A recent Court of Chancery decision granted a motion for judgment on the pleadings on several claims relating to post-closing earn-out payments due in connection with an acquisition. In GreenStar IH Rep, LLC v. Tutor Perini Corporation, C.A. No. 12885-VCS (Del. Ch. Oct. 31, 2017), the court found that the terms of the agreement were unambiguous and that the facts alleged were sufficient to enter judgment on three of the eight counts in the complaint that sought damages and declaratory judgments relating to the failure of the buyer to make earn-out payments as required by the merger agreement.
Background: This case involved the sale of GreenStar Services Corporation to Tutor Perini Corporation. The agreement provided for a right to receive post-closing earn-out consideration in the event certain pre-tax profit milestones were achieved. The motion for judgment on the pleadings that this opinion decided, related to those parts of the complaint which asserted breach of contract claims for failure to make the earn-out payments in the third, fourth and fifth years after closing. The court determined that based on a review of the applicable agreement and the facts alleged in the complaint that the seller was entitled to earn-out payments as a matter of law based on the clear and unambiguous terms of the agreement. The court also determined that the buyer was not entitled to any offset based on any alleged wrongdoing in the counterclaims. The court also rejected claims for fraud based on the failure to plead with the necessary particularity.
The relevant provisions in the merger agreement provided for the calculation of the earn-out payments based on pre-tax profit. The agreement defined pre-tax profit as the amount calculated and included in a pre-tax profit report compiled in accordance with GAAP. If the pre-tax profit report was not objected to, then the parties would be bound by it for purposes of calculating the earn-out. If there was an objection to the pre-tax profit report, there was a procedure in the agreement providing for binding arbitration.
Analysis: The court recited basic contract principles including the truism that when, as in this matter, the language of an agreement is unambiguous, the court is bound by the language within the agreement. See cases cited at footnotes 50 and 51.
The court read the agreement as unambiguously providing for the calculation of the earn-out payments due based on the pre-tax profit reports. When, as in this case, there was no objection to those reports, the parties agreed that those reports would be binding in terms of determining the amount of the earn-out payments that were due.
The court specifically rejected the argument of the buyer that the unambiguous provisions of the agreement regarding the binding nature of the report should be subject to a condition that the report would not be binding if the buyer either failed to properly calculate the pre-tax profit or if the buyer allegedly relied on inaccurate financial statements. The court rejected that argument in part, because it would allow the buyer to unilaterally determine when the pre-tax profit report was not considered binding.
Likewise, in rejecting that argument, the court also rejected the argument that the implied covenant of good faith and fair dealing should allow for an implication that the report would only be binding if it was determined to be accurate.
Implied Covenant of Good Faith and Fair Dealing: The court defined the limitations of the implied covenant of good faith and fair dealing, which will not be used when contract language could have easily been drafted to expressly provide for the allegedly missing terms and when the existing contract speaks directly to the issue in dispute. Stated differently, the covenant exists solely to fulfill the reasonable expectations of the parties, and to avoid arbitrary frustrations of the parties’ bargain, but in order for the implied covenant to apply, the obligation asserted and the obligation to be implied must not contradict the purposes reflected in the express language of the contract.
Holding: In sum, the court found that there were “no gaps to be filled” and that the court would not imply a term that is inconsistent with the intent of the parties as evidenced by the express terms of the agreement. See footnote 70 and cases distinguished therein.
Also notable is the court’s rejection of the argument that the existence of 13 affirmative defenses made it premature to grant a motion for judgment on the pleadings. Cases cited in footnotes 72 through 74 supported the court’s reasoning that the “rhythmic incantation of multiple affirmative defenses, each revealed in a single sentence, cannot, alone, defeat an otherwise well-supported motion for judgment on the pleadings.”
Takeaway: Although most earn-out disputes involve genuine issues of material fact that might make a dispositive motion more challenging, where there are purely contractual interpretation issues that are subject to unambiguous terms, this decision may help to support an effort to seek a pre-trial ruling on at least some of the contract issues in an earn-out dispute.