The Delaware Superior Court held that the buyer in purchase agreement’s post-closing operation covenants had breached a covenant to grow target’s fleet of tractor trucks by 60 tractors per year for three years.
M&A Stories
May 13, 2022
Introduction:
Earnout disputes are common in post-closing deals, particularly when earnouts make up a significant portion of the purchase price. In a recent case, a Delaware Superior Court ruled that a strategic buyer of a trucking company must pay a $40 million earnout to the seller, even though the acquired business failed to meet the EBITDA earnout targets.
The Deal:
The deal involved the strategic acquisition of a trucking firm for a purchase price of $169 million, including three earnout payments of up to $40 million. The earnout payments were contingent on the target company meeting specific EBITDA targets during three consecutive measurement periods.
The Issue: The buyer and seller had different perspectives on the operation of the acquired business post-closing. The seller sought to maximize the chance of achieving the earnout payments, while the buyer wanted flexibility in integrating the target company into its overall business operations. The purchase agreement allowed the buyer to operate the business as they saw fit, subject to certain operating covenants.
The Dispute:
During negotiations, the buyer and seller agreed that the buyer would grow the company’s trucking fleet by 60 tractors during each of the earnout’s three-year target EBITDA measurement periods. However, the purchase agreement only stated that the buyer must cause the target to acquire at least sixty (60) class 8 tractors during each measurement period, without explicitly mentioning “growing” the tractor fleet.
The Outcome:
Despite the target company missing the EBITDA targets in all three measurement periods, the buyer argued that they had fulfilled their obligation by purchasing 60 tractors in each period, even if some were replacements for existing tractors. The Delaware Superior Court ruled that the agreement was ambiguous but found evidence in the negotiations indicating that the parties had indeed agreed to grow the trucking fleet by 60 tractors. Consequently, the court ordered the buyer to pay the $40 million earnout to the seller.
This case is referred to as Schneider National Carriers, Inc. v. Kuntz, C.A. No. N21C-10-157-PAF, Superior Court of Delaware, (Submitted: February 16, 2022. Decided: April 25, 2022.)
Conclusion:
This case serves as a warning for buyers when structuring earnouts in deals. By making a portion of the purchase price dependent on earnouts, buyers might face pressure from sellers to operate the business in a manner that maximizes the chance of achieving EBITDA targets. In retrospect, the buyer should have resisted including a tractor purchase operational covenant to avoid potential disputes and ambiguities in the agreement.
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
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