September 13, 2018

Earnouts: Ambiguous Milestones Prevent Dismissal of Claim

Last month, in Fortis Advisors LLC v. Stora Enso Ab, (Del. Ch.; 8/18), Vice Chancellor Slights declined to dismiss a breach of contract claim arising out of a buyer’s failure to make contractual milestone payments relating to the construction of two plants & the production of certain materials.  Here’s an excerpt from this Shearman & Sterling blog summarizing the decision:

Plaintiff asserted that defendant breached certain of its representations in, and failed to satisfy certain requirements of, the merger agreement, both of which were intended to increase the likelihood the milestones would be achieved. Plaintiff alleged that a representation in the merger agreement by defendant that the latter had “taken all corporate action necessary . . . to perform its obligations” under the merger agreement required defendant to have received pre-closing authorization to order, in a timely manner following closing, a piece of equipment alleged to be the “centerpiece” of achieving one of the milestones.

Defendant argued, however, that the representation was nothing more than “a standard corporate authorization provision that simply acknowledged [its] legal authority to enter into and consummate the [m]erger” and not a representation that it had obtained all internal approvals required to take all post-closing steps necessary to build the plants contemplated by the milestones.

Plaintiff also alleged that defendant breached a provision of the agreement obligating business to be conducted in accordance with a “financial and human resource plan” that included a timeline for a required number of employees and expenditures in connection with the milestone process. But defendant countered that the timeframes were guidelines and plaintiff’s construction would nullify the contingency of the milestone payments.

The Vice Chancellor concluded that both sides’ interpretations were reasonable, and so declined to dismiss the complaint. Look, I know a case holding that earnout milestone language is ambiguous is “dog bites man” stuff – so just consider this blog another addition to the “But the earnout seemed like such a good idea at the time!” file.

Since we’re adding things to that file – be sure to check out this Fried Frank memo, which reviews two other recent Delaware cases dealing with the pitfalls of earnouts.

John Jenkins