Explore a real-life M&A dispute where a seller’s fraud lawsuit against a buyer over an earnout disagreement led to a court ruling. Gain insights into the legal intricacies of this case and the implications for M&A agreements.
November 6, 2019
Introduction:
Disappointment in earnout deals is common in the business world. This article discusses a specific case where a seller filed a fraud lawsuit against a buyer over an earnout disagreement.
The Deal:
In this case, a competitor acquired a legal analytics company by buying its stocks. The total price was $9 million in cash with an additional $3 million potential earnout, contingent on achieving certain revenue goals in the first two years after the deal closed. During negotiations, the buyer presented optimistic revenue projections, but their actual business had experienced a significant revenue drop. However, they didn’t disclose this to the seller.
As negotiations were wrapping up in December 2014, the seller sought confirmation from the buyer that they were aligned on earning the earnout. The buyer responded positively but didn’t disclose their financial issues. The stock purchase agreement was signed on January 8, 2015, and a separate agreement outlined post-acquisition services the target’s CEO would provide to the buyer.
The Lawsuit:
After the deal closed, the buyer didn’t make a significant effort to sell the target’s products or reach the revenue threshold required for the earnout payments. In the first earnout period, they achieved less than 20% of the projected revenue. Moreover, the buyer didn’t engage the target’s CEO for post-closing services and, in December 2015, sold the legal division, including the target, to a competitor that had no interest in the target’s product.
Due to the buyer’s actions, the seller sued them in an Illinois federal district court, alleging that the buyer had induced the seller to enter the stock purchase agreement through false representations about their intentions and ability to meet the earnout requirements. The lawsuit invoked the Illinois Securities Law and Illinois common law.
The buyer argued that the claims lacked merit and asked the court to dismiss the lawsuit. However, the court ruled that the allegations in the case constituted a valid fraud claim under both the Illinois Securities Law and Illinois common law.
Comment:
The court’s decision shed light on two common provisions often found in M&A agreements: integration and anti-reliance clauses. In this case, the integration clause, which stated that the agreement represented the entire understanding between the parties, did not shield the buyer from fraudulent representations. On the other hand, an anti-reliance provision, where the seller would have promised not to rely on any statements outside the agreement, could have changed the outcome in this case.
Case Reference:
This case is referred to as Gruner v. Huron Consulting Group, Inc., No. 18 CV 02143, United States District Court, N.D. Illinois, Eastern Division (August 12, 2019)
By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
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Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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