June 10, 2021

Earnouts: Buyer’s Discretionary Authority Doesn’t Bar Claim

When negotiating an earnout, buyers typically resist efforts to tie their hands when it comes to operating a business post-closing. Frequently, the contract expressly gives the buyer discretion with respect to decisions relating to post-closing operations. That can be a formidable obstacle for a seller to overcome when in earnout litigation, but the Chancery Court’s recent decision in Shareholders Representative Services v. Albertsons, (Del. Ch.; 6/21) shows that it’s not always insurmountable.

The case arose out of the supermarket goliath Albertsons’ 2017 acquisition of Plated, a subscription food kit delivery business. Under the terms of the deal, Albertsons agreed to an upfront payment of $175 million at closing, and an earnout provision obligating it to pay up to an additional $125 million if certain milestones were met.

The earnout language gave Albertsons the right to make all post-closing business and operational decisions “in its sole and absolute discretion” and expressly stated that it would have “no obligation to operate [Plated] in a manner to maximize achievement of the Earnout Issuance.” However, that right was subject to a provision obligating Albertson’s not to “take any action (or omit to take any actions) with the intent of decreasing or avoiding” payment of the earnout.

The plaintiff contended that the earnout was premised on Plated’s historical performance and projected results, and that Albertsons had provided repeated assurances throughout the negotiating process that it intended to grown Plated’s traditional e-commerce business. According to the plaintiff, that would’ve given Plated’s shareholders a good shot at achieving the earnout milestones, but Albertsons immediately put the e-commerce business on the back burner. This excerpt from Steve Quinlivan’s blog on the case provides more detail on the plaintiff’s claims and Vice Chancellor Slights’ response:

According to Plaintiff, immediately upon closing, Albertsons directed that Plated drastically reallocate its resources to get a retail product into 1,000 stores in the span of one week, to the detriment of the e-commerce business. Albertsons, according to Plaintiff, knew this endeavor was commercially unreasonable.  It created a reasonable inference that Albertson’s knew its push for in-store sales at the expense of subscriptions and the e-commerce business would cause Plated to fail to reach the earnout targets.

According to the Court, the reasonable inference allowed by Plaintiff’s allegations is not that Albertsons sabotaged a company it just paid $175 million for.   Rather it created an inference that Albertsons intended to avoid short-term earnout targets in favor of long term gains. Even if Albertsons took these actions only in part with the purpose of causing Plated to miss the earnout milestones, this was enough at the pleading stage to support Plaintiff’s breach of contract claim.

Albertsons argued that Plaintiff’s allegations cannot sustain a breach of contract claim when the conduct giving rise to the claim was expressly permitted under that same contract. In doing so the Court said Albertsons seized upon its contractual allowance to operate Plated within its discretion.  However, Albertsons had ignored the contractual prohibition against operational decisions intended to avoid or reduce the earnout.

The plaintiff alleged that Albertsons’ actions violated its contractual obligations under the terms of the earnout, involved a breach of the implied covenant of good faith and fair dealing, and constituted fraudulent inducement.  The Vice Chancellor rejected the latter two claims, but held that the plaintiff had made reasonably conceivable allegations that Albertsons’ actions with respect to Plated’s business were engaged in with the intent to avoid the earnout in violation of its contractual obligations.

John Jenkins