Notes Bearing Interest
Published by the Business Law Section of the North Carolina Bar Association • Section Vol. 37, No. 3 • April 2016 • www.ncbar.org
Caveat Earnout1
The Chair’s Comments
We held our Business Law Institute and
Annual Meeting on February 18 and 19 at
the Pinehurst Resort. Attendance was very
high, and those who attended experienced
the customary high quality slate of speakers
and topics. We again combined with the International Law & Practice Section for joint
annual meetings, and this combination of
our premier annual events continues to be
Anna Mills
successful. I would like to again thank our
course planners, Abbie Baynes, David Broughton and David Shuford, for planning and executing such an excellent program. They,
and the members of the planning committee, did an outstanding job.
Please save the date for the section’s 2017 Business Law Institute and
Annual Meeting. We have already reserved the Pinehurst Resort for
February 16 and 17.
At the annual meeting, we were pleased to announce Ben
Baldwin as the 2016 recipient of the section’s Distinguished Service
Award. Ben has shown outstanding service to the Business Law Section and the profession. He has been a council member, a co-planner
of our annual meeting, the chair of NC LEAP and played a pivotal
role in our section’s North Carolina/Delaware Law Comparison.
Outside of his activities with the section, many of us benefit from
his work as the General Editor of Robinson on North Carolina Law.
Also at the annual meeting, we elected new section officers
and council members. For our 2016-2017 fiscal year beginning at
the NCBA Annual Meeting in late June, we elected Nick Bakatsias
of Greensboro and Mark Allebach of Wilmington as secretary and
treasurer, respectively. We also elected the following lawyers to the
section council for three-year terms from 2016-2019: Vida Harvey
of Robinson Bradshaw, Gene Jones of Morningstar Law Group,
April Kight of Schell Bray, and Deborah Tarwasokono of Smith
Anderson. Congratulations and thank you to this group, and thank
you to section members who suggested candidates.
Finally, please keep in mind our flagship pro bono project, NC
LEAP (North Carolina Lawyers for Entrepreneurs Assistance Program). As you know, the section has for the past several years made
an annual contribution to NC LEAP, and I want to continue to
commend that program to you. NC LEAP provides pro bono legal
services to low-wealth entrepreneurs who are starting or expanding
their businesses in North Carolina. Please consider volunteering
and contributing to this effort. I know you will find it rewarding.
Thank you again for your contributions to our section. I look
forward to hearing from you. —Anna Mills
www.ncbar.org
919.677.0561
@NCBAorg
By John Treadwell, Bud Baker and Brian
Brown
Earnouts are frequently used in M&A transactions as
a tool for purchasers and sellers to resolve disagreements over
the value of a target company or assets. Generally an earnout
provides for payment of a portion of the purchase price to be
deferred until after the closing by adopting certain performance
targets or the occurrence of certain defined events. Earnouts
are appealing because not only do they bridge the valuation gap
between purchaser and seller, but in some instances, can incentivize sellers to assist in continuing to grow the business for the
benefit of purchasers after the closing. A major caveat, however,
as one Delaware2 court noted, is that “an earnout often converts
today’s disagreement over price into tomorrow’s litigation over
the outcome.”3
Recent litigation in Delaware has focused on what, if any,
obligations and duties a purchaser may have to ensure that the
target company reaches goals agreed upon in an earnout provision. The courts have found that where there is an earnout
an implied covenant of good faith and fair dealing requires the
purchaser to conduct the acquired business reasonably and
in good faith after the closing.4 However, the covenant only
serves a gap-filling function creating an obligation only when
Continued on page 2
Inside this Issue...
Notes Bearing
Interest
Published by the Business Law
Section of the North Carolina
Bar Association
Section Vol. 37, No. 2
February 2016
Editor
James P. Beckwith Jr.
Chair
Anna S. Mills
Immediate Past Chair
Kenneth G. Carroll
Vice Chair
Stephen F. Later
Secretary
Nicholas J. Bakatsias
Treasurer
Mark A. Allebach
Section Council
Benjamin W. Baldwin
Abbie G. Baynes
Kenneth M. Greene
Russell M. Robinson III
Krista R. Bowen
George T. Brady III
John N. Fleming
George W. Joyner III
Deborah B. Andrews
John W. Babcock
Thomas J. Molony
Jennifer Weaver
© 2016 North Carolina Bar Association. Views and
opinions expressed in articles published herein are
the authors’ only and are not to be attributed to
Notes Bearing Interest, the Business Law Section
or the NCBA unless expressly stated. Authors are
responsible for the accuracy of all citations and
quotations. No portion of the publication may be
reprinted without permission.
Caveat Earnout, continued from the front page
a contingency arises that the purchaser and seller did not anticipate at the time of contracting.5 The test is whether it is clear from what was expressly agreed upon that the parties would
proscribe the conduct later complained of had they thought to negotiate with respect to that
matter.6 A purchaser is in breach of the covenant when it acts with an intent to lower or avoid
an earnout payment and that action was not contemplated by the parties at the time of contracting.7 To find intent courts look to whether the purchaser took action specifically motivated by
a desire to avoid the earnout; simply showing that a purchaser had knowledge that conduct
would reduce the likelihood of an earnout payment is not enough.8 Thus, unless specifically
contracted for, purchasers have no affirmative obligation to maximize the amount of an earnout
payment in the absence of bad faith.9
For instance, the Delaware Supreme Court found in one case that a purchaser was not
required to accept certain lower distribution fees from a third party that would maximize the
earnout payments to the seller.10 The court reasoned that the purchaser did not act with the intent to lower the earnout payments and that the implied covenant of good faith and fair dealing
cannot be applied to give seller contractual protections that they failed to secure for themselves
at the bargaining table.11
What can a seller do to protect the value of its earnout payments? Sellers should seek an
express good-faith obligation from the purchaser to maximize the earnout and not rely solely
on the implied covenant of good faith and fair dealing to expand the purchaser’s earnout obligations. Conversely, purchasers should be cautious about any implied covenants and reject
requests from sellers to include express good-faith obligations to maximize the earnout.
John Treadwell is vice president/divisional counsel at Laboratory Corporation of America
Holdings. Brian Brown is a partner in the Raleigh office of K&L Gates and focuses his
practice on corporate law, mergers and acquisitions, life sciences, health care, estate planning
and estate administration. Bud Baker is an associate in the Raleigh office of K&L Gates and
a member of the corporate group.
(Endnotes)
1
The word “earnout” is also spelled with a hyphen as “earn-out.”
2
Delaware law is cited because of the well-developed body of corporate case law and the significant
number of companies incorporated in Delaware.
3 Airborne Health, Inc. and Weil, Gotshal & Manges LLP v. Squid Soap, LP, C.A. No. 4410-VCL (Del.
Ch. Nov. 23, 2009).
4 Id.
5 American Capital Acquisition Partners, LLC v. LPL Holdings, Inc., CA NO. 9490-VCG, 2014 WL
354496 at *5 (Del. Ch. Feb. 3, 2014).
6 Id. at *33.
7 Lazard Technology Partners, LLC v. Qinetiq North America Operations LLC, 114 A.3d 193
(Del. 2015).
8 Id.
9 Winshall v. Viacom Int’l., Inc., 76 A.3d 808, 816 (Del. 2013).
10 Id. at 816.
11 Id.
PLEASE SAVE THE DATE
Basics of Business Law
Thursday, October 6, 2016
NC Bar Center, Cary (Live and Webcast)
2
Notes Bearing Interest
www.ncbar.org