Good Faith in M&A Deals at the Supreme Court of Delaware: A Canadian Perspective

The January 12, 2026 decision of the Supreme Court of Delaware in Johnson & Johnson v. Fortis Advisors LLC, File No. 490, 2024 offers Canadian lawyers a fascinating window into how contractual duties of good faith may affect mergers and acquisitions (“M&A”).  While Canadian disputes over good faith in M&A deals are relatively rare, such litigation is likely to build as courts develop doctrines like the duty of honest performance and the duty to exercise contractual discretion reasonably in the wake of Bhasin v. Hrynew, 2014 SCC 71.  Against this backdrop, the implied covenant of good faith and fair dealing in Delaware contract law is of considerable interest.  According to J&J, the covenant serves a narrow function in M&A post-closing regulatory obligations, where it operates as “a scalpel, not a brush”.  The limited role that J&J assigns to good faith here is instructive for Canadian courts, and as discussed below, finds an analogy in their treatment of post-closing regulatory obligations outside the M&A context.

The J&J Decision: An Overview

The J&J litigation involved a post-closing earnout dispute which arose after Johnson & Johnson (“J&J”) acquired Auris Health, Inc. (“Auris”), a medical robotics company.  The parties’ Agreement and Plan of Merger (the “Merger Agreement”) required J&J to pay $3.4 billion to the Auris stockholders upfront, plus a $2.5 billion earnout payment that was contingent on J&J achieving several regulatory and sales milestones for Auris’s robotic-assisted surgical devices (“RASDs”).  Each of the regulatory milestones required J&J to obtain “510(k) premarket notification” from the U.S. Food and Drug Administration (the “FDA”) for specified devices and surgical indications.

J&J undertook to use “commercially reasonable efforts” to achieve the milestones.  The Merger Agreement defined such efforts as those consistent with J&J’s “usual practice” for its own “priority” medical device products at a comparable stage.  It also expressly prohibited J&J from acting “with the intention of avoiding” any earnout payment, or from factoring the cost of an earnout into its post-closing business decisions.

After the acquisition closed, J&J engaged in several actions that undermined the RSADs (e.g., pitting its own products against those it acquired from Auris, and seeking regulatory approval for more complicated procedures than was necessary).  As well, the FDA informed the parties that one of the primary RSADs (the iPlatform Surgical System) would require “De Novo” review, which was a slower regulatory pathway than the 510(k) clearance set out in the Merger Agreement.  This would not make achievement of the milestones impossible or even impracticable, as J&J could have pursued a De Novo clearance for the first milestone, and used that to obtain 510(k) clearance for the remaining ones with minimal delay.  Nevertheless, J&J treated the FDA development as excusing it from its earnout obligations.  It wrote down the value of all the milestones to zero, eliminated the employee incentives that were tied to them, and ultimately did not meet any of the milestones by the contractual deadlines.  As a result, none of the $2.35 billion in earnouts was paid.

A claim was brought against J&J on behalf of the former Auris stockholders by Fortis Advisors LLC (“Fortis”).  It alleged that J&J failed to honour its contractual obligations, and fraudulently induced Auris to accept a $100 million contingent payment instead of an additional upfront payment for one of the RSADs (the Monarch lung-robotics platform) by falsely representing that the achievement of a regulatory milestone for it was essentially certain.

At trial, the Delaware Court of Chancery found that J&J breached the Merger Agreement by not devoting the contractually required level of effort to iPlatform, and acted with the contractually prohibited intent to avoid the earnouts.  The Court relied on the implied covenant of good faith and fair dealing to reach this decision for the first milestone, while finding that J&J breached the express obligation to use commercially reasonable, “priority” device efforts to achieve the remaining regulatory milestones.  With respect to good faith, the Court held that the implied covenant required J&J to pursue the alternative pathway of De Novo review for iPlatform’s first regulatory milestone once the FDA closed the 510(k) pathway, and treat it as functionally equivalent to the 510(k) clearance set out in the contract.  Separately, the Court found that J&J fraudulently induced Auris to accept the $100 million contingent payment for Monarch, and held that liability for this was not precluded by the Merger Agreement’s exclusive remedies clause, since Auris (unlike J&J) did not disclaim reliance on extra-contractual statements by its counterparty.  As a remedy, the Court awarded Fortis damages in excess of $1 billion in contract and fraud, plus pre-judgment interest.

On appeal, the Supreme Court of Delaware reversed the Court of Chancery’s decision relating to the implied covenant of good faith and fair dealing, but otherwise affirmed its judgment.  The matter was remanded to the Court of Chancery to recalculate the interest award based on a damages payment that excluded the first milestone.

The Supreme Court’s Treatment of the Implied Covenant of Good Faith and Fair Dealing

The reasons of the Supreme Court regarding the implied covenant of good faith and fair dealing are extensive, and explore the role that it plays within Delaware contract law generally.  According to the Court, the implied covenant inheres in every Delaware contract, where it “ensures that neither party acts arbitrarily or unreasonably to frustrate the fruits of their bargain”.  In doing so, the covenant operates in a narrow way.  It “authorizes a court to imply terms only ‘where obligations can be understood from the text of a written agreement but have nevertheless been omitted in the literal sense,’ and only to protect the ‘reasonable expectations’ that the parties shared at signing”, “not to paint over contractual provisions that one side later regrets”.  In short, the covenant “functions like a scalpel, not a brush”.

The implied covenant plays two primary roles.  The first is where “a contract allocates discretionary authority to one party over a central aspect of the contract”, and that party “exploits that discretion in a manner that defeats the ‘overarching purpose’ of the bargain”.  Where this occurs, “courts may imply a requirement that such discretion be exercised reasonably and in good faith to ensure that the discretionary power is applied consistently with what reasonable parties would have agreed to at signing”.

Second, “the covenant may be used to address unforeseen developments – contingencies neither anticipated nor resolved by the contract – that threaten the parties’ bargained-for economic expectations”.  However, this latter power is a ‘limited and extraordinary remedy”, particularly in “sophisticated, contract-driven commercial settings”.  It “applies only where there is a genuine contractual gap about a truly unanticipated development and only then to vindicate the parties’ shared expectations at signing”.  If “a development could have been anticipated, even if it was unlikely to occur, the implied covenant cannot be invoked to provide protections that ‘easily could have been drafted’ at the bargaining table”, regardless of whether the development was actually considered by the parties.

The appeal in J&J was concerned with the second, gap-filling role of the implied covenant.  Unlike the Court of Chancery, the Supreme Court found that the covenant could not play this role here, since there was “no genuine contractual gap for the covenant to fill”.  Rather than “speak in general terms about ‘regulatory approval’”, the Merger Agreement “condition[ed] each regulatory earnout, in express and repeated language, on achieving “510(k) premarket notification”.  The parties “neither defined the milestones by reference to ‘regulatory approval by 510(k) or any successor or alternative pathway’ nor provided that the earnouts would adjust if the FDA closed the 510(k) route or extended its review”.  Instead, they “anchored their milestones to a specific regulatory category and nothing more” – 510(k) premarket notification – and “[t]hat drafting choice foreclose[d] any claim that the contract [was] silent about what form of FDA clearance would suffice”.  In “the sophisticated, highly regulated setting of this transaction, the risk that the FDA would require heightened ‘De Novo’ review for a complex RASD was both foreseeable and addressed in the parties’ carefully negotiated agreement”.  Since the implied covenant of good faith and fair dealing “cannot be invoked as ‘an equitable remedy for rebalancing economic interests after events that could have been anticipated but were not’”, it was an error for the Court of Chancery to rely on it in finding that J&J was required to pursue De Novo review for iPlatform once the FDA closed the 510(k) pathway.

Comparisons with Canada

In contrast to Delaware, the courts in common law Canada do not recognize a general implied covenant of good faith and fair dealing in all contracts.  Instead, good faith functions as a general organizing principle in Canadian contract law, which is manifested in discrete doctrines.  These doctrines include mandatory or implied duties of good faith that arise in particular situations (e.g., a duty of honest performance, a duty to exercise contractual discretion reasonably, a duty not to evade contractual obligations, and a duty to cooperate) or particular relationships (e.g., employment, insurance or tendering).  Nonetheless, some of these duties are similar to the two functions served by the implied covenant of good faith and fair dealing in Delaware (the duty to exercise contractual discretion reasonably, for instance, is very close to the first function), and a number of parallels can be drawn between the treatment of good faith in the two jurisdictions.

In the specific context of M&A transactions, allegations that a party has breached a duty of good faith performance in common law Canada are relatively rare.  Nevertheless, some cases of this nature do exist (e.g., NEP Canada ULC v. MEC Op LLC, 2021 ABQB 180; Cineplex v. Cineworld, 2021 ONSC 8016), including in the context of post-closing obligations such as earnouts (e.g., Bhatnagar v. Cresco Labs Inc., 2023 ONCA 401).  Were a Canadian court to consider a set of facts similar to J&J, it would likely approach the good faith principle in a restrained way.  As recognized in Bhasin, the principle is “highly context-specific”, and would seem to have limited utility in supplementing the terms of a heavily-negotiated M&A agreement between sophisticated commercial parties, at least absent egregious circumstances such as dishonesty.

Further, Canadian courts have resisted the notion that duties of good faith can be used to alter post-closing obligations in other settings.  This is illustrated by the recent decision of the Court of Appeal for Ontario in Icetrading Inc. v. Trayanov, 2025 ONCA 793.  The contract in that case provided that the plaintiffs, on closing, would occupy a portion of land owned by the defendants, which the plaintiffs would subsequently purchase should the defendants obtain the necessary municipal approvals to convert the land into a commercial condominium.  When the defendants initiated the process of condominium conversion, they were told by the municipal planning committee that they should submit an industrial plan of subdivision instead, which was a more expensive and complex process.  The defendants failed to do so, and the plaintiffs claimed that the defendants breached their duty of good faith by not carrying out a cost-benefit analysis relating to an industrial plan of subdivision.  This argument was rejected by the Court of Appeal, which found that the defendants “had no contractual obligation to consider this alternative plan”.  Instead, “the contract was premised on a planned condominium conversion”, so requiring the defendants to pursue an industrial plan of subdivision once the municipality rejected the condominium conversion would “amount to a ‘re-write of the Agreement between the parties’”.  Though Icetrading did not involve an M&A deal, the Court of Appeal’s refusal to use good faith to alter the specific post-closing regulatory obligation set out in the contract is similar to J&J.

Takeaways

The role of good faith in M&A transactions is still at an early stage of development in Canada.  As more cases come before the courts, guidance is likely to be sought from jurisdictions like Delaware, where the particular concerns that good faith raises in the M&A context have already received extensive consideration.  The Supreme Court of Delaware’s decision in J&J suggests that good faith has a limited role to play in supplementing the post-closing regulatory obligations in an M&A agreement.  While J&J drew upon a different analytical framework for good faith than that in common law Canada, its approach is consistent with how Canadian courts have treated post-closing regulatory obligations in other settings, and may prove influential here as well.

Brandon Kain is the head of the National Appellate Litigation Group at McCarthy Tétrault LLP, and the author of Good Faith in Canadian Contract Law, published by LexisNexis Canada in 2024.