Houston federal court holds that under Texas law, the buyer had no implied obligation of good faith and fair dealing to seller’s owner to use best efforts to commercialize drilling tool line the buyer purchased from the seller.
M&A Stories
September 7, 2022
Introduction
Agreeing to an earnout, where a portion of the purchase price depends on future performance, can be risky for sellers. In a recent case, a Houston federal court held that the buyer of an oil and gas drilling tool maker had no implied obligation to make significant efforts in commercializing the tools purchased from the seller.
The Deal
The acquisition involved a Texas-based oil and gas drilling tool maker, with the buyer acquiring the assets for $1.5 million. As part of the agreement, the seller’s owner was promised a potential earnout of up to $3 million if the revenue from selling the tools exceeded $2.4 million within five years after the closing. The earnout was due whether or not the seller’s owner continued as an employee of the buyer. The seller’s owner did not receive an earnout.
Lawsuit and Court Ruling
The seller’s owner filed a lawsuit against the buyer, alleging that the buyer had breached an implied obligation to use its best efforts in promoting and selling the drilling tool line. However, the court sided with the buyer and dismissed the claim. According to the court, there was no express or implied requirement in the purchase or employment agreement for the buyer to exert its best efforts. The court further explained that a general duty of good faith and fair dealing does not exist in ordinary commercial transactions under Texas law, unless explicitly stated in the contract or when a special relationship of trust exists between the parties.
See Lott v. Cougar Drilling Solutions USA, Inc., Civil Action No. 22-1292, United States District Court, S.D. Texas, Houston Division, (August 29, 2022).
Comment
In this situation, the seller’s owner could have negotiated an earnout provision explicitly stating that the buyer would use their “best efforts” to commercialize the tool line. However, securing such a provision might have been challenging. Alternatively, the seller could have proposed eliminating the earnout altogether in exchange for a higher purchase price.
By John McCauley: I write about recent legal problems of buyer and sellers of small businesses.
Email: jmccauley@mk-law.com
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