DealLawyers.com Blog

Last week’s Chancery Court decision in Arthur J. Gallagher & Co. v. Agiato (Del. Ch.; 7/25) involved a dispute, not about earnout milestones, but about whether conduct by sellers’ founder (who also acted as sellers’ representative) relieved the buyer from making an earnout payment. The asset purchase agreement provided for a $50 million upfront purchase price with $150 million in possible earnout payments if the newly formed division of the buyer (run by the sellers’ founder) achieved certain Net Commissions and Fee Income thresholds. After initially delivering an earnout statement that excluded certain cash payments buyer felt should not count towards the total, the buyer eventually stipulated in the litigation that the amount of cash generated and received by the new division equaled or exceeded the first earnout threshold. It nonetheless argued that it was excused from paying the earnout because, it alleged:

The founder failed to conduct the business of the new division in accordance with buyer’s business practices, policies, and procedures and failed to manage the division for the long-term benefit of buyer’s shareholders;

The founder failed to comply with his Employment Agreement; and

Certain representations and warranties in the APA were inaccurate.

Vice Chancellor Will was not persuaded that these were conditions precedent to the earnout.

Although “‘[t]here are no particular words that must be used to create a condition precedent,’ a condition precedent must be expressed clearly and unambiguously.” “Parties’ intent to set a condition precedent to performance may be evidenced by such terms as ‘if,’ ‘provided that,’ ‘on condition that,’ or some other phrase that conditions performance” connoting “an intent for a condition rather than a promise.”  . . .

None of these provisions bear on whether Gallagher owes the Year 1 earnout. Although Gallagher requests I imply conditions to payment of the earnout, Delaware courts “cannot rewrite contracts or supply omitted provisions.” The APA places no conditions on payment of the earnout once the NCFI threshold is achieved. Because it is undisputed that the NCFI threshold for Year 1 was met, the corresponding earnout payment is past due and owed to the Sellers.

VC Will also determined that she needn’t resolve whether the APA was breached since that was irrelevant to whether the earnout was owed.

Such a breach would provide it with grounds to seek indemnification—not to withhold the earnout. The APA sets out an intricate process for one party to obtain remuneration from another for “breach of, or . . . failure to fulfill, any representation, warranty, agreement, or covenant” in the APA. It describes the process for making a written claim, and sets both a base amount required to seek indemnification and a cap.

The Escrow Agreement facilitates the APA’s indemnification process by ensuring that funds are set aside to compensate Gallagher for a valid indemnification claim. The APA’s earnout provisions omit any reference to indemnification process. The APA also does not condition earnout payments to the Sellers on their fulfillment of the representations and warranties in Section 6. The sole condition to payment of the Year 1 earnout is meeting the NCFI threshold, which has indisputably occurred.

On this issue, VC Will granted the motion for partial judgment by sellers’ representative and ordered the payment of the first earnout amount, with interest.

– Meredith Ervine