Unlock critical insights for lower middle market M&A. This post reveals a non-obvious risk for sellers relying on earnouts: what happens when the selling entity faces post-closing bankruptcy? Learn crucial pre-closing contractual strategies to protect your earnout and navigate complex disputes with buyers, drawing lessons from a recent, high-stakes court battle.
M&A Stories
July 14, 2025
Earnouts are often essential mechanisms that facilitate the closing of a business acquisition, bridging valuation gaps and aligning incentives. Yet, beneath their promise lies a non-obvious risk: the possibility that a seller may never receive their earnout, particularly if a post-closing bankruptcy intervenes for the selling entity.
Consider a recent case involving a genetic test maker in financial distress, which sold its reproductive health assets. The transaction included an earnout, a payment contingent on post-closing performance metrics. Just a month after the deal closed, the seller sought Chapter 11 bankruptcy protection.
As part of its reorganization, the seller, in its role as debtor, elected to reject the Asset Purchase Agreement. This legal maneuver, typical in bankruptcy for shedding burdensome ongoing contracts, unexpectedly triggered a dispute between the seller and the buyer in both the bankruptcy court and the Delaware courts. The buyer contended that the seller’s rejection of its remaining post-closing obligations under the agreement relieved the buyer of its duty to pay the earnout.
The intricate matter will ultimately be decided by the Delaware Court of Chancery. However, it appears the seller holds a stronger position. The buyer’s earnout obligation likely constituted a vested pre-petition commitment, one that would ordinarily remain unaffected by the seller’s subsequent rejection of its executory post-closing covenants.
This case offers a vital lesson for sellers of lower middle market businesses. Even when bankruptcy is not on the horizon, proactive steps can significantly minimize the risk of losing out on hard-won earnouts. A seller can bolster its position by meticulously crafting specific earnout provisions within the purchase agreement itself.
For instance, the agreement should unequivocally state that the seller’s right to receive the earnout payment vests fully and irrevocably upon the closing of the transaction, irrespective of the fact that the final amount may be calculated and deferred to a later date. Furthermore, it should clarify that the buyer’s obligation to pay the earnout constitutes a pre-petition debt, enforceable by the seller’s bankruptcy estate, notwithstanding any future rejection of other executory aspects of the purchase agreement. Such foresight in the contractual provisions can transform a potential legal quagmire into a more predictable and protected outcome for the seller.
See: In Re Invitae Corporation., Case No. 24-11362 (MBK), Adv. Pro. No. 25-01015 (MBK), United States Bankruptcy Court, D. New Jersey (July 2, 2025).
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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