May 13, 2021

Earnouts: Del. Chancery Refuses to Re-Write Contract Terms

In Obsidian Finance Group v. Identity Theft Guard Solutions, (Del. Ch.; 4/21), Vice Chancellor Slights held that a seller was not entitled to an earnout payment that was contingent upon a six-year extension of a U.S. government contract. The seller claimed that it was entitled to payment even though an extension of that duration hadn’t been obtained, because the Federal Acquisition Regulation, or FAR, prohibited six-year extensions for the type of contract at issue. Here’s an excerpt from this Shearman blog on the decision:

Obsidian sued ID Experts for breach of contract, declaratory judgment, and/or reformation of the earnout provision based on mutual mistake. The Court analyzed the breach claim under the theories of impracticability and forfeiture. The Court was reluctant to allow Obsidian to use the defense of impracticability as an offensive claim, finding no authority for such a proposition, and concluded in any event that the parties should have been aware of the FAR at the time of the agreement.

The Court also held that the FAR did not prohibit contracting periods of six years, but rather limited the number of base years to five years and allowed for “transition” periods of up to one year. Accordingly, because the OPM contract could have been extended by six years, performance was not impracticable. The Court also rejected the forfeiture argument, again finding no authority for Obsidian’s assertion “that a party to a merger agreement may be excused from satisfying a condition to an earnout on grounds of forfeiture.”

The Court further rejected Obsidian’s claim for reformation of the merger agreement, holding that Obsidian’s complaint contained no particularized facts detailing a specific prior understanding of the terms of the earnout that differed materially from the written agreement. The Court noted this was particularly true because the OPM contract could have been extended by six years. Accordingly, the Court granted ID Experts’ motion to dismiss all three claims.

John Jenkins