In a recent decision that underscores the importance of precise contract language in M&A deals, the Delaware Court of Chancery dealt a blow to former Cephalon shareholders seeking a post-merger payday. The case, Himawan v. Cephalon, Inc., C.A. No. 2018-0075-SG (Del. Ch.), centered on the interpretation of contingent value rights (CVRs) issued as part of Teva Pharmaceutical’s acquisition of Cephalon.

The saga began in 2011 when Teva Pharmaceutical Industries Ltd. acquired Cephalon, Inc. for $6.8 billion. As part of the deal, Cephalon shareholders received $81.50 per share in cash, plus CVRs that promised additional payments if certain Cephalon drug candidates hit specific milestones. These CVRs were designed to bridge the valuation gap between Teva’s offer and Cephalon shareholders’ expectations, particularly regarding the potential of Cephalon’s pipeline drugs. The dispute arose when former shareholders claimed that Cephalon, under Teva’s ownership, had indeed met the criteria for CVR payouts through its development and commercialization efforts for certain drug products.

The plaintiffs, hoping to cash in on additional compensation, argued that Cephalon (now under Teva’s umbrella) had triggered the CVR payout conditions through its drug development efforts. However, Vice Chancellor Glasscock saw things differently, applying Delaware’s strict contract interpretation principles to dash the shareholders’ dreams of a windfall. Citing Rhone-Poulenc Basic Chems. Co. v. Am. Motorists Ins. Co., 616 A.2d 1192, 1195 (Del. 1992), the court emphasized that clear and unambiguous language in a contract should be given its ordinary and usual meaning.

Key Takeaways:

  1. Clear language wins: The court found the merger agreement’s terms unambiguous, emphasizing the critical role of precise drafting in high-stakes deals. As noted in Lorillard Tobacco Co. v. Am. Legacy Found., 903 A.2d 728, 739 (Del. 2006), “clear and unambiguous terms” in a contract are to be given their plain meaning.
  2. No stretching allowed: Attempts to expand the agreement’s scope beyond its plain meaning fell flat, reminding dealmakers that courts won’t rewrite contracts to suit post-merger desires. The court invoked Gertrude L.Q. v. Stephen P.Q., 466 A.2d 1213, 1217 (Del. 1983), stating that it cannot “create a new contract with rights, liabilities and duties to which the parties had not assented.”
  3. Performance matters, but within limits: While the court examined Cephalon’s actions in developing certain drugs, it ultimately concluded these efforts didn’t cross the threshold set by the agreement for additional payouts. This aligns with the principle in Nemec v. Shrader, 991 A.2d 1120, 1126 (Del. 2010), which emphasizes that parties are held to the bargain they struck.

The Himawan decision serves as a stark reminder to both corporate buyers and sellers: when it comes to CVRs and other contingent compensation mechanisms, the devil is truly in the details. Careful drafting and a clear-eyed view of potential outcomes are essential to avoid post-merger headaches and courtroom showdowns.

For dealmakers and their advisors, this case underscores the need for precision in crafting merger agreements, particularly when complex payout structures are involved. As always in the world of M&A, an ounce of prevention in the boardroom can prevent a pound of cure in the courtroom.