Delaware Supreme Court Clarifies Buyer’s Earn-Out Obligations

On April 23, 2015, the Delaware Supreme Court decided a case (Lazard Technology Partners, LLC v. Qinetic North America Operations LLC) concerning a dispute over the interpretation of an earn-out provision in a merger agreement.  In the merger agreement at issue, there was an earn-out provision which stated that post-closing, the buyer was prohibited from taking any action to divert or defer revenue from the target company with the intent of reducing or limiting the seller’s earn-out payment.

The court found in favor of the buyer because the seller could not prove that any of the buyer’s post-closing actions were performed with the intent of reducing or limiting the earn-out payment.  The court noted that even if the buyer had knowledge that certain of its post-closing actions had the potential to reduce or limit the seller’s earn-out payment, such knowledge by itself was not enough to breach the earn-out provision because the standard for breaching the earn-out provision was based solely on the buyer’s intent.  Furthermore, the court rejected the seller’s argument that the buyer breached the implied covenant of good faith and fair dealing in the merger agreement because the earn-out provision was sufficiently clear and heavily negotiated between the parties.

Buyers can take comfort knowing that courts will likely not apply a vague covenant of good faith and fair dealing to their post-closing conduct when an earn-out provision is sufficiently precise.  Sellers  should be aware that an earn-out provision in their acquisition agreement will likely be interpreted in a literal way and that courts will not expand the scope of a buyer’s obligation to maximize any potential earn-out payment.  Sellers should therefore be advised to negotiate any specific protections in the acquisition agreement for itself if a material part of the consideration in a transaction is structured as an earn-out payment.