Explore a real M&A case (Sapp v. Indus. Action Services, LLC) involving earnout disputes and the legal battle between expert determination and arbitration. Learn the key findings, implications, and the court’s role in resolving EBITDA threshold disagreements.
November 8, 2023
Earnouts are a common feature in M&A deals, often triggering legal disagreements, particularly around EBITDA thresholds. Parties typically opt for an accounting firm to resolve these disputes, but the wording in the agreement can impact court intervention.
In a 2016 asset sale of a company specializing in industrial services, the $12 million closing payment, $1.5 million buyer owner stock, $3 million deferred compensation, and potential $15 million Earn Out Consideration were at the center of the dispute. The latter was contingent on the buyer meeting EBITDA benchmarks over three years.
Issues arose when the buyer claimed it fell short of EBITDA targets for all three Earn Out Periods, with the seller alleging intentional undermining. This disagreement prompted a seller lawsuit in a Delaware federal district court.
The seller sought court intervention for earnout entitlement, while the buyer insisted on arbitration as per the purchase agreement. The district court mandated binding arbitration by the selected accounting firm. The seller, however, argued for nonbinding expert determination, leading to an appeal.
The appellate court determined that the procedure outlined in the purchase agreement resembled expert determination more than arbitration. The accounting firm had limited authority, a specific duty scope, a short deadline, and lacked discovery procedures or legal argument acceptance.
The case returns to the district court, where the accounting firm reviews the buyer’s EBITDA calculations. Unlike arbitration, the seller can contest the accounting firm’s decision in court if dissatisfied.
Sapp v. Indus. Action Services, LLC, No. 22-2181 United States Court of Appeals, Third Circuit (Argued April 13, 2023. Opinion filed July 20, 2023).
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
Telephone: 714 273-6291
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.