy against fraud requires a clear and unambiguous disclaimer of reliance.
  • Express Scripts, Inc. v. Bracket Hldgs. Corp. was distinguished: it addresses remedy limits and scienter gradations for fraud tied to contractual representations, not the separate requirement (under Abry P'rs V, L.P. v. F & W Acq. LLC) of an anti-reliance clause to bar extra-contractual fraud.

Legal Reasoning

1) The implied covenant cannot substitute a different regulatory pathway for an expressly negotiated trigger

The Court’s central move was to recast the Chancery “gap” as a choice the parties already made. The milestones did not require “FDA approval” in general; they required “510(k) premarket notification” repeatedly and expressly. And the agreement expressly warned that milestones were “subject to a variety of factors and uncertainties,” including FDA “developments” affecting approval route, timing, and cost—allocating that risk to the sellers.

Against that drafting, treating De Novo as a “functional equivalent” of 510(k) was not filling silence; it was changing the condition. The Court also rejected the notion that “unlikely” equals “unforeseeable” in implied-covenant analysis. In a sophisticated, heavily regulated transaction, the possibility that FDA might change its approach—especially where FDA had already signaled 510(k) modernization— was within the foreseeable risk set. Under Nemec v. Shrader, the implied covenant does not rescue a party from a foreseeable risk it did not contract around.

2) Reversal on Milestone 1 did not unravel liability and damages for the remaining milestones

The Court drew a sharp line: once 510(k) became unavailable for the first iPlatform clearance, Milestone 1 as written could not be satisfied, so the damages tied to that milestone had to be vacated. But the remaining milestones still required 510(k), and the record supported that a De Novo clearance could serve as a predicate enabling later 510(k) submissions. Thus, J&J’s express “commercially reasonable efforts” obligations continued to apply to the later milestones and were breached on the Chancery court’s (largely unchallenged) factual findings.

3) “Commercially reasonable efforts” meant priority-device efforts, with limited calibration—not a business-judgment escape hatch

The Court endorsed Chancery’s sequencing of Section 2.07(e): an affirmative duty to achieve milestones using “commercially reasonable efforts,” defined as efforts consistent with J&J’s usual practice for “priority medical device products,” with the ten enumerated factors serving as permissible considerations in setting effort levels within that baseline.

J&J’s contrary reading would have allowed the ten factors (profitability, competitiveness, development risks) to justify deprioritizing iPlatform in ways that predictably undermined milestone achievement—effectively rendering “priority medical device” and the anti-avoidance clause (Section 2.07(e)(iii)) surplusage. Delaware interpretation norms disfavor such constructions, particularly in a heavily negotiated earnout covenant meant to prevent post-closing opportunism.

4) Fraud: “high certainty” + nondisclosure of known regulatory jeopardy supports active concealment and scienter

The Court upheld a fraud finding based on active concealment, not mere silence: the CEO’s affirmative pitch (“high certainty” and “effective up front”) was found to induce reliance while omitting known facts that made the milestone materially uncertain (a patient death and FDA for-cause investigation). The Court treated these as quintessentially material in a regulatory-dependent milestone, and it held the record supported at least reckless indifference to the truth—satisfying scienter under Delaware’s common law fraud standard (citing Stephenson v. Capano Dev., Inc.).

5) Exclusive remedy clauses do not bar extra-contractual fraud without an anti-reliance clause by the relying party

The Court’s fraud/contract interface holding is practically important: even a strongly worded exclusive-remedy provision will not, by itself, eliminate extra-contractual fraud claims unless the party asserting reliance has clearly disclaimed reliance in an Abry-compliant way. Here, the contract contained a one-sided anti-reliance clause running against J&J, not Auris—supporting the inference that Auris did not waive reliance. The Court refused to let the exclusive-remedy clause accomplish indirectly what Delaware requires to be done directly and unambiguously.

Impact

1) Earnout drafting in regulated industries: define the trigger to match the business objective

The most immediate impact is on transactions where earnouts hinge on regulatory events. If parties truly intend “FDA authorization by any appropriate pathway,” they must not hard-code a single pathway (e.g., 510(k)) without a fallback. This decision signals that Delaware will not use the implied covenant to provide a “successor” pathway when the contract repeatedly and deliberately chose a specific regulatory trigger and allocated regulatory-change risk.

2) Efforts covenants: “priority comparator” standards can be seller-friendly

The Court’s affirmance of the comparator-based “priority medical device” standard reinforces that inward-facing efforts clauses can impose meaningful, litigation-tested benchmarks. Where the buyer has a well-documented internal “priority” practice, Delaware courts may scrutinize deviations as potential breach, especially if the buyer’s actions appear to impede milestone achievement and implicate anti-avoidance language.

3) Fraud risk allocation: exclusive-remedy is not a substitute for anti-reliance

The decision strengthens deal-law practice norms: if a party wants to cut off extra-contractual fraud, it should obtain an express anti-reliance covenant from the counterparty—the exclusive-remedy clause is not enough. One-sided anti-reliance provisions create asymmetric exposure: the non-disclaiming party may still sue for extra-contractual fraud.

4) Litigation posture: implied covenant arguments face steep headwinds where the text is specific

For practitioners, the opinion is a caution against implied-covenant theories that seek to “functional-equivalent” a bargained-for condition. Delaware will ask (a) is there true silence, (b) was the risk foreseeable, and (c) does the contract’s structure show allocation of that risk? Where the answer points to allocation, the implied covenant will not supply a new deal term.

Complex Concepts Simplified

  • 510(k) vs. De Novo vs. PMA: FDA pathways to market. 510(k) is predicate-based “substantial equivalence”; De Novo is for novel low/moderate-risk devices without predicates; PMA is the most rigorous for high-risk devices.
  • Earnout: Additional purchase price payable only if post-closing milestones are met; it creates incentives for post-closing disputes because the buyer controls performance.
  • Implied covenant of good faith and fair dealing: A narrow doctrine courts use to fill true contractual gaps for unforeseen circumstances; it cannot contradict express terms or rescue a party from foreseeable risks it did not negotiate around.
  • Inward-facing “commercially reasonable efforts”: Efforts measured against the buyer’s own practices (here, for “priority” devices), not against an industry average.
  • Anti-reliance clause: A contractual promise by the relying party that it is not relying on extra-contractual statements; under Delaware law, it is the key tool for barring extra-contractual fraud claims.
  • Exclusive remedy clause: A provision limiting post-closing claims to specified remedies (often indemnification). Delaware will not treat it as an anti-reliance substitute.
  • Active concealment: More than silence—an affirmative act (including a misleading assurance) that prevents discovery of material facts.

Conclusion

Johnson & Johnson v. Fortis Advisors LLC establishes two practical Delaware rules for modern M&A: (1) courts will not use the implied covenant to convert an expressly negotiated, pathway-specific regulatory milestone (510(k)) into a different approval regime (De Novo) where the agreement allocates regulatory-development risk and thus leaves no “gap”; and (2) an exclusive-remedy provision will not bar extra-contractual fraud claims absent clear anti-reliance language by the party asserting reliance—especially where the contract’s anti-reliance clause is one-sided and does not run against that party.

At the same time, the Court reaffirmed robust enforcement of earnout efforts covenants when drafted to a concrete internal comparator (“priority medical device” practice), and it demonstrated continued willingness to police fraud in negotiation conduct that affirmatively misleads counterparties about regulatory risk.