Delve into the intricacies of M&A earnout disputes with our latest blog post. Explore the complexities beyond accountant arbitration, as we dissect a notable case and offer insights into drafting M&A agreements for clarity and foresight.
M&A Stories
May 9, 2024
In the dynamic realm of mergers and acquisitions (M&A), the concept of an earnout often serves as a crucial bridge between buyer and seller, particularly when valuations differ. Typically, both parties agree upon post-closing metrics to determine the earnout, with the expectation that any disputes will find resolution through arbitration by an accounting firm. However, recent cases remind us that the journey from agreement to resolution can be fraught with complexities.
Consider a notable instance from 2017, where a global industry giant acquired a small Buffalo-based wholesale distributor specializing in commercial AV projectors. The seller, a modest entity with $280 million in revenue and 210 employees, joined forces with a behemoth boasting $16 billion in revenue and a presence spanning 20 countries.
Central to their agreement was an earnout arrangement tied to net income, payable over three 12-month periods contingent upon meeting specified metrics. Per the stock purchase agreement, the buyer assumed responsibility for calculating the earnout, with any disputes earmarked for resolution through independent accountant arbitration.
Following a customary path, the parties invoked arbitration to settle a dispute arising from the initial 12-month earnout calculation. However, the plot thickened when the seller escalated matters by filing a $24 million suit against the buyer in a Buffalo federal district court. Allegations swirled around the buyer’s alleged breach of promises outlined in the purchase agreement, particularly regarding the commitment to operate the acquired entity in good faith and with a focus on maximizing profits.
The buyer countered by seeking dismissal of these claims, contending that they fell squarely within the purview of the arbitration provision, covering all earnout disputes. However, the court’s ruling diverged from this expectation. In denying the motion to dismiss, the court emphasized that the arbitration provision exclusively pertained to earnout calculations and did not extend to broader earnout-related disputes.
Of particular note is the court’s refusal to reform the earnout provision in light of the COVID-19 pandemic. Despite the seller’s plea to adjust the provision to accommodate unforeseen challenges, the court held firm, underscoring the absence of an agreement stipulating the use of only uninterrupted or minimally profitable quarters.
This case, exemplified by Kelly v. DCC Technology Holdings, Inc., underscores the importance of clarity and foresight in drafting M&A agreements. While accountant arbitration remains a linchpin in dispute resolution, the boundaries of its application merit careful delineation to preclude future ambiguities.
In the intricate dance of M&A transactions, where fortunes pivot on the minutiae of contractual language, navigating the terrain demands vigilance and precision. As entrepreneurs, business owners, advisors, and stakeholders contemplate the path forward, the saga of earnout disputes serves as a poignant reminder of the intricacies inherent in the pursuit of M&A success.
Case Reference: Kelly v. DCC Technology Holdings, Inc. No. 22-CV-518S., United States District Court, W.D. New York, (March 20, 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 recent legal 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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