This blog explores the complexities of earnout structures in M&A deals, emphasizing the need for sellers to negotiate clear post-closing obligations. Using a real-life Delaware court case, the post highlights how vague earnout terms can lead to disputes and legal challenges, reminding readers of the importance of commercially reasonable efforts and detailed contract provisions.
M&A Stories
October 3, 2024
Offering a seller an additional purchase price based on post-closing business performance can bridge gaps when parties are far apart on a fixed price. But when the earnout structure lacks clear terms, disputes often arise.
In 2020, a global buyer group acquired a ready-to-drink beverage company for $12 million, with an added earnout tied to 2022 net sales exceeding $25 million. When sales fell short, no earnout was paid. The seller sued the buyer and its parent company in Delaware, alleging breach of contract and violation of the implied covenant of good faith and fair dealing.
The court dismissed the case, siding with the buyer. It found no breach of the purchase agreement and dismissed claims against the parent, which wasn’t a party to the contract. The seller’s argument that the buyer failed to use “commercially reasonable efforts” post-closing also fell flat, as the purchase agreement contained no such obligation.
The court emphasized that the implied covenant of good faith and fair dealing cannot be used to rewrite a contract. It only applies when a contract is silent on an issue and one party acts against the deal’s core purpose. In this case, the seller hadn’t negotiated for specific protections or obligations around the earnout. The buyer was therefore not required to act in any particular way to hit the sales targets.
The lesson is clear: sellers must negotiate detailed earnout obligations, including commercially reasonable efforts, to protect themselves after closing. Without clear terms, buyers are only bound to pay if specific milestones are reached, not to take steps to ensure they are.
Case Reference: Limitless Coffee, LLC v. Mott’s, LLP, C.A. No. N23C-12-229 EMD CCLD , Superior Court of Delaware, (September 19, 2024).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law.
By John McCauley: I write about recenegal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
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Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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