October 29, 2019

Earnouts: “Comprehensive & Explicit” Language Wins the Day for Buyer

Earnouts are often used as a bridge to keep a deal together when the parties differ on valuation.  Since that’s the case, people sometimes tip-toe around all sorts of issues relating to the terms of the earnout, including the extent of the buyer’s obligations to facilitate the achievement of milestones. As I’ve blogged previously, that’s a recipe for protracted litigation.

On the other hand, the Delaware Superior Court’s recent decision in Collab 9 v. En Pointe Technologies Sales (Del. Super.; 9/19) says that clarity is definitely a virtue when it comes to defining a buyer’s obligations under an earnout.  In fact, this excerpt from a recent Morris James blog summarizing the case suggests that the best approach may be to hit the seller in the face with a 2 x 4 when it comes to this issue:

Under an asset purchase agreement (“APA”), the purchaser (“PCM”) acquired substantially all of the assets of the “En Pointe” business from the seller (“Collab9”). The APA provided for an earn-out payment, calculated upon a percentage of En Pointe’s Adjusted Gross Profit over several years. The APA provided that the purchaser “shall have sole discretion with regard to all matters relating to the operation of the Business.”

The agreement further disclaimed any express or implied obligation on the part of the purchaser to take any action, or omit to take any action, to maximize the earn-out amount, and stated that the purchaser “owes no duty, as a fiduciary or otherwise” to the seller. The APA also contained a clear combined integration and anti-reliance provision.

When the earnout milestone wasn’t achieved, the seller sued the buyer, alleging breach of the implied covenant of good faith and fraud. In dismissing the contract claim, the Court noted the asset purchase agreement’s “comprehensive and explicit” language on the parties’ obligations regarding post-closing operations, and concluded that there were no gaps to be filled by the implied covenant.  It also dismissed the fraud claim, concluding that it was basically a repackaging of the breach of contract claim.

John Jenkins