M&A Stories
January 11, 2026
One Question
If a buyer with multiple subsidiaries moves your legacy customers and star salespeople to a different branch of their company, does your earnout contract contain the specific “if/then” rules required to prove a breach of contract, or are you relying on a judge’s definition of “fairness”?
The seller in this case operated a specialized technology firm focused on cloud-based communication systems. The buyer was a national technology conglomerate with a complex structure of various business branches and subsidiaries.
In this deal, the seller was absorbed into a large corporate machine. The danger realized here was that the buyer moved the revenue-generating assets—the customers and the star employees—into different business units that were not included in the earnout calculation. Because the earnout was tied only to the profits of the specific entity that was sold, the buyer was able to shift the revenue out of the seller’s reach without technically violating the written contract.
The judge dismissed the seller’s claims because the contract gave the buyer “sole discretion” to run the business. Without specific, objective guardrails, the court refused to override the buyer’s management decisions. To avoid this outcome, a seller must have specific rules that act as a tether between their former assets and their earnout payout.
Facts
The seller provided specialized IT and cloud services. The buyer, a national provider with numerous subsidiaries, purchased the seller’s assets for an upfront payment plus a three-year earnout based on future profits.
After the deal closed, the buyer integrated the business. The seller alleged the buyer moved sales staff and customer accounts to other companies the buyer already owned. This shifted the revenue away from the seller’s specific earnout calculation. The seller sued for “bad faith,” but the buyer pointed to a clause in the contract giving them “sole discretion” over all business operations and stating they had no obligation to maximize the earnout.
Issues
The primary issue was the hollowing out of the business unit. The Delaware Superior Court had to decide if a buyer could move the people and customers that generate an earnout to a different subsidiary to avoid paying the seller. Additionally, the court addressed the fairness argument, determining if a general requirement to act in “good faith” overrides a specific contract clause that gives the buyer “sole discretion.”
Decision
The court ruled in favor of the buyer and granted the motion to dismiss. There was no earnout protection for the seller regarding the moved accounts and staff. The court held that the contract language was the final word and that the seller could not use a fairness argument to create protections they did not negotiate.
Reasons
The court focused on the power of the “Sole Discretion” clause. The contract explicitly stated the buyer had no obligation to take any action to maximize the earnout. Delaware courts do not rescue sophisticated sellers from lopsided deals if the contract allows the buyer’s behavior. Furthermore, the court noted that the “implied covenant of good faith” only fills unexpected gaps. Since the parties could have written a rule about moving staff or customers but did not, the court refused to create one.
Strategic Lessons for the Seller
This case demonstrates that in a strategic acquisition, your biggest competitor for the earnout might be the buyer’s other business divisions. It highlights an integration risk where a buyer can follow the literal letter of the contract while effectively zeroing out your payout by shifting resources. Relying on “good faith” or “fairness” is not a reliable safety net; protection must be built into the contract as an objective, financial rule.
Recommended Covenants
To help survive a motion to dismiss, a seller must be able to point to a specific, objective rule that was broken. Relying on “bad faith” is often a losing strategy at the start of a case because it is difficult to prove without a full trial. These two covenants would have helped the seller’s legal position.
The “Follow the Customer” Rule
The contract should identify a specific list of the seller’s customers at the time of closing. The rule must state that any sale made to a customer on that list—whether by the buyer, the target company, or any other subsidiary the buyer owns—must be credited to the seller’s earnout. This ensures the revenue is tracked by the identity of the customer rather than the identity of the office sending the invoice. It makes the buyer’s corporate structure irrelevant to the math of the earnout.
The “Stay-Put” Rule for Key Employees
The contract should name key employees and strictly forbid the buyer from transferring them away from the specific business unit being measured for the earnout. If the buyer moves a key person to a different branch or promotes them out of the unit, the contract should trigger an automatic, pre-calculated credit to the earnout total. This prevents the buyer from removing the talent necessary to hit the profit targets and provides a clear fact for a judge to evaluate during a motion to dismiss.
C.A. Nos. N16C-12-032 MMJ CCLD, N19C-02-141 MMJ CCLD, Superior Court of Delaware (September 17, 2019)
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.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law in lower middle market private target deals.
By John McCauley: I write about recent problems of buyers and sellers in lower middle market private target deals.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my books: Buying Established Business Assets: A Guide for Owners, https://www.amazon.com/dp/B09TJQ5CL5
and Advisors and Selling Established Business Assets: A Guide for Owners and Advisors, https://www.amazon.com/dp/B0BPTLZNRM
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