In January 2026, the Delaware Supreme Court issued an en banc decision in J&J v. Fortis, a high-profile earnout dispute arising from Johnson & Johnson’s acquisition of Auris Health, involving up to $2.35 billion in contingent payments tied to regulatory and commercial milestones.[1] When the agreed upon 510(k) regulatory pathway became unavailable, the seller alleged that the buyer failed to pursue an alternative to achieve the milestones.[2]
The Court of Chancery agreed with the seller and awarded over $1 billion in damages plus interest. The Delaware Supreme Court partially reversed that ruling, holding that the agreement’s text governed and that the implied covenant of good faith and fair dealing could not be invoked to supply protections the parties did not negotiate. In doing so, the decision reinforces a central feature of earnouts—they are a deliberate allocation of risk, and parties bear the consequences of foreseeable contingencies, even when those contingencies significantly affect the likelihood of payment.
Risk Allocation, Valuation Gaps, and Recent Trends
Earnouts are deferred payments in M&A transactions that are contingent on the target’s future performance post-closing. They are commonly used in transactions involving private targets and sectors such as healthcare and technology where information asymmetry, disagreement about growth prospects, and inherent uncertainty in performance targets often make it difficult to agree on a fixed upfront price, creating a valuation gap.
By tying part of the consideration to post-closing performance—measured through financial metrics such as revenue or EBITDA, or non-financial milestones such as regulatory approval—earnouts allow parties to bridge that valuation gap, protect the buyer from overpayment upfront, and transfer part of the performance risk to the seller.
Based on an analysis of all M&A deals announced or completed between January 1, 2020, to December 31, 2025, involving the acquisition of private firms with an earnout or other contingent payment component in the total deal consideration, I find that:
- Earnouts are a persistent feature of M&A markets, accounting for roughly one-quarter of total transaction value aggregated over all deals during the past six years (2020-2025).
- The average value of transactions with an earnout increased from $173 million in 2024 to $266 million in 2025.
- Earnouts are concentrated in sectors such as healthcare and technology, where value depends on future outcomes like regulatory approvals and R&D success.
- Earnouts made up a larger share of the deal size in smaller transactions, with a median share of 39.2% for deals below $10 million in 2025, declining to around 27–28% for mid-sized deals ($50–$500 million) and about 20% for deals above $500 million.
Post-Closing Control and Incentive Conflicts
In J&J’s acquisition of Auris, most of the value of Auris was dependent on FDA approval of its robotic surgical products. The earnout helped bridge the valuation gap between J&J and Auris and shifted the risk of non-approval to Auris’s former stockholders.
Although an earnout transfers the risk of failure to meet the performance target to the seller, it does not eliminate that risk. External factors, such as regulatory changes in the case of J&J v. Fortis, or adverse demand shocks, competitive entry, or macro-economic cycles, could prevent the firm from achieving the milestone.
The risk is borne by the seller, while the control of the operations of the acquired business typically shifts to the buyer. The separation of risk and control could result in conflicts and disputes, as the buyer doesn’t bear the full consequences of its actions. In such cases the seller may allege that the buyer strategically depressed performance of the acquired business to avoid earnout payments.
Disputes can also arise when seller’s management retains control of the day-to-day operations of the acquired business post-closing. In such cases, the seller has incentives to see that the milestone is achieved but the buyer may allege that those incentives led to meeting short-term metrics at the expense of long-term value.
Disputes Over Performance Measurement
Incentive conflicts often turn into disputes over measuring the financial performance target. Although acquisition agreements typically specify the methodology for calculating the relevant performance measure, disputes could arise over whether that methodology was applied correctly, or whether post-closing accounting and operating decisions depressed the reported outcome (or inflated it if the seller remained involved with the management).
Common examples of such disputes include:
- Expense timing: Shifting discretionary expenses into and out of the earnout period affects a performance metric such as earnings.
- Revenue recognition: Disagreements may arise over whether revenue was appropriately recognized or deferred.
- Purchase accounting effects: Acquisition accounting adjustments, such as inventory step-ups, can lower post-closing earnings, while a seller could argue for excluding such adjustments. Disputes could arise if contracts fail to specify the applicable accounting basis for earnout calculations.
- Asset and reserves revaluations: Changes in reserves or asset valuations can shift reported performance.
- Intercompany allocations: Corporate overhead allocations or inter-company charges may affect the financial results of the acquired business.
These disputes highlight a recurring issue of the sensitivity of the earnout metrics on discretionary choices, even when those choices are made within the bounds of generally accepted accounting principles. Careful financial and accounting analysis is needed to assess whether defendant’s accounting and operational choices were reasonable given the facts and circumstances of the case.
Conclusion
Earnouts remain a widely used and economically significant feature of M&A transactions, particularly in deals involving private targets in industries characterized by high uncertainty such as healthcare and technology. They enable parties to bridge valuation gaps and allocate risk, but they also create the potential for post-closing disputes driven by incentive conflicts. The Delaware Supreme Court decision in J&J v. Fortis serves as a reminder that the risk-allocation agreed between the parties cannot be renegotiated due to a foreseeable contingency.
ENDNOTES
[1] Johnson & Johnson v. Fortis Advisors LLC, Delaware Supreme Court, No. 490, 2024 (Jan. 12, 2026).
[2] A 510(k) is a simplified FDA clearance pathway based on showing that a new device is “substantially equivalent” to an existing legal predicate, whereas De Novo classification is a more rigorous pathway for novel, low-to-moderate risk devices that have no existing predicate and require a fresh risk-based evaluation.
Rahul Chhabra is a principal in the finance practice at Charles River Associates. This post is based on his recent article “Earnouts in M&A: Risk allocation, incentives, and post-closing disputes,” available here.