Explore the complexities of M&A transactions with a deep dive into the legal battles surrounding earnouts. This post dissects a real-world case involving a $226 million acquisition in the insurance industry, where the buyer alleges overpayment due to fraudulent earnout practices. Uncover insights into the legal strategies, the implications of financial misrepresentation, and the critical importance of good faith in M&A agreements. Perfect for M&A professionals, legal experts, and anyone interested in the intricacies of acquisition deals and their legal repercussions.
M&A Stories
May 20, 2024
Earnouts are a common feature in M&A transactions, typically placing the risk on the seller who must achieve specific post-closing targets to receive additional payments. However, this isn’t always the case.
In a recent $226 million acquisition, a private equity-backed insurance brokerage from Utah purchased a Bellingham, Washington-based insurance agency. This 2021 deal included retaining the agency’s owner to run it as a division of the buyer’s company.
The agreement stipulated an earnout if the agency hit certain earnings growth targets within five years, with the first-year target being the most lucrative. If the agency’s EBITDA exceeded the closing EBITDA by more than 3% at the end of the first year, the buyer would pay ten times the amount of that growth. In subsequent years, the growth targets were higher to achieve the same multiple.
The seller’s owner secured a significant first-year earnout, but the buyer later claimed it had overpaid by $28 million. This led to a legal battle in a Seattle federal district court, with the buyer alleging breach of contract, fraud, and violation of the implied covenant of good faith and fair dealing.
The seller’s owner moved to dismiss the suit but was unsuccessful, leading to ongoing litigation. The court highlighted a pre-sale email where the seller’s owner instructed an employee to delay recording commission checks until after closing to inflate the earnout. The buyer also alleged the seller’s owner misrepresented earnings and maintained secret accounting systems.
The court noted the buyer’s claim that the seller’s owner failed to cooperate in good faith in preparing the estimated earnout EBITDA. This included not providing access to necessary books, records, and personnel. The buyer accused the seller’s owner of overstating revenues, understating expenses, and deliberately obstructing the buyer’s access to crucial financial information, thereby inflating the earnout payments.
Case Reference: PCF Insurance Services of West, LLC Case No. C23-1468-JCC., United States District Court, W.D. Washington, Seattle, (March 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.
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By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
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