Earnouts and the Importance of Key Employee Retention

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M&A earnouts pose significant risks for sellers, especially when buyers control post-closing business performance. This blog examines a case where a seller lost a $5 million earnout after a private equity buyer moved key employees to a separate management company. The Delaware court’s refusal to dismiss the seller’s breach of contract claims underscores the importance of structuring enforceable earnout provisions. Learn how sellers can protect their interests by securing key employee retention clauses and ensuring buyers adhere to their obligations.

M&A Stories

February 7, 2025

M&A earnouts are inherently risky for sellers because the buyer controls the post-closing performance of the business. One way to mitigate this risk is to require the buyer to retain key employees during the earnout period.

A Phoenix-based distributor of pipes, valves, and fittings faced this challenge after its 2022 sale to a Dallas-based private equity firm. The PE firm acquired the business as part of a roll-up, purchasing five other similar suppliers. To structure the transaction, it formed an acquisition subsidiary (the buyer) and a management company to oversee the six acquired businesses.

The seller was promised an earnout of up to $5 million based on a 2023 EBITDA target. The purchase agreement required the buyer to retain three named key employees during 2023. However, instead of keeping them within the acquired business, the buyer transferred them to the management company. As a result, the EBITDA target was not met, and the seller received no earnout.

In response, the seller sued the buyer and the management company in Delaware Superior Court for breach of contract. The buyer moved to dismiss the claim, but the court refused, allowing the seller to pursue its breach of contract claims.

The buyer’s reasoning for transferring the key employees remains unclear. It may have overlooked the contractual obligation or assumed the move wouldn’t affect the target’s financial performance. Regardless, the case highlights a critical lesson for both parties: buyers must understand and adhere to their earnout obligations, while sellers should ensure that key employee retention clauses are enforceable and protected against post-closing maneuvering.

See: In Re MHC IV, LLC v. TCFIV Venturi Buyer P, LLC. C.A. No. N24C-02-174 VLM CCLD., Superior Court of Delaware, (December 19, 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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in Key Employee Retention Requirement, problems with earnouts Tagged with: , , , , , , , , , , , , , , , , , , ,

Undisclosed Founder Loan Leads to Post-Merger Liability

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Undisclosed shareholder loans can become post-merger liabilities, creating unexpected financial exposure for buyers. This blog explores a real M&A case where a founder’s unrecorded loan led to legal disputes after a merger. Learn how courts interpret implied repayment obligations, why proper loan documentation is critical, and how deal structure—merger vs. asset sale—affects liability risks. Essential insights for business owners, buyers, and M&A professionals navigating legal complexities in private company acquisitions.

M&A Stories

February 6, 2025

Shareholder loans to a startup M&A target are sometimes not documented on the company’s balance sheet. This can cause problems for both the buyer and the lending founder.

This case involves the acquisition of a target company by merger. The buyer formed a subsidiary that merged into the target, making the target the surviving entity and a subsidiary of the buyer.

After the merger, the principal target founder sued the target in a Manhattan federal district court for repayment of a $1.5 million loan she had made to the company at its inception. The loan was not recorded on the balance sheet, catching the buyer by surprise. The target, now owned by the buyer, denied any liability, arguing that there was no loan documentation between the target and the founder. However, the court found extensive circumstantial evidence—such as the co-owner and the target bookkeeper providing information to the lender post-loan—that created an implied obligation for the target to repay the loan.

The clear takeaway for business owners is to document any loans they make to their company and ensure repayment terms are addressed in the acquisition documents. For buyers, structuring a deal as a merger is effectively like buying the stock of a company—all liabilities, including undisclosed ones, remain with the acquired business. One advantage of an asset sale is that a buyer can generally pick and choose which liabilities it will assume.

See: Alsayer v. Omnix Labs, Inc. No. 22-cv-2628 (LJL), United States District Court, S.D. New York, (January 15, 2025).

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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in Problems with Undisclosed Liabilities Tagged with: , , , , , , , , , , , , , , , , , , ,

Risk of M&A Seller Financing and Contractual Protections

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In this blog post, we explore the legal complexities of seller financing in M&A transactions, with a focus on a case involving a Boise-based graphic design company. The post examines the risks sellers face when accepting deferred payments like promissory notes, earnouts, and other contingent arrangements. A court ruling reveals how these financial structures can leave sellers exposed to the mismanagement or nonpayment risks of the buyer, particularly in bankruptcy scenarios. The post provides practical insights for sellers to safeguard their interests in such deals through strategic clauses and protections.

M&A Stories

January 31, 2025

Seller financing in M&A transactions can leave sellers exposed to the risk of buyer mismanagement and potential nonpayment. In one case, the sole owner of a Boise-based graphic design company sold her stock to a buyer and agreed to finance a significant portion of the purchase price via a promissory note. The note was secured by a pledge agreement that provided her with 100% voting rights until the note was paid off. However, the buyer defaulted on the note, and as the CEO and sole director of the company, filed for bankruptcy in Idaho.

The seller argued that the bankruptcy filing was unauthorized, given that she, as the holder of all shareholder voting rights, should have been consulted. But the court ruled that the directors—who, in this case, was the buyer acting as the sole director—had the authority to file for bankruptcy under Idaho law.

This case highlights the inherent risks for sellers who accept significant deferred payments, such as seller notes, earnouts, or other contingent payments. These financial arrangements often depend heavily on the buyer’s ability and willingness to effectively manage the business post-acquisition. In this instance, the buyer’s failure to fulfill the terms of the deal left the seller with no recourse.

The key takeaway for sellers is that deferred payments tied to future business performance, while appealing, can be precarious if the buyer mismanages or undermines the business. To mitigate these risks, sellers should consider incorporating protective clauses into the deal. These may include requiring regular financial reporting, providing consent rights over major decisions (such as bankruptcy filings), and placing restrictions on cash distributions. By anticipating potential challenges and structuring deals with these protections, sellers can reduce their exposure to risk in M&A transactions.

See: IN RE MURIE GRAPHIC DESIGN INC.., Case No. 24-00419-NGH, United States Bankruptcy Court, D. Idaho(January 23, 2025).

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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in Problems with Deferred Purchase Price Tagged with: , , , , , , , , , , , , , , , ,

Court Holds M&A Agreement’s Limitation of Ohio’s Statute of Limitation Unenforceable

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This blog explores a recent Ohio federal district court ruling, which rendered an M&A agreement’s limitation on the statute of limitations unenforceable. It highlights the nuances of survival clauses in asset purchase agreements and their legal implications for sellers in M&A transactions. With a focus on indemnification claims and state law variations, the post offers valuable insights into how sellers can navigate these clauses and ensure compliance with local statutes. Understanding how different states treat survival clauses can help sellers avoid costly legal disputes and better negotiate terms.

M&A Stories

January 24, 2025

An M&A seller typically seeks closure on pre-closing liabilities of the sold business. While the statute of limitations for buyer indemnification claims varies between states, it usually spans three to six years. Sellers often shorten this period with a survival clause, but the enforceability of such clauses must align with the laws of the relevant state.

The seller in this case, a manufacturer of aluminum products based in the greater Cincinnati area, sold its assets to a tier-one auto supplier for $56.5 million in cash and debt assumption, with a $20 million deferred purchase price. However, post-closing, the buyer filed an $8 million indemnification claim and refused to pay the deferred amount. The dispute ultimately landed in an Ohio federal district court.

The seller argued that $5 million of the buyer’s claim was time-barred because the buyer had not provided notice by the deadline set forth in the asset purchase agreement’s survival clause. The buyer conceded that point but contended that under Ohio law, the survival clause did not preclude making a claim after the deadline, and since the claim was made before Ohio’s statute of limitations expired, it should be allowed.

The court sided with the buyer. It found that while the survival clause stipulated that claims made before the deadline would survive, it did not unequivocally state that claims made after the deadline would be barred. This interpretation was in line with Ohio’s restrictive stance on contractual limitations of its statute of limitations.

The lesson is clear: sellers should ensure that survival provisions in M&A agreements comply with the applicable state law. Many states, including New York, Delaware, California, and Texas, would have likely enforced the survival clause as written, upholding the limitation period. However, states like Alabama, Missouri, South Carolina, and Florida prohibit survival clauses that shorten the statute of limitations, and sellers should be mindful of these restrictions when negotiating terms.

See: The Bidwell Family Corp. v. Shape Corp., Case No. 1:19-cv-201, United States District Court, S.D. Ohio, Western Division(December 31, 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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in problems with survival provisions Tagged with: , , , , , , , , , , , , , , , , , , , , ,

How Overstated Revenue Leads to Fraud Claims and Unlimited Liability

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Discover the high stakes of fraud allegations in M&A transactions through this case study involving overstated revenue and nondisclosure. When an IT consulting firm failed to disclose that its projected $25 million revenue was inflated due to enterprise division contributions, it led to a legal battle over the deferred purchase price and fraud claims. This post highlights the significant risks for sellers, including how transparency and accurate disclosures can prevent costly litigation and reputational damage. Read about the key lessons for M&A transactions, including the importance of truthful representations, indemnification caps, and the consequences of withholding critical information.

M&A Stories

January 17, 2025

Accusations of fraud in an M&A deal can lead to significant damages, which usually bypass the carefully negotiated indemnification cap. This case illustrates how overstated revenue—both in due diligence projections and contractual representations—can create fraud claims with substantial liability.

The seller, an information technology consulting firm specializing in Microsoft software, operated two divisions: one serving small and medium-sized businesses (SMBs) and another catering to enterprise clients. The buyer, a competitor in the same industry, sought to acquire the SMB division.

During due diligence in 2021, the buyer identified declining performance in the SMB division. To address these concerns, the seller provided a $25 million revenue forecast for the year, which became a key factor in the buyer’s decision to proceed. The buyer agreed to purchase the SMB division’s assets for $16.5 million—$8 million payable at closing on November 1, 2021, and $8.5 million due on April 30, 2022.

The asset purchase agreement included a representation and warranty that the SMB division had generated $25 million in revenue during the 12 months ending August 31, 2021. It also provided for a purchase price adjustment if the division’s revenue fell short of that figure.

To protect sensitive information, the seller blacked out customer names in the revenue forecasts shared during due diligence. Given the competitive relationship between the buyer and seller, this decision was reasonable. However, the blackout prevented the buyer from verifying whether the forecasted revenue came solely from SMB customers or if it included revenue from the enterprise division.

Before closing, the seller’s CEO discovered that a significant portion of the $25 million in revenue was tied to services provided to enterprise customers, not SMBs. Despite knowing this discrepancy, the seller failed to inform the buyer.

After closing, the buyer uncovered the issue and refused to pay the $8.5 million deferred portion of the purchase price, claiming the seller’s failure to disclose the source of the revenue constituted fraud. Litigation ensued in Delaware Superior Court, with the buyer alleging fraud and using the nondisclosure as a defense for withholding payment.

The seller, in turn, sued the buyer, its acquisition subsidiary, and its parent company for breach of contract. The seller sought damages for the deferred purchase price and attempted to dismiss the buyer’s fraud claims.

The Delaware Superior Court declined to grant summary judgment for the seller on its claims for the deferred purchase price or against the buyer’s fraud allegations, leaving the matter to trial.

While the seller’s blackout of customer names was reasonable given the competitive dynamic, its failure to disclose the revenue discrepancy was not. Correcting the revenue forecast before closing, though potentially reducing the purchase price or even derailing the deal—would have avoided accusations of fraud and the risk of significant damages that exceed the indemnification cap.

This case underscores the importance of accurate and transparent disclosures in M&A transactions. Sellers who knowingly withhold material information not only risk withheld payments but also protracted litigation, reputational damage, and liabilities far exceeding their negotiated protections.

See: Columbus US Inc. v. Enavate SMB, LLC, C.A. No. N22C-06-053, SKR CCLD, Superior Court of Delaware(December 23, 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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in fraud in business sale, fraudulent inducement Tagged with: , , , , , , , , , , , , , , , , , , , , ,

When Private Equity’s Global Strategy Undermines Earnouts

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This blog delves into the legal complexities of earnouts in private equity acquisitions, using a recent Delaware Superior Court case as a key example. It explores the risks sellers face when private equity firms orchestrate strategic decisions that negatively affect the earnout opportunity, while providing insight into Delaware’s affiliate immunity defense and its impact on claims against PE firms. The case underscores the challenges sellers may encounter in holding private equity sponsors accountable for actions that harm their earnout potential.

M&A Stories

January 10, 2025

Earnouts are often a centerpiece of acquisitions involving private equity, offering sellers the potential for additional compensation tied to the future performance of the business. However, a recent case in Delaware Superior Court involving a private equity firm and its portfolio company illustrates the complexities and risks sellers face when their earnout depends on the actions of a buyer group with competing priorities.

In this case, the seller of a precision sheet metal fabrication company agreed to sell its business for $90 million in cash plus an earnout. The acquisition was made by a portfolio company and acquisition subsidiary (collectively, “Buyer Group”) backed by a private equity firm, and the deal included an earnout tied to EBITDA performance over two years. However, despite the earnout provision, the seller ultimately received no earnout. The seller claimed that a series of decisions—including diverting resources, transferring personnel, and reprioritizing customer orders—negatively impacted the target’s EBITDA, which directly hindered the seller’s ability to earn the full earnout payment.

Complicating matters, the seller attempted to hold the private equity sponsor liable for tortious interference with the acquisition agreement. The seller also sought punitive damages, alleging that the private equity firm’s conduct was malicious and wanton. However, the Delaware Superior Court dismissed this claim under Delaware’s affiliate immunity doctrine, which protects affiliates from being held liable for actions taken by one of the entities in the corporate group. Notably, the private equity firm was not a party to the purchase agreement between the seller and the Buyer Group, and the court ruled that the private equity firm could not be held liable for the actions of the platform company or acquisition subsidiary.

While the private equity firm successfully had the tortious interference claim dismissed, the court did not grant the same result for the breach of the earnout provision claim. The court allowed the seller’s claim against the platform company and acquisition subsidiary to proceed, denying their motion to dismiss. This ruling shows that the earnout dispute itself was deemed to have sufficient merit to move forward, despite the involvement of the private equity firm in broader strategic decisions.

Overcoming the Affiliate Immunity Defense: A Steep Climb Under Delaware Law

A crucial takeaway from this case is the difficulty sellers face in overcoming Delaware’s affiliate immunity defense in a claim against the sponsoring private equity firm, because the PE firm is usually not a party to the acquisition agreements. Delaware courts have long respected the legal separateness of entities, particularly in private equity structures. To successfully pierce the immunity defense, the seller would need to provide clear evidence that the private equity firm acted outside its ordinary business roles such as through explicit instructions that intentionally harmed the seller’s ability to earn or receive the earnout.

Even with compelling evidence, such as direct communications from the private equity firm instructing actions to harm the earnout, Delaware courts are generally hesitant to allow tort claims to circumvent the protections offered by affiliate immunity.

See: Conlon v. CGI Manufacturing Buyer, LLC, C.A. No. N23C-11-151 EMD CCLD, Superior Court of Delaware(August 8, 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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in private equity, problems with earnouts Tagged with: , , , , , , , , , , , , , , , , , , , , , , ,

When Relocation Is Part of a Dealership Sale: Automaker Consent and “Good Cause”

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Selling a auto dealership with a planned buyer relocation can complicate obtaining the automaker’s consent to the transaction.

M&A Stories

December 9, 2024

Selling a car dealership requires automaker consent, and state laws generally require automakers to act with “good cause” when granting or withholding that consent. This requirement becomes particularly significant when a dealership sale involves a planned relocation.

This issue arose in the sale of a GM dealership in Ohio. The buyer intended to relocate the dealership as part of the transaction. GM approved the transfer of ownership but refused to consent to the new location.

The buyer and seller contested GM’s decision before the Ohio Motor Vehicle Dealers Board, claiming that GM lacked good cause to withhold its consent. GM argued that the Board had no jurisdiction to review its decision regarding the relocation, contending that only its approval or denial of the sale itself was subject to oversight.

The Board found otherwise. It determined that GM’s refusal to approve the relocation was inseparable from its decision on the sale and concluded that GM did not have good cause to withhold its consent. Both a trial court and an appellate court upheld the Board’s ruling, affirming that the relocation was integral to the transaction. By denying consent to the relocation, GM effectively rejected the deal as a whole.

The courts ultimately permitted the sale to proceed without GM’s consent to the relocation.

This case underscores an important distinction: while automakers may have more leeway to reject standalone relocation requests, transactions involving dealership sales often fall under the jurisdiction of state dealer boards. Buyers and sellers should be prepared for potential pushback from automakers when relocations are part of the deal, and they should carefully evaluate whether the automaker has “good cause” for its decisions.

See: General Motors, LLC v. Autosmart Chevrolet, Inc., No. 24AP-239, Court of Appeals of Ohio, Tenth District, Franklin County(November 26, 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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in Problems with sale of auto dealerships Tagged with: , , , , , , , , ,

The Risks of Earnouts with Buyers Who Compete

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Earnouts are risky, especially when your buyer has a pre-existing competitive business. 

M&A Stories

December 6, 2024

In 2019, a seller of athletic event registration software agreed to sell its assets to a buyer in the same industry. The transaction included a $770,000 upfront payment and a potential $1.9 million earnout tied to post-closing revenue targets. The buyer, which already owned a competing business, was contractually obligated to use “commercially reasonable efforts to maximize the performance of the Business during the Measurement Period.”

The seller ultimately received no earnout and accused the buyer of diverting $2 million in revenue from specific athletic events to its pre-existing competing business. According to the seller, this diversion, coupled with the closure of the acquired operations, prevented it from achieving the earnout.

When the dispute reached a Delaware court, the buyer sought to dismiss the seller’s breach of contract claim, arguing it lacked sufficient factual support. The court disagreed, finding that the seller’s allegations of revenue diversion and business closure were detailed enough to move forward.

This case highlights a key risk for sellers in earnout agreements: when the buyer owns a pre-existing competing business, there is a clear incentive to prioritize the buyer’s operations at the expense of the seller’s earnout. Sellers should approach such arrangements cautiously and ensure the agreement includes strong protection to mitigate these risks.

See: I Am Athlete, LLC v. IM Enmotive, LLC, C.A. No. N24C-03-280 EMD CCLD, Superior Court of Delaware(November 27, 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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

Posted in problems with earnouts Tagged with: , , , , , , , , , , , , ,

Buyer’s Forum Selection Clause Strategy Backfires in Baseball Program Acquisition

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This blog examines the impact of a permissive forum selection clause in an M&A asset purchase agreement, focusing on a case where a Nebraska buyer acquired a Texas-based youth baseball organization. The clause allowed the buyer the option, but not the obligation, to litigate in Omaha, Nebraska. The buyer likely included the clause, expecting to control any litigation. However, when the seller filed the lawsuit first in Texas, the court upheld the seller’s choice of forum. The post highlights the risks of drafting flexible clauses and provides valuable insights for buyers on how to better protect themselves in forum selection during M&A transactions.

M&A Stories

November 28, 2024

In 2023, a Nebraska-based buyer acquired the assets of a Texas youth baseball organization specializing in training players and fielding competitive teams in regional and national tournaments. The $1.3 million asset purchase agreement included a forum selection clause stating that disputes “may” be litigated in Omaha, Nebraska. The purchase price was payable in monthly installments over eight years.

After making only a few payments, the buyer stopped. The seller then sued the buyer in a Texas federal district court. The buyer sought to transfer the case to Omaha under the forum selection clause. However, the court denied the transfer, ruling that the clause was permissive, not mandatory. Because the clause used the word “may” instead of “shall,” the seller was not obligated to file in Nebraska and could proceed in Texas.

It seems likely the buyer included the permissive clause expecting it would be the party initiating any potential lawsuit, thereby retaining the flexibility to file in Nebraska or another jurisdiction depending on the circumstances. Unfortunately for the buyer, it was the seller who filed first and did so in Texas, leaving the buyer to defend itself in a less favorable forum.

This case highlights the importance of anticipating worst-case scenarios in drafting forum selection clauses. A clause that allows flexibility for one party may leave the other exposed to unwanted litigation in an unfamiliar or inconvenient jurisdiction.

See: Brewster v. Proplayer Athletics, LLC, Civil Action No. 2:24-CV-00677-JRG, United States District Court, E.D. Texas, Marshall Division(November 18, 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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

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Buyer-Friendly Earnout Provision Shields Buyer from Seller’s Claim

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This blog dives into a key M&A case from the Delaware Court of Chancery that underscores the importance of earnout clauses in asset acquisition deals. It centers on a $1.7 million acquisition in the data management sector, where the buyer faced a claim after declining a potential Walmart contract. Learn how a “buyer-friendly” earnout provision shielded the buyer from the seller’s claim, with the court affirming the buyer’s right to prioritize its own interests. This case study offers insights for M&A professionals on structuring earnouts to protect buyers while managing seller expectations.

M&A Stories

November 12, 2024

This case highlights a 2021 asset acquisition of a data management company serving the beverage alcohol industry. The purchase price was $1.7 million, with an additional potential earnout of up to $5.5 million, contingent on revenue targets.

At the time of the sale, the seller had been seeking a contract with Walmart for data management services. Almost two years after closing, Walmart issued a request for proposal for a five-year contract and informed the buyer that its products appeared uniquely suited to Walmart’s needs. Walmart invited the buyer to submit a proposal.

On the deadline for submitting, the buyer informed Walmart that it would not be bidding. The buyer later explained to the seller’s founder that it opted out because it was in the midst of negotiations to bring in an equal partner.

The seller responded by filing suit in Delaware’s Court of Chancery, alleging that the buyer had intentionally bypassed the Walmart opportunity to avoid triggering the earnout. The buyer moved to dismiss, arguing that even if the seller’s claims were accurate, they did not constitute a breach of the earnout provision.

The court ruled in the buyer’s favor, characterizing the earnout clause as “buyer-friendly.” The clause explicitly allowed the buyer to operate the acquired business in its own best interests, irrespective of earnout effects. The only restriction was that the buyer could not act in bad faith with the specific intent to reduce the earnout.

The court noted the absence of seller-friendly terms in the provision—there was no requirement for best efforts, commercially reasonable efforts, or even good faith efforts to meet the earnout.

Ultimately, the court dismissed the seller’s claim, finding no evidence that the buyer’s choice to pass on the Walmart proposal, especially amid a major investment transaction, constituted bad faith.

This case illustrates the protective power of a buyer-friendly earnout provision, though it may be challenging to negotiate such terms with a seller who has leverage and skilled advisers.

See: STX Business Solutions, LLC v. Financial-Information-Technologies, LLC, C.A. No. 2024-0038-JTL, Court of Chancery of Delaware(October 31, 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 recenegal 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

Podcasts https://www.buzzsprout.com/2142689/12339043

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

Legal Disclaimer

The blogs on this website are provided as a resource for general information for the public. The information on these web pages is not intended to serve as legal advice or as a guarantee, warranty or prediction regarding the outcome of any particular legal matter. The information on these web pages is subject to change at any time and may be incomplete and/or may contain errors. You should not rely on these pages without first consulting a qualified attorney.

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