The seller sold its dental practice to the buyer, a dental care practice with about 200 offices located in several states, pursuant to an asset purchase agreement. The buyer purchased the practice for $2.8 million in cash. The asset purchase agreement also contained an earnout payment setting out the buyer’s promise to pay the seller a payment calculated on revenues earned by the practice in the second year following the execution of the asset purchase agreement.
Specifically, the buyer promised to pay the seller an earnout based on a sliding scale ranging from $0 if net revenues were lower than $4.8 million up to a maximum of $500,000 if revenues hit $5.3 million or more. The seller claimed that the buyer took post-closing actions that prevented the seller from receiving the $500,000 earnout payment.
At the closing, the seller stated that it was operating its dental practice in a manner that, if continued, would have resulted in a maximum earnout payment of $500,000. Then for approximately five months, the buyer continued the practice in a similar fashion. However, after that, the buyer made several changes to the purchased practice that had a substantial impact on the bottom line and reduced the purchased practice’s revenue to a point where the seller would not be entitled to any earnout payment under the formula contained in the asset purchase agreement.
Specifically, the buyer: (1) cancelled a dental services financing plan used by over half of the practice’s patients, resulting in a substantial drop in appointments and revenue; (2) cancelled an agreement with a major healthcare insurance plan resulting in a substantial drop in patients and revenue; and (3) failed to pay dentists employed by the practice as agreed in employment agreements, resulting in a loss in revenues and the departure of at least two high producing dentists.
The buyer moved to dismiss the seller’s lawsuit, arguing the seller fail to allege the buyer acted in bad faith with the requisite intent to avoid the earnout payment. The court agreed with the buyer.
The court said that the asset purchase agreement specifically provides for how the buyer shall operate the practice in regard to the earnout. The agreement gives the buyer sole discretion with regards to all matters relating to the operation of the practice, and clearly states that in operating the practice, the buyer has no obligation to operate the purchased practice to achieve or maximize any earnout payments; provided that the buyer operates the practice in good faith and not in a manner intended to avoid making an earnout payment.
The court said that it was dismissing the lawsuit because the seller failed to include any specific allegation that the buyer undertook the allegedly unreasonable acts with the intention of depriving the seller of an earnout payment.
However, the court gave the seller permission to amend its complaint, to make that specific allegation. Nevertheless, the court cautioned the seller that it faced an uphill battle to demonstrate that the buyer acted with the intention of denying the seller an earnout payment. The court characterized the seller’s current theory that the buyer’s pattern of conduct, after taking control of the purchased practice, drove a valuable and historically successful practice into the ground resembles unwise business decisions rather than intentional acts to drive away customers and lower net revenues to avoid triggering the earnout.
This case is referred to as Colby v. Interdent Service Corporation, Case No. 6:18-cv-781-MC, United States District Court, D. Oregon, (August 1, 2018).
Comment. Taking a portion of the purchase price from an earnout is risky; because post-closing disputes are common and recovering an earnout that the buyer claims was not earned can be difficult for the seller to prove.
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