Explore a recent M&A case involving a seller’s earnout lawsuit against a strategic buyer. Delve into the details of the case and its implications for the M&A landscape. Learn about the importance of precise APA language and the challenges sellers face with earnouts based on revenue or gross profit.
June 26, 2019
M&A Stories
Introduction
In the realm of M&A, this is a recent case involving a seller’s earnout lawsuit against a strategic buyer. This blog delves into the details of the case and its implications for the M&A landscape.
The Background:
In 2013, a seller engaged in providing pharmaceutical products and services to long-term care facilities in New Mexico entered into an asset purchase agreement (APA) with a nationwide pharmacy services provider for institutional care settings. The APA included an earnout clause based on the business’s gross profits during the first and second anniversaries of the closing.
The Earnout Clause:
The earnout, potentially worth $1.25 million, hinged on the gross profits generated by customers who remained with the buyer beyond the second anniversary of the deal. If these profits exceeded $2.2 million, the seller would receive the full earnout. However, a formula would reduce it for profits between $2.2 million and $1.87 million, and no earnout would be granted if profits fell below $1.87 million.
The Lawsuit:
At the end of the second anniversary, the buyer informed the seller that the minimum gross profit target was missed by approximately $600,000, effectively nullifying the earnout. In response, the seller filed a lawsuit, alleging that the buyer had undermined customer accounts, leading to contract terminations and depriving the seller of the earnout. The seller contended that this amounted to a breach of the implied duty of good faith and fair dealing under Delaware law.
The Verdict:
While the court did not deem it necessary to imply a buyer covenant for good faith customer servicing, it found no evidence of bad faith on the part of the buyer. The court concluded that the buyer’s response to customer complaints, although often slow and ineffective, did not constitute willful or unreasonable conduct. Consequently, the seller failed to demonstrate that the buyer acted in bad faith to deny the earnout.
Key Takeaways:
Earnouts based on revenue or gross profit can be challenging for sellers to control, given the buyer’s post-closing actions. This case underscores the importance of precise APA language, particularly concerning the level of service the buyer must provide to the assumed accounts. While hindsight suggests that the seller could have opted for a smaller upfront payment instead of the $1.25 million earnout, the case highlights the intricacies of M&A agreements.
In summary, this blog discusses a recent M&A case in which a seller’s earnout lawsuit was unsuccessful due to the court’s determination that the buyer did not act in bad faith. It highlights the complexities of earnout agreements and the importance of precise contract language in M&A deals.
Case Reference:
Huntingford v. Pharmacy Corporation Of America, No. 1:17-cv-1210-RB-LF, United States District Court, D. New Mexico, (June 14, 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
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Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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