DealLawyers.com Blog

This Fried Frank memo discusses the Delaware Chancery Court’s recent decision in Greenstar IH Rep v. Tutor Perini (Del. Ch.; 10/17) – in which the Court rejected a buyer’s efforts to avoid earnout payments based on allegations that the seller’s former CEO was providing fraudulent information to inflate those payments.

Vice Chancellor Slights held that the buyer could not withhold payments based on alleged wrongdoing in the face of specific contract language setting forth the procedure for determining the earnout payment, and providing that the amount determined in accordance with that procedure “shall be binding” on the parties absent a timely objection by the seller.

The memo reviews the Chancery Court’s decision, and provides an overview of Delaware’s approach to earnouts in general & the key lessons drawn from the case. Here’s an excerpt about how buyers can address the potential leverage that sellers’ might enjoy over the potential earnout payment through their continued participation in the business:

A buyer should consider ways in which a seller may have the practical ability to exert pressure on the buyer to make earnout payments—even if earnout targets are clearly not met and there are no issues about the buyer’s post-closing actions. For example, a seller, if it continues to play a major role in the company post-closing, may be able to exert influence on customers and suppliers or other aspects of the operations, or to trigger negative publicity about the financial situation of the business. (Indeed, a seller may itself also be a customer of or supplier to the acquired business.)

Buyers should consider specific covenants relating to post-closing actions by the seller or persons who will benefit from the earnout payments. These could include, for example, specified consequences relating to the earnout if a person who will benefit from earnout payments competes during the earnout period.

The memo also points out that while earnouts remain a very popular way to bridge valuation gaps, they’re also a frequent source of post-closing disputes.  Hey, wait a minute – I think I’ve heard that somewhere before. . .

– John Jenkins