PRIVILEGED AND CONFIDENTIAL — ATTORNEY WORK PRODUCT This memorandum is protected by the attorney-client privilege and the work product doctrine. It is intended solely for the use of the addressees and authorized recipients identified herein. Any unauthorized review, use, disclosure, or distribution is strictly prohibited. If you have received this document in error, please notify Calderwood & Harkness LLP immediately and destroy all copies.
MEMORANDUM
CALDERWOOD & HARKNESS LLP 555 South Hope Street, Suite 4400 Los Angeles, California 90071
FROM: Tiffany Rosenthal, Lead Associate, Mergers & Acquisitions Practice Group, Calderwood & Harkness LLP
TO: James Prentice, Responsible Partner Sandra Tung, Billing Partner Andrew Fitzpatrick, Senior Associate Leonard Cross, Specialist Partner, Tax
DATE: May 9, 2023
RE: Earnout Structure Analysis — Divestiture of OncuPath™ Companion Diagnostics Assay Line by Genome Dx Therapeutics Inc. to Meridian Precision Diagnostics, Inc.
MATTER NO.: 1013-00006&A-4471
CC: Rebecca Chiang, General Counsel, Genome Dx Therapeutics Inc. (via separate privilege-protected transmittal)
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I. Executive Summary
This memorandum analyzes the earnout provisions negotiated in the Asset Purchase Agreement (the "APA") between Genome Dx Therapeutics Inc. ("GDT" or "Seller") and Meridian Precision Diagnostics, Inc. ("Meridian" or "Buyer") for the sale of GDT's OncuPath™ companion diagnostics assay line (the "OncuPath™ Business" or the "Business"). The APA is expected to be executed tomorrow, May 10, 2023, with closing anticipated on or about August 8, 2023, subject to satisfaction of customary closing conditions, including HSR Act clearance and required third-party consents. This memorandum is prepared for the internal deal team and sets forth our final analysis of the negotiated earnout terms as reflected in the near-final APA, including Exhibit D thereto (the "Earnout Agreement").
The total consideration for the transaction is $140,000,000, structured as follows:
• Closing Cash Payment: $126,000,000, payable at closing by wire transfer of immediately available funds.
• Earnout Consideration: Up to $14,000,000 in contingent milestone-based payments, representing approximately 10% of total consideration.
The earnout is structured around two clinical and regulatory milestones, each payable within a 36-month Earnout Period following the closing of the transaction:
• Milestone 1: $8,000,000, tied to FDA clearance or approval of the OncuPath-HER3™ assay as a companion diagnostic for any FDA-approved therapeutic agent, payable upon the occurrence of such clearance or approval on or before August 8, 2025 (24 months post-closing).
• Milestone 2: $6,000,000, tied to the cumulative satisfaction of two sub-conditions: (i) the issuance by the Centers for Medicare & Medicaid Services ("CMS") of a unique Healthcare Common Procedure Coding System ("HCPCS") code for OncuPath-HER3™, and (ii) Buyer's receipt of first Medicare reimbursement payment for a test performed using the OncuPath-HER3™ assay under such HCPCS code, in each case on or before August 8, 2026 (36 months post-closing).
Key protections negotiated by Calderwood & Harkness on behalf of GDT include: a commercially reasonable efforts standard governing Buyer's obligation to pursue milestone achievement; anti-sandbagging provisions prohibiting Buyer from taking affirmative actions to delay or prevent milestone achievement; anti-embarrassment protections entitling Seller to additional consideration if Buyer divests the OncuPath-HER3™ program at a premium during the Earnout Period; full acceleration of all unpaid milestones upon a Change of Control of Buyer; and a structured, multi-tier dispute resolution framework encompassing good-faith executive negotiation, expert determination by an independent regulatory affairs consultant, and binding arbitration under the rules of the American Arbitration Association. Seller also secured a prohibition on set-off of indemnification claims against earnout payments.
This memorandum summarizes the earnout mechanism as reflected in the near-final APA and Earnout Agreement, identifies drafting considerations and residual risk areas for the Seller, and provides recommendations for post-closing monitoring and enforcement. The balance of this memorandum is organized as follows: Section II provides background and strategic context; Section III details the earnout milestone definitions; Section IV analyzes the commercially reasonable efforts standard; Section V describes the dispute resolution mechanics; Section VI addresses acceleration provisions; Section VII discusses anti-embarrassment protections; Section VIII examines the interplay between the earnout and other key transaction terms; Section IX provides a Seller-favorable risk assessment and recommendations; Section X presents a summary table of key earnout terms; and Section XI offers our concluding recommendations.
II. Background and Strategic Context
A. Transaction Overview
Seller. Genome Dx Therapeutics Inc. ("GDT") is a Delaware corporation headquartered in San Diego, California. GDT is a portfolio company of Pinnacle Biosciences Partners Fund III, L.P. ("Pinnacle" or "PBP III"), a life sciences-focused private equity fund managed by Pinnacle Capital Management LLC, which holds approximately 68.4% of GDT's outstanding common stock. The remaining equity is held by GDT management, employees, and certain minority institutional investors. GDT's core retained business following consummation of the transaction will be its GenoStrat™ liquid biopsy platform, a next-generation sequencing-based platform used for real-time monitoring of circulating tumor DNA in oncology patients. The OncuPath™ companion diagnostics assay line, which GDT acquired in 2019 through the purchase of PathMark Diagnostics, Inc., is a legacy product line that no longer aligns with GDT's strategic roadmap and capital allocation priorities. GDT's total revenue for the fiscal year ended December 31, 2022 was approximately $312 million, of which the OncuPath™ Business contributed approximately $47.6 million, representing approximately 15.3% of total GDT revenue.
Buyer. Meridian Precision Diagnostics, Inc. ("Meridian") is a Delaware corporation headquartered in Research Triangle Park, North Carolina. Meridian is a publicly traded company (NASDAQ: MPDI) with a diversified portfolio of molecular and precision diagnostics products. For the fiscal year ended December 31, 2022, Meridian reported revenue of approximately $589 million and adjusted EBITDA of approximately $104 million. Meridian operates twelve CLIA-certified and CAP-accredited laboratories across the United States and maintains an extensive companion diagnostics test menu serving pharmaceutical partners and clinical oncology customers. The OncuPath™ line complements Meridian's existing CLIA-validated test menu and is expected to generate significant commercial synergies through Meridian's established laboratory network and sales infrastructure.
Transaction Structure. The transaction is structured as an asset purchase, pursuant to which Buyer will acquire substantially all of the assets used in or related to the OncuPath™ Business, including intellectual property, tangible personal property, customer contracts, permits and licenses (to the extent transferable), and certain assumed liabilities. The APA is governed by Delaware law. The closing of the transaction is subject to customary conditions, including, among others, receipt of HSR Act clearance, accuracy of representations and warranties in all material respects, compliance with covenants in all material respects, and receipt of required third-party consents.
Advisors. Brindoval Partners LLC (Victor Sandoval, Managing Director) serves as GDT's financial advisor. Calderwood & Harkness LLP (James Prentice, Responsible Partner) serves as GDT's legal counsel. Meridian's legal counsel is Whitfield Sayer & Gregg LLP (Jonathan Whitfield, Lead Partner). Meridian's financial advisor is J.P. Villanova & Co.
B. Rationale for Earnout Structure
The earnout structure was adopted to bridge a valuation gap between Buyer and Seller with respect to the OncuPath-HER3™ next-generation companion diagnostic assay, which is currently the subject of a PMA supplement (No. P230014) submitted to the U.S. Food and Drug Administration ("FDA") on January 30, 2023. The valuation gap centered on the following divergent assessments:
Buyer's Position. Meridian's position throughout negotiations was that the OncuPath-HER3™ assay, while promising, carries material regulatory approval risk. The PMA supplement was submitted only approximately three months before the anticipated APA signing date, and no PDUFA date has been assigned as of the date of this memorandum. Buyer's diligence team identified several risk factors, including the possibility of an FDA request for additional clinical data, potential for a complete response letter, and competitive pressure from at least two other HER3-targeted companion diagnostic assays in development by third parties. Buyer therefore sought to shift a portion of the consideration attributable to the OncuPath-HER3™ program to a contingent, milestone-based structure.
Seller's Position. GDT's position was that the OncuPath-HER3™ assay has a strong probability of receiving FDA approval based on the clinical validation data generated to date, and that the economic value attributable to the program should be captured in the transaction consideration. GDT's internal regulatory affairs team, led by Yuki Tanabe, assessed the probability of FDA approval at approximately 70-80% based on the strength of the analytical validation and clinical concordance data included in the PMA supplement. GDT acknowledged, however, that the timing uncertainty inherent in the FDA review process made some form of contingent consideration a reasonable negotiating accommodation.
Compromise. The parties agreed to an earnout structure under which 90% of total consideration ($126 million) is paid in cash at closing, and the remaining 10% ($14 million) is contingent on the achievement of two defined milestones within a 36-month Earnout Period. From Pinnacle's perspective, this structure maximizes near-term cash realizations at closing while preserving upside through milestone-based contingent payments. The earnout amount of $14 million, representing 10% of total consideration, was viewed by Pinnacle as an acceptable risk-reward split given the overall valuation of the OncuPath™ Business and the probability-weighted expected value of the milestone payments.
Personnel Continuity. As an important element supporting the feasibility of milestone achievement under Buyer's post-closing management, three key OncuPath™ Business personnel have agreed to transfer to Meridian at closing: Dr. Lara Okonkwo (Vice President, OncuPath R&D), Yuki Tanabe (Head of Regulatory Affairs, OncuPath), and Samuel Briggs (Director, OncuPath Commercial Operations). These individuals possess deep institutional knowledge of the OncuPath-HER3™ program and are expected to play critical roles in advancing the PMA supplement through FDA review and pursuing CMS reimbursement. In total, 83 OncuPath™ Business employees received offers of employment from Meridian in connection with the transaction, of which 78 accepted and will transfer at closing. The five employees who did not accept Meridian's offers held non-critical roles, and their departure is not expected to materially affect milestone achievement.
III. Earnout Milestone Definitions
The Earnout Agreement, attached as Exhibit D to the APA, sets forth two discrete milestones, each with a defined trigger event, deadline, payment amount, and payment timing. The following sections analyze each milestone in detail.
A. Milestone 1 — FDA Clearance/Approval of OncuPath-HER3™ ($8,000,000)
Trigger Event. Milestone 1 is triggered upon FDA clearance (via the Section 510(k) pathway) or approval (via the Premarket Approval ("PMA") pathway) of the OncuPath-HER3™ assay as a companion diagnostic for any FDA-approved therapeutic agent. The definition of "FDA Clearance or Approval" in Section 1.1(a) of the Earnout Agreement is intentionally drafted broadly: it encompasses both the 510(k) clearance and PMA approval pathways, and is not limited to a specific therapeutic agent or indication. This breadth was negotiated at Seller's request to maximize the potential pathways through which the milestone could be triggered. If, for example, the OncuPath-HER3™ assay receives FDA approval as a companion diagnostic for a therapeutic agent different from the one currently identified in the PMA supplement, the milestone would nonetheless be achieved.
Deadline. On or before August 8, 2025, which is 24 months following the anticipated closing date of August 8, 2023. The 24-month deadline was the subject of extensive negotiation. Buyer initially proposed an 18-month deadline, arguing that GDT's internal projections suggested a 12-14 month FDA review timeline for the PMA supplement. Seller pushed for 30 months, citing the inherent unpredictability of FDA review timelines and the possibility of requests for additional information or data. The parties compromised at 24 months.
Payment Amount. $8,000,000, representing approximately 57% of the maximum aggregate earnout.
Payment Timing. Within 10 business days following Buyer's receipt of the FDA clearance or approval letter. The payment is triggered by the regulatory action itself — specifically, the issuance of the FDA clearance or approval letter — and does not require commercial launch, marketing authorization in any other jurisdiction, or any other post-approval activity.
Current Status. The PMA supplement (No. P230014) was submitted to the FDA on January 30, 2023. As of the anticipated closing date, no PDUFA date has been assigned. Based on GDT's regulatory affairs team's assessment, the FDA is expected to assign a PDUFA date within 60-90 days of filing, with a standard review cycle of 180 days from filing acceptance. However, these timelines are subject to FDA discretion, and delays are not uncommon, particularly in the companion diagnostics space where coordinated review with the corresponding therapeutic product may be required.
Key Drafting Issue — Conditional or Provisional FDA Responses. A significant drafting issue that arose during negotiations was whether a conditional or provisional FDA response would constitute "clearance or approval" sufficient to trigger the milestone. Examples of conditional responses include an "approvable" letter (historically used by FDA, though less common in recent years), a conditional approval with post-market study requirements, or an approval contingent upon specific labeling modifications. The Earnout Agreement resolves this issue by defining "FDA Clearance or Approval" as requiring a final, unconditional clearance letter (in the case of 510(k)) or approval order (in the case of PMA) from the FDA. Conditional approvals, approvable letters, and approvals subject to unresolved conditions precedent do not satisfy the milestone definition. However, an approval that includes standard post-market study commitments (e.g., Phase IV commitments or post-market surveillance requirements) does constitute a qualifying approval, as such commitments are routine conditions of PMA approvals and do not render the approval "conditional" within the meaning of the Earnout Agreement.
B. Milestone 2 — CMS HCPCS Code and First Medicare Reimbursement ($6,000,000)
Trigger Event. Milestone 2 is triggered upon the cumulative satisfaction of two sub-conditions:
(i) CMS issuance of a unique HCPCS code for OncuPath-HER3™ (or any successor assay based on the same underlying technology); and
(ii) Buyer's receipt of first Medicare reimbursement payment for a test performed using the OncuPath-HER3™ assay (or successor assay) under such HCPCS code.
Both sub-conditions must be satisfied on or before the applicable deadline. The issuance of a HCPCS code alone, without actual receipt of reimbursement, does not trigger the milestone. Similarly, receipt of reimbursement under a miscellaneous or unassigned code does not satisfy the milestone requirement — the reimbursement must be received under the unique HCPCS code issued specifically for OncuPath-HER3™ or its successor assay.
Successor Assay Language. The inclusion of "successor assay" language in the Milestone 2 definition was insisted upon by Seller during the penultimate negotiation session (April 28, 2023). This language is designed to prevent Buyer from circumventing the milestone by re-branding, re-naming, or slightly modifying the OncuPath-HER3™ assay in a manner that would technically take it outside the milestone definition while preserving the economic substance of the program. "Successor assay" is defined in Section 1.1(b) of the Earnout Agreement as "any in vitro diagnostic assay that is based on the same underlying technology, analytical methodology, and biomarker targets as the OncuPath-HER3™ assay, regardless of any changes in nomenclature, branding, formatting, or incremental modifications that do not fundamentally alter the assay's intended use or mechanism of detection."
Deadline. On or before August 8, 2026, which is 36 months following the anticipated closing date. The additional 12 months beyond the Milestone 1 deadline reflects the sequential nature of the regulatory and reimbursement process: as a practical matter, FDA approval is typically a prerequisite to CMS coverage determination for a companion diagnostic, and the CMS HCPCS code application and Medicare reimbursement process involves its own distinct timeline.
Payment Amount. $6,000,000, representing approximately 43% of the maximum aggregate earnout.
Payment Timing. Within 10 business days following Buyer's receipt of the first Medicare reimbursement payment under the applicable HCPCS code.
Independence of Milestones. Milestone 2 is structured as independent of Milestone 1. Technically, Milestone 2 can be achieved even if Milestone 1 is not achieved — for example, if the OncuPath-HER3™ assay (or a successor assay) obtains FDA approval through a pathway or timeline not contemplated by Milestone 1's 24-month deadline, and subsequently receives a HCPCS code and Medicare reimbursement within the 36-month Milestone 2 deadline. However, as a practical and regulatory matter, FDA approval is a de facto precondition to Medicare coverage for a companion diagnostic assay, as CMS coverage determinations for new diagnostic technologies are typically contingent upon the existence of FDA clearance or approval. Accordingly, the failure to achieve Milestone 1 within its 24-month deadline would materially reduce (though not entirely eliminate) the probability of achieving Milestone 2 within the 36-month period.
C. Aggregate Earnout Cap
The maximum aggregate earnout payments under the Earnout Agreement are capped at $14,000,000. The following table summarizes the potential outcomes:
In the event that neither milestone is achieved by its respective deadline, no additional consideration beyond the closing cash payment of $126,000,000 (subject to the working capital adjustment described in Section VIII.E below) will be payable by Buyer.
IV. Commercially Reasonable Efforts Standard
A. Definition and Scope
The Buyer's obligation to pursue achievement of the earnout milestones is governed by a "commercially reasonable efforts" standard, as set forth in Section 2.1 of the Earnout Agreement. The Buyer covenants to use commercially reasonable efforts to achieve each earnout milestone within the applicable deadline.
The term "commercially reasonable efforts" is defined in Section 1.2 of the Earnout Agreement as follows:
"Commercially Reasonable Efforts" means those efforts and resources consistent with those that a similarly situated company in the diagnostics industry, of comparable size, resources, and capabilities to Buyer, would use to develop, seek regulatory approval for, and commercialize a companion diagnostic assay with similar market potential, stage of development, safety and efficacy profile, and competitive landscape, taking into account all relevant factors, including safety, efficacy, regulatory requirements, competitive conditions, intellectual property considerations, and the overall economic return expected from such efforts.
This definition was the product of significant negotiation. Seller initially proposed a "best efforts" standard, which would have imposed a higher obligation on Buyer. Buyer countered with a "reasonable efforts" standard, which would have afforded Buyer significantly more discretion. The parties ultimately agreed on the "commercially reasonable efforts" formulation, which is the prevailing standard in life sciences M&A earnout provisions and has a substantial body of interpretive case law under Delaware law, including the Delaware Court of Chancery's analysis in Himawan v. Cephalon, Inc., C.A. No. 2018-0075-SG (Del. Ch. 2019), and related precedent.
The definition explicitly provides that the commercially reasonable efforts standard does not require Buyer to take actions that would be commercially unreasonable for a company of Meridian's size and resources. Additionally, the Earnout Agreement includes carve-outs from the efforts standard for (a) unforeseen regulatory requirements imposed by FDA, CMS, or other governmental authorities, (b) material changes in applicable law or regulation, and (c) force majeure events as defined in Section 10.14 of the APA.
B. Affirmative Obligations
In addition to the general commercially reasonable efforts covenant, Section 2.2 of the Earnout Agreement sets forth specific affirmative obligations of the Buyer during the Earnout Period, including the following:
(a) Adequate Staffing. Buyer must maintain adequate staffing of the OncuPath-HER3™ regulatory and development team, including the key transferred personnel (Dr. Lara Okonkwo, Yuki Tanabe, and Samuel Briggs), to the extent such individuals remain employed by Buyer or its affiliates. The Earnout Agreement does not mandate the retention of specific individuals, but does require that Buyer maintain a qualified team of comparable experience and capability. If any key transferred personnel depart Buyer's employ during the Earnout Period, Buyer is obligated to use commercially reasonable efforts to replace such individuals with personnel of comparable qualifications within a reasonable time.
(b) Timely Response to FDA Communications. Buyer must respond to FDA requests for additional information, deficiency letters, or other communications relating to the PMA supplement (P230014) or any successor filing for the OncuPath-HER3™ assay within commercially reasonable timelines, and in no event later than the timelines specified by the FDA in such communications.
(c) No Voluntary Withdrawal of PMA Supplement. Buyer may not voluntarily withdraw or abandon the PMA supplement (P230014) without Seller's prior written consent, which consent shall not be unreasonably withheld, conditioned, or delayed if Buyer demonstrates a bona fide scientific, regulatory, or safety basis for such withdrawal. The Earnout Agreement specifies that "bona fide scientific, regulatory, or safety basis" includes, without limitation, a final FDA determination that the OncuPath-HER3™ assay poses an unacceptable safety risk, a material change in the competitive landscape that renders the assay clinically obsolete, or the identification of a fundamental analytical validity deficiency that cannot be remedied through reasonable additional development efforts.
(d) CMS Application. Following FDA clearance or approval of the OncuPath-HER3™ assay, Buyer must prepare and submit the HCPCS code application to CMS within a commercially reasonable time, and in any event within 90 days of FDA clearance or approval.
(e) No Obstruction of Reimbursement Process. Buyer shall not delay, obstruct, or take any affirmative action to undermine the Medicare reimbursement process for the OncuPath-HER3™ assay, including the coding, coverage, and payment determination process.
C. Negative Covenants / Anti-Sandbagging Provisions
Section 2.3 of the Earnout Agreement includes a set of negative covenants designed to protect Seller against "sandbagging" — i.e., conduct by Buyer that is intended to prevent or delay the achievement of earnout milestones in order to avoid making the earnout payments. These provisions were a critical negotiating priority for Seller and reflect Delaware case law recognizing the implied covenant of good faith and fair dealing in earnout contexts. See, e.g., Adriatic Industries Technology Partners, LLC v. Qinetiq North America Operations LLC, C.A. No. 7920-VCG (Del. Ch. 2014).
The negative covenants include the following:
(a) No Deliberate Delay or Prevention. Buyer shall not take any affirmative action with the primary purpose or effect of preventing or delaying the achievement of any earnout milestone. This provision targets conduct such as intentionally deprioritizing the OncuPath-HER3™ program, diverting key personnel to other projects, or failing to respond to FDA or CMS communications in a timely manner.
(b) No Unauthorized Transfer of Technology. Buyer shall not assign, transfer, sublicense, or otherwise dispose of the OncuPath-HER3™ technology or related intellectual property to any third party in a manner that would impair the ability to achieve the milestones, without Seller's prior written consent. This provision does not restrict intra-affiliate transfers or internal reorganizations, provided that the transferee affiliate assumes Buyer's obligations under the Earnout Agreement.
(c) No Disproportionate Funding Reductions. Buyer shall not reduce funding for, or reprioritize, the OncuPath-HER3™ program below commercially reasonable levels relative to Meridian's overall diagnostics pipeline and development budget. This provision is designed to address the risk that Buyer, having acquired the OncuPath™ Business and its associated revenue streams, might rationally choose to allocate development resources to other, potentially more profitable programs at the expense of the OncuPath-HER3™ program.
(d) Seller's Remedies. Seller retains the right to claim breach of the commercially reasonable efforts covenant if Buyer takes affirmative steps to delay or prevent milestone achievement, and may pursue remedies through the dispute resolution mechanisms set forth in Section V below, including, where appropriate, injunctive relief.
D. Reporting Obligations
Section 2.4 of the Earnout Agreement establishes ongoing reporting and transparency obligations to ensure that Seller has adequate visibility into Buyer's development efforts during the Earnout Period. These obligations include:
(a) Quarterly Written Reports. Buyer shall provide Seller with quarterly written reports on progress toward each earnout milestone, to be delivered within 30 days following the end of each calendar quarter during the Earnout Period. Each quarterly report shall include, at a minimum: (i) the current status of FDA communications relating to the OncuPath-HER3™ PMA supplement or any successor filing, including any substantive correspondence received from or sent to the FDA; (ii) a summary of any clinical trial data generated or analyzed during the quarter, if applicable; (iii) the status of regulatory submissions and anticipated FDA action timelines; (iv) a summary of CMS interactions, including the status of any HCPCS code application or coverage determination process; and (v) anticipated timelines for milestone achievement based on current development plans.
(b) In-Person Meeting Rights. Seller has the right to request one in-person meeting per calendar quarter with Buyer's regulatory and development teams responsible for the OncuPath-HER3™ program. Such meetings shall be held at Buyer's facilities in Research Triangle Park, North Carolina, or at such other location as the parties may mutually agree, at Seller's expense. Buyer shall make available for such meetings the senior members of the OncuPath-HER3™ regulatory and development team, including Dr. Lara Okonkwo and Yuki Tanabe (to the extent they remain employed by Buyer).
(c) Prompt Notification of Material Adverse Developments. Buyer shall promptly notify Seller, and in no event later than five (5) business days following the occurrence thereof, of any material adverse development affecting the likelihood of milestone achievement. Material adverse developments include, without limitation: FDA refusal to file the PMA supplement; receipt of a complete response letter from the FDA; imposition of a clinical hold; identification of a material safety signal; CMS coverage denials; and any decision by Buyer to materially alter the development or regulatory strategy for the OncuPath-HER3™ program.
The reporting obligations are designed to provide Seller with sufficient information to monitor Buyer's compliance with the commercially reasonable efforts standard and to identify potential disputes at an early stage. The quarterly reporting framework also provides a structured mechanism for ongoing communication between the parties regarding the status of the OncuPath-HER3™ program, which is expected to facilitate cooperative engagement during the Earnout Period.
V. Dispute Resolution Mechanics
The Earnout Agreement establishes a three-tier dispute resolution framework for resolving disputes relating to earnout milestone achievement, Buyer's compliance with the commercially reasonable efforts standard, and the calculation and payment of earnout amounts. The tiered structure is designed to encourage early, cost-effective resolution while preserving the parties' ability to obtain binding adjudication when necessary.
A. Good-Faith Negotiation
Pursuant to Section 4.1 of the Earnout Agreement, any dispute relating to the earnout provisions must first be submitted to designated senior executives of each party for good-faith negotiation. The designated executives are:
• For Seller: Dr. Helena Vasquez, Chief Executive Officer of GDT, or her designee.
• For Buyer: Thomas Ellsworth, Chief Executive Officer of Meridian, or his designee.
The initiating party must deliver a written notice (a "Dispute Notice") to the other party identifying the nature of the dispute in reasonable detail. The senior executives shall meet (in person or by videoconference) within 15 days of delivery of the Dispute Notice and shall use good-faith efforts to resolve the dispute within 30 days of the Dispute Notice. No party may escalate a dispute to expert determination or arbitration without first complying with this executive negotiation requirement.
B. Expert Determination
If a dispute is not resolved through executive negotiation within the 30-day period, Section 4.2 of the Earnout Agreement provides for submission of certain categories of disputes to an independent expert for binding determination. Specifically, disputes regarding scientific or regulatory matters — including, without limitation, whether Buyer has exercised commercially reasonable efforts to achieve the earnout milestones, whether Buyer's development and regulatory strategy for OncuPath-HER3™ is consistent with industry standards, and whether a particular FDA or CMS action or inaction constitutes a material adverse development — shall be submitted to an independent expert.
The independent expert shall be a regulatory affairs consultant mutually agreed upon by the parties, who meets the following qualifications: (i) at least 15 years of experience in FDA regulatory submissions for in vitro diagnostic devices, with a specific focus on companion diagnostics; (ii) no prior business relationship with either party or their respective affiliates; and (iii) no financial interest in the outcome of the dispute. If the parties are unable to agree on the selection of an expert within 15 days following the expiration of the executive negotiation period, either party may request the American Arbitration Association to appoint an expert meeting the foregoing qualifications.
The expert's determination shall be rendered in writing within 60 days of appointment, shall include a reasoned analysis of the factual and scientific bases for the determination, and shall be binding and non-appealable, except in the case of manifest error or fraud. Each party shall bear one-half of the expert's fees and expenses, and each party shall bear its own legal and advisory costs in connection with the expert determination proceeding.
C. Arbitration. Disputes that are not resolved through expert determination, or that are not amenable to expert review — including, without limitation, disputes regarding contractual interpretation, the calculation of earnout payment amounts, the applicability of acceleration provisions, and claims for breach of the anti-sandbagging or anti-embarrassment provisions — shall be resolved by binding arbitration administered by the American Arbitration Association ("AAA") under its Commercial Arbitration Rules, as set forth in Section 4.3 of the Earnout Agreement.
The arbitration shall be seated in Wilmington, Delaware, consistent with the Delaware governing law provision of the APA (Section 10.9). The arbitration shall be conducted by a single arbitrator selected through the AAA's arbitrator selection procedures, provided that the arbitrator must have substantial experience in mergers and acquisitions transactions and the life sciences industry. The arbitrator's award shall be final and binding on the parties, and judgment upon the award may be entered in any court of competent jurisdiction, including the Delaware Court of Chancery and the United States District Court for the District of Delaware.
The arbitration provision includes customary procedural safeguards, including limited discovery, a compressed timeline for hearing and award (no more than 120 days from arbitrator appointment to final award), and confidentiality protections for information exchanged during the proceeding.
D. Interim Relief
Notwithstanding the foregoing tiered dispute resolution framework, Section 4.4 of the Earnout Agreement expressly preserves each party's right to seek injunctive or other equitable relief in any court of competent jurisdiction to prevent irreparable harm pending the resolution of a dispute through the mechanisms described above. This carve-out is particularly important for Seller, as it preserves GDT's ability to seek a temporary restraining order or preliminary injunction in circumstances where Buyer's actions (or inactions) threaten to cause irreversible damage to the prospects for milestone achievement — for example, an injunction to prevent Buyer from withdrawing the PMA supplement without Seller's consent, or to compel Buyer to respond to an FDA deficiency letter within the required timeframe.
The interim relief provision does not require exhaustion of the executive negotiation or expert determination tiers as a prerequisite to filing for injunctive relief. This was a Seller-favorable drafting point that ensures GDT can act quickly in time-sensitive situations without being required to wait through the 30-day negotiation period.
VI. Acceleration Provisions
A. Buyer Change of Control
Section 3.1 of the Earnout Agreement provides that if Buyer undergoes a "Change of Control" at any time during the Earnout Period, all unpaid earnout milestone payments shall become immediately due and payable at their full stated amounts, without regard to whether the applicable milestone has been achieved or is reasonably likely to be achieved.
"Change of Control" is defined in Section 1.3 of the Earnout Agreement as the occurrence of any of the following events:
(a) Any person or group (within the meaning of Section 13(d)(3) of the Securities Exchange Act of 1934, as amended) acquires, directly or indirectly, beneficial ownership of more than 50% of the voting power of the outstanding voting securities of Buyer;
(b) Buyer consummates a merger, consolidation, or similar business combination transaction with any person, unless immediately following such transaction, the holders of Buyer's voting securities immediately prior to the transaction hold, directly or indirectly, more than 50% of the voting power of the surviving or resulting entity;
(c) Buyer sells, transfers, or otherwise disposes of all or substantially all of its assets to any person other than a wholly owned subsidiary of Buyer; or
(d) The individuals who constitute the Board of Directors of Buyer as of the closing date (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board of Directors, provided that any individual whose election or nomination was approved by a majority of the Incumbent Board shall be deemed a member of the Incumbent Board for purposes of this clause.
Payment Mechanics. In the event of a Change of Control, the aggregate amount of all unpaid earnout milestone payments shall become immediately due and payable by Buyer (or its successor) within 10 business days of the closing of the Change of Control transaction. If both milestones remain unpaid at the time of the Change of Control, the accelerated amount is $14,000,000. If Milestone 1 has already been paid but Milestone 2 remains unpaid, the accelerated amount is $6,000,000. If Milestone 2 has been paid but Milestone 1 remains unpaid (an unlikely but theoretically possible scenario), the accelerated amount is $8,000,000.
Rationale. The Change of Control acceleration provision was among the most heavily negotiated terms in the Earnout Agreement. The rationale from Seller's perspective is straightforward: if Buyer sells the OncuPath-HER3™ asset (or undergoes a transaction that effectively transfers control of Buyer) during the Earnout Period, the commercially reasonable efforts obligation may be impaired, as the acquirer may not have the same incentive or capability to pursue the milestones. Full acceleration ensures that Seller captures the earnout value regardless of the acquirer's intentions with respect to the OncuPath-HER3™ program.
Negotiation History. Buyer initially resisted full acceleration and proposed a pro rata payment mechanism based on the stage of progress toward each milestone at the time of the Change of Control. Under Buyer's proposal, an independent expert would assess the percentage completion of each milestone, and Seller would receive a proportionate payment. Seller rejected this proposal on the grounds that it would introduce significant subjectivity and dispute risk, and would provide inadequate protection in scenarios where milestones were at an early stage of completion. Seller prevailed on full acceleration after Brindoval Partners (Victor Sandoval) communicated to Buyer's financial advisor that Pinnacle viewed the Change of Control acceleration provision as a closing condition for the transaction.
B. Voluntary Abandonment
Section 3.2 of the Earnout Agreement provides a separate acceleration trigger in the event of Buyer's voluntary abandonment of the OncuPath-HER3™ development program. If Buyer voluntarily abandons the development of OncuPath-HER3™ — defined as any of the following actions taken without Seller's prior written consent and without demonstrating a bona fide scientific, regulatory, or safety basis:
(a) Withdrawal of the PMA supplement (P230014) or any successor regulatory filing for the OncuPath-HER3™ assay;
(b) Cessation of HCPCS code application efforts with CMS;
(c) Public announcement by Buyer of the discontinuation of the OncuPath-HER3™ program; or
(d) Any other action or series of actions by Buyer that, individually or in the aggregate, constitutes a de facto abandonment of the OncuPath-HER3™ development program —
then all unpaid milestone payments shall accelerate and become immediately due and payable within 10 business days of the date of voluntary abandonment.
The Earnout Agreement draws a critical distinction between voluntary abandonment and involuntary regulatory setbacks. Involuntary regulatory setbacks — including, without limitation, FDA refusal to file, issuance of a complete response letter, imposition of a clinical hold, or CMS coverage denial — do not trigger the voluntary abandonment acceleration provision, provided that Buyer continues to use commercially reasonable efforts to address such setbacks and pursue the milestones through alternative approaches where available. The burden of proof rests with Buyer to demonstrate that any abandonment was involuntary and that Buyer had a bona fide scientific, regulatory, or safety basis for its decision.
VII. Anti-Embarrassment Protections
A. Scope. Section 3.3 of the Earnout Agreement includes anti-embarrassment protections designed to ensure that Seller shares in any value appreciation attributable to the OncuPath-HER3™ program during the Earnout Period. Specifically, if Buyer divests, licenses, or otherwise transfers the OncuPath-HER3™ assay (or any successor assay based on the same underlying technology, as defined in Section 1.1(b)) to a third party during the Earnout Period at a valuation that implies a higher value for the OncuPath-HER3™ program than reflected in the aggregate earnout consideration, Seller is entitled to an anti-embarrassment payment.
The anti-embarrassment payment is calculated as follows:
The lesser of:
(a) The positive difference, if any, between the implied value of the OncuPath-HER3™ program in the subsequent transaction (determined based on the aggregate consideration allocated to the OncuPath-HER3™ program in such transaction, as set forth in the applicable purchase agreement or, in the absence of such allocation, as determined by an independent valuation firm mutually selected by the parties) and the maximum aggregate earnout consideration of $14,000,000; and
(b) The maximum aggregate earnout consideration of $14,000,000, less any earnout amounts already paid by Buyer to Seller as of the date of such subsequent transaction.
The anti-embarrassment payment, if any, shall be payable by Buyer within 10 business days of the closing of the subsequent transaction. The anti-embarrassment provision effectively caps Seller's additional recovery at the amount of unpaid earnout, but ensures that Seller is compensated to the full extent of the earnout if Buyer's subsequent disposition of the OncuPath-HER3™ program validates the program's value.
B. Practical Application
The anti-embarrassment provision is designed to protect GDT (and, by extension, Pinnacle Biosciences Partners Fund III) from a scenario in which Buyer acquires the OncuPath™ Business at a valuation that incorporates a $14 million earnout discount, and then flips the OncuPath-HER3™ asset to a third party at a premium shortly after closing, capturing the upside attributable to the milestones without making the earnout payments. This is a recognized risk in M&A transactions involving contingent consideration, and anti-embarrassment provisions have become increasingly common in private equity-backed divestitures of life sciences assets.
The anti-embarrassment provision does not apply to:
(a) Internal reorganizations or corporate restructurings involving Buyer and its affiliates, provided that the transferee affiliate assumes Buyer's obligations under the Earnout Agreement; or
(b) Licensing or collaboration arrangements entered into by Buyer in the ordinary course of business that do not constitute a disposition of the OncuPath-HER3™ program in its entirety.
VIII. Interplay with Other Transaction Terms
A. Escrow Mechanics
The APA provides for a $14,000,000 escrow deposit at Ashgrove Equity Partners Escrow Services, Inc. (Account No. 8841-7023-5500) to secure Seller's indemnification obligations under Article IX of the APA. The escrow is established at closing and will be maintained for the duration of the 18-month general survival period, subject to extensions for pending claims. The escrow serves as the primary source of recovery for Buyer's indemnification claims.
It is important to note that the escrow is separate and distinct from the earnout obligations. Earnout payments are not secured by, and are not payable from, the escrow. They are direct payment obligations of Buyer, payable from Buyer's general corporate funds. This distinction is significant because it means that the earnout obligations survive independent of the escrow and are not subject to depletion by indemnification claims.
No Set-Off Right. Section 3.5 of the Earnout Agreement provides that Buyer may not set off, deduct, or counterclaim any indemnification claims, losses, or other amounts owed to Buyer under the APA against any earnout payments owed to Seller. This is a Seller-favorable provision that was the subject of considerable negotiation. Buyer initially sought a broad set-off right, arguing that the earnout payments represent deferred purchase price and should be available to offset Seller's indemnification obligations. Seller argued — and ultimately prevailed on the position — that the earnout payments are contingent consideration earned through the achievement of defined milestones and should not be subject to diminution by unrelated indemnification claims. Any indemnification recovery must be pursued by Buyer through the escrow mechanism or through direct indemnification claims under Article IX of the APA, independent of the earnout.
B. Indemnification Cap and Basket
The APA's indemnification framework is summarized below for context, though the earnout obligations operate independently of these provisions:
• Indemnification Cap: $28,000,000, representing 20% of total consideration of $140 million. This cap applies to all indemnification claims other than claims for breach of fundamental representations, fraud, or intentional misrepresentation, which are not subject to the cap.
• Aggregate Basket (Tipping): $1,400,000, representing 1% of total consideration. Once aggregate losses exceed the basket amount, Buyer may recover from the first dollar (tipping basket, not deductible).
• De Minimis Per-Claim Threshold: $75,000. Individual claims with losses below $75,000 do not count toward the aggregate basket and are not indemnifiable.
• Survival Period: General representations and warranties survive for 18 months following closing (August 8, 2023 through February 8, 2025). Fundamental representations (organization, authority, capitalization, title to assets, broker's fees, and tax representations) survive for 60 months following closing (through August 8, 2028).
Earnout obligations are independent of and not subject to the indemnification cap or basket. The earnout payments are purchase price obligations of Buyer, not indemnification claims of Seller. This characterization is consistent with established Delaware law and with the parties' intent as reflected in the APA and Earnout Agreement.
C. R&W Insurance
Meridian has obtained a buyer-side representations and warranties insurance policy from Apex Mutual Insurance Company (Policy No. RWI-2023-07182) with the following key terms:
• Policy Limit: $28,000,000
• Retention: $1,400,000 (which is aligned with the indemnification basket under the APA)
• Premium: $840,000, split equally between Seller and Buyer ($420,000 per party)
• Policy Term: Coterminous with the survival periods under the APA (18 months for general representations; 60 months for fundamental representations)
The R&W insurance policy provides Buyer with a source of recovery for breaches of Seller's representations and warranties, in addition to (and in certain circumstances in lieu of) direct claims against the escrow. However, the R&W policy does not cover earnout payment disputes. Earnout obligations are contractual purchase price components, not breaches of representations and warranties, and are therefore outside the scope of the R&W policy. This distinction was confirmed during the R&W insurance underwriting process, and the policy includes an explicit carve-out for "Contingent Consideration Disputes."
D. Tax Treatment of Earnout Payments
Based on the tax structuring analysis prepared by Leonard Cross, the earnout payments, if and when received, will be treated for federal income tax purposes as follows:
Additional Purchase Price. The earnout payments will be treated as additional purchase price received by Seller in connection with the asset sale, allocated among the transferred assets in accordance with IRC § 1060 and the residual allocation method prescribed thereunder. The preliminary purchase price allocation (subject to adjustment for any earnout payments) is as follows:
The parties have agreed to cooperate in good faith to finalize the purchase price allocation within 120 days of closing (by December 6, 2023). Any earnout payments received subsequent to the initial allocation will require a corresponding allocation adjustment, with the incremental consideration allocated among the relevant asset classes in a manner consistent with the original allocation methodology and IRC § 1060.
Installment Sale Reporting. The contingent nature of the earnout payments raises considerations under IRC § 453 relating to installment sale reporting for contingent payment obligations. Leonard Cross has advised that GDT may elect to report the earnout payments on the installment method, recognizing gain as payments are received, subject to applicable limitations including the requirement to treat the maximum selling price ($140 million) as the stated selling price if the contingent amounts are subject to a maximum. However, because the earnout is capped at $14 million, and the aggregate consideration is therefore determinable, the installment method analysis may require GDT to treat the full $140 million as the stated selling price at closing, with a basis recovery adjustment upon expiration of the milestones if not achieved. Leonard Cross will finalize the installment sale analysis and coordinate reporting with Haverford & Lane LLP (Douglas Crane, Engagement Partner), GDT's independent auditor.
California Source Income. GDT is a Delaware corporation headquartered in San Diego, California. California source income apportionment rules will apply to Seller's gain from the asset sale, including any earnout receipts. The California Franchise Tax Board may assert that earnout payments received by GDT are allocable to California based on the location of the transferred business operations. Leonard Cross is coordinating state tax analysis with GDT's tax advisors.
E. Working Capital Adjustment
The APA includes a customary working capital adjustment mechanism based on the net working capital of the OncuPath™ Business as of the closing date:
• Target Net Working Capital ("NWC"): $6,800,000
• Collar: ±$350,000 (i.e., no adjustment for deviations within the range of $6,450,000 to $7,150,000)
• True-Up Mechanism: Final closing balance sheet to be prepared by Haverford & Lane LLP (Douglas Crane, Engagement Partner) within 60 days of closing; Buyer review period of 30 days; true-up payment within 90 days post-closing (by November 6, 2023)
The working capital adjustment is a separate closing adjustment mechanism and operates independently of the earnout calculations. The earnout milestone payments are not affected by the working capital true-up, and vice versa. The NWC adjustment relates solely to the closing cash payment of $126,000,000 and does not modify the aggregate earnout cap of $14,000,000.
IX. Seller-Favorable Drafting Considerations and Risk Assessment
A. Strengths of Current Earnout Structure
Calderwood & Harkness has negotiated a number of Seller-favorable provisions that materially strengthen GDT's position with respect to the earnout. The principal strengths of the current structure are as follows:
Objective, Verifiable Milestones. The earnout milestones are defined by reference to specific, objective, verifiable regulatory and reimbursement events — namely, FDA clearance or approval and CMS issuance of a HCPCS code coupled with receipt of Medicare reimbursement. Unlike revenue-based or EBITDA-based earnouts, which are inherently susceptible to manipulation through accounting judgments, cost allocations, and operational decisions, milestone-based earnouts tied to regulatory actions are binary in nature: the milestone either occurred or it did not. This significantly reduces the scope for subjective disputes regarding milestone achievement.
Anti-Sandbagging Provisions. The anti-sandbagging provisions in Section 2.3 of the Earnout Agreement provide robust protection against Buyer deliberately undermining milestone achievement. These provisions impose both affirmative obligations (commercially reasonable efforts) and negative covenants (no deliberate delay or prevention) on Buyer, and explicitly preserve Seller's right to claim breach and pursue remedies, including injunctive relief.
Full Acceleration on Change of Control. The Change of Control acceleration provision ensures that Seller captures the full earnout value in the event of a Buyer sale or merger during the Earnout Period. This protection is critical in the current M&A environment, where serial acquisitions in the diagnostics sector are common, and eliminates the risk that a Buyer change of control would terminate the commercially reasonable efforts obligation without compensating Seller.
Anti-Embarrassment Clause. The anti-embarrassment provision prevents Buyer from profiting disproportionately from a subsequent disposition of the OncuPath-HER3™ program at a premium during the Earnout Period. This provision is particularly relevant given the potential for significant value creation in the event of FDA approval and Medicare reimbursement.
No Set-Off Right. The prohibition on set-off of indemnification claims against earnout payments ensures that Buyer cannot use real or manufactured indemnification claims as a mechanism to reduce or eliminate earnout payments. This is one of the most significant Seller-favorable provisions in the Earnout Agreement and provides GDT with certainty regarding the earnout payments independent of any indemnification disputes.
Quarterly Reporting Obligations. The reporting obligations provide Seller with ongoing visibility into Buyer's development efforts, enabling early identification of potential compliance issues and creating a documentary record that may be relevant in any future dispute regarding commercially reasonable efforts.
Successor Assay Language. The inclusion of "successor assay" language in the Milestone 2 definition prevents Buyer from circumventing the milestone through cosmetic re-branding or minor modifications to the assay.
B. Residual Risks for Seller
Notwithstanding the foregoing protections, several residual risks remain for Seller under the current earnout structure:
Regulatory Risk. The most significant risk is that the FDA may not approve or clear OncuPath-HER3™ within the 24-month Milestone 1 deadline (or at all). FDA regulatory outcomes are inherently uncertain, and the outcome of the PMA supplement review is a binary event that is not entirely within Buyer's control, even with commercially reasonable efforts. If the FDA issues a complete response letter requesting additional clinical data, or if safety signals emerge that delay or prevent approval, Milestone 1 may not be achieved. While Seller has negotiated a robust commercially reasonable efforts standard, this standard does not guarantee a favorable FDA outcome.
CMS Reimbursement Risk. Even in the event of successful FDA approval, the timeline for CMS issuance of a unique HCPCS code and Medicare reimbursement is uncertain and may extend beyond the 36-month Milestone 2 deadline. CMS coverage determination processes for novel diagnostic technologies have historically been subject to significant delays, and recent backlogs in CMS's HCPCS code application review process may exacerbate this risk. Additionally, CMS may determine that the OncuPath-HER3™ assay does not meet the reasonable and necessary standard for Medicare coverage, which would prevent achievement of both sub-conditions of Milestone 2.
Enforcement Risk. The "commercially reasonable efforts" standard, while well-established in Delaware law, is inherently fact-intensive and difficult to adjudicate. Proving that Buyer failed to exercise commercially reasonable efforts requires Seller to demonstrate that Buyer's actions fell below the standard of a similarly situated diagnostics company, which necessarily involves subjective assessments of industry practice, resource allocation, and regulatory strategy. While the expert determination mechanism provides a specialized adjudicatory forum for such disputes, the process is nevertheless costly, time-consuming, and uncertain in outcome.
Credit Risk. The earnout payments are unsecured obligations of Buyer, not secured by the escrow, a parent guarantee, a letter of credit, or any other form of collateral or credit support. If Buyer's financial condition deteriorates during the Earnout Period — for example, due to adverse business developments, excessive leverage, or a downturn in the diagnostics industry — GDT's ability to collect on the earnout payments could be impaired. However, this risk is mitigated by Meridian's current financial profile: FY 2022 revenue of $589 million, adjusted EBITDA of $104 million, and a publicly traded equity with significant market capitalization. Additionally, Buyer's acquisition financing through Summit National Bank, N.A. ($95 million term loan commitment, Karen Delacroix, Relationship Manager) is structured with covenants and limitations that should not impair Buyer's ability to make milestone payments of the amounts contemplated.
Key Personnel Risk. The achievement of the earnout milestones is significantly dependent on the continued engagement of key transferred personnel, particularly Dr. Lara Okonkwo (VP, OncuPath R&D) and Yuki Tanabe (Head of Regulatory Affairs, OncuPath). If these individuals depart Meridian's employ during the Earnout Period — whether voluntarily or involuntarily — milestone achievement could be adversely affected. The Earnout Agreement requires Buyer to maintain adequate staffing and to use commercially reasonable efforts to replace departing key personnel, but does not guarantee retention of specific individuals. Moreover, while the APA includes a two-year non-solicitation agreement restricting GDT from re-hiring transferred employees, this restriction does not prevent voluntary departure to third parties unaffiliated with GDT.
C. Recommendations. Based on our analysis, Calderwood & Harkness offers the following recommendations to GDT's management and board:
1. Monitoring and Engagement. Seller should actively monitor the quarterly reports provided by Buyer and exercise its in-person meeting rights to maintain direct visibility into the OncuPath-HER3™ development program. GDT should designate an internal point of contact (we recommend Dr. Vasquez's office or Rebecca Chiang, General Counsel) to receive and review each quarterly report, track progress against milestone timelines, and flag any potential concerns for escalation.
2. Prompt Dispute Resolution. If at any point Buyer's quarterly reports or other communications suggest that Buyer is deviating from the commercially reasonable efforts standard — for example, by reducing staffing, deprioritizing the OncuPath-HER3™ program, or failing to respond to FDA communications in a timely manner — Seller should promptly engage the dispute resolution mechanisms set forth in the Earnout Agreement. Early intervention is critical, as delays in raising commercially reasonable efforts concerns may be prejudicial in any subsequent expert determination or arbitration proceeding.
3.