Explore the case of a Texas-based seller’s earnout dispute and the consequences of failing to verify earnout calculations. Learn valuable lessons for business sellers in M&A deals
September 3, 2019
M&A Stories
Introduction:
When buying or selling a business, disagreements over the purchase price often lead to the use of an “earnout.” This arrangement allows the buyer to calculate additional payments based on the business’s performance, with provisions for dispute resolution. In a recent case, a seller’s failure to verify the accuracy of the earnout calculation had significant consequences.
The Deal:
In 2015, a Texas-based seller in the environmental management services sector sold their business assets to a buyer. The agreement included a fixed purchase price and an earnout based on the business’s earnings for the years 2016, 2017, and 2018.
The Lawsuit:
The buyer provided earnout statements for 2016 and 2017, indicating losses and no additional payments due. Unfortunately, the seller did not review these statements or challenge their accuracy within the specified 30-day window, as per the agreement.
In 2018, the seller suspected discrepancies in the 2016 and 2017 statements but failed to receive the necessary documentation from the buyer. The seller subsequently sued the buyer, leading to a dispute in a Delaware federal district court.
The Outcome:
The seller’s lawsuit relied on fraud claims because they hadn’t followed the earnout dispute resolution procedures outlined in the agreement. The court sided with the buyer, recommending dismissal of the case.
The magistrate held that the seller had the right, under the agreement, to inspect the business’s books and records to verify calculations and dispute them if needed. The failure to do so weakened the fraud claims.
Comment:
Additionally, the court rejected the seller’s attempt to bypass the economic loss doctrine, which usually prevents tort claims for economic harm in business transactions. In this case, the seller’s claims essentially mirrored the agreement’s provisions for addressing inaccuracies in earnout statements
Case Reference:
Richie v. Hillstone Environmental Partners, LLC, Civil Action No. 19-649-RGA-SRF, United States District Court, D. Delaware, (July 9, 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
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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