M&A Earnouts, Risk Allocation, and Post-Closing Incentive Conflicts

This piece from author Rahul Chhabra for the CLS Blue Sky Blog discusses the Delaware Supreme Court’s January 2026 decision in J&J v. Fortis, a major earnout dispute stemming from Johnson & Johnson’s acquisition of Auris Health. The case centered on contingent payments worth up to $2.35 billion tied to regulatory and commercial milestones. After the anticipated FDA approval pathway became unavailable, the seller claimed J&J failed to pursue alternative strategies to achieve the milestones. While the Delaware Court of Chancery initially awarded the seller more than $1 billion in damages, the Delaware Supreme Court partially reversed the ruling, emphasizing that the transaction agreement’s express language controlled the allocation of risk.

The article explains how earnouts are commonly used in M&A transactions to bridge valuation gaps between buyers and sellers, particularly in industries such as healthcare and technology where future performance is uncertain. By tying a portion of the purchase price to post-closing outcomes — such as revenue growth, EBITDA targets, or regulatory approvals — earnouts allow buyers to reduce upfront payment risk while shifting some uncertainty to sellers. Chhabra’s analysis of private-company M&A transactions from 2020 to 2025 shows that earnouts remain a significant feature of dealmaking, accounting for roughly one-quarter of aggregate transaction value during that period.

Chhabra also examines the incentive conflicts that frequently emerge after deals close. While sellers bear the financial risk of missing earnout targets, operational control of the acquired company usually transfers to the buyer. This separation of risk and control can create disputes when sellers believe buyers intentionally deprioritize the acquired business or make decisions that reduce the likelihood of triggering earnout payments. Conversely, when former seller management remains involved in operations, buyers may argue that short-term decisions were made solely to maximize earnout payouts rather than preserve long-term value.

The piece further explores how disputes often arise over the calculation of financial performance metrics tied to earnouts. Common areas of disagreement include revenue recognition practices, the timing of expenses, acquisition accounting adjustments, reserve and asset valuations, and the allocation of corporate overhead costs. Even where agreements specify accounting methodologies, discretionary operational and accounting decisions can materially affect reported results, making careful drafting and financial analysis critical in minimizing post-closing litigation risk…

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