A recent article on The Harvard Law School Corporate Governance Blog collected decisions, mostly based on Delaware law, that address Earn Out disputes, which generally involve agreements for the sale of a company that allow for post-closing payments subject to various milestones or revenue targets being satisfied. Commonly, the buyer of the company is required to use a level of effort to reach those milestones or revenue goals that is variously described as reasonable efforts or diligent efforts or similar “hard to measure” language.

Recent Delaware decisions on those topics have been highlighted on these pages here and here and here, but the above-linked article does a notable job of compiling many recent cases in one place with helpful commentary.

My favorite scholarly commentary on the topic of “commercially reasonable efforts” in general, is provided by friend of the blog, Professor Stephen Bainbridge, whose scholarship is often cited in Delaware court opinions.

The recent Delaware Court of Chancery decision in Windy City Investments Holdings, LLC v. Teachers’ Insurance and Annuity Association of America, C.A. No. 2018-0519-MTZ (Del. Ch. July 26, 2019), discussed an often recurring issue in commercial litigation: a seller of a business who claims that the Earn-Out provisions in the agreement of sale were not complied with by the buyer.

Key Takeaways:

The most noteworthy aspects of this decision are the thorough recitation of important contract interpretation principles, and a similarly thorough application of those principles. The key statements of law are found on pages 14 and 17.  The court’s reasoning is found most prominently at pages 15 and 22.

·     For example, the court explained that in the context of a motion to dismiss, the moving party in a contract dispute must demonstrate that its interpretation is the only reasonable reading of the disputed provision.

·     However, when the court “may reasonably ascribe multiple and different interpretations to a contract, it will find that the contract is ambiguous.  To be ambiguous, a disputed contract term must be reasonably susceptible to more than one meaning.”  See footnotes 36 and 37 and accompanying text.

·     In this case, the court found that each party’s contract construction left “something to be desired,” and would require the court to “import extra-contractual concepts to reconcile” the language in the agreement.

·     The court observed that an unreasonable interpretation of an agreement “produces an absurd result or one that no reasonable person would have accepted when entering the contract.”  See footnote 46 and related text.

·     The court reasoned that no party offered the only reasonable construction, and because the contract was susceptible to two or more reasonable interpretations and two of more meanings, the contract was ambiguous and required extrinsic evidence to determine the contractual intent of the parties–thus being inappropriate for decision at the motion to dismiss stage.  See footnote 58 and accompanying text.

One of the more common forms of commercial litigation continues to be disputes regarding earn-out formulas for post-closing payments due if certain milestones are met.  The Delaware Court of Chancery decision in Fortis Advisors LLC v. Stora Enso AB, C.A. No. 12291-VCS (Del. Ch. Aug. 10, 2018), involved a motion to dismiss earn-out claims. 


The amended complaint alleged that there were two post-closing payments due upon the achievement of designated milestones (the “Milestone Payments”).  The Milestone Payments were based on certain provisions in the merger agreement that called for various actions to be completed, and if they were completed, then substantial additional payments would be due to the seller.  Exhibits to the merger agreement provided the details and deadlines regarding the Milestone Payments.  The first Milestone Payment required a construction of a plant and the completion of the production of certain products.  The second Milestone Payment required the construction of a separate plant and the production of certain products at a specific price by a specific deadline.

The claim for breach of contract alleged that the buyer did not comply with the business plan that was a part of the Merger Agreement and that the actions required to be taken in order for the Milestone Payments to be due, were not performed.

Legal Analysis:

The usefulness of this decision is primarily based on the court’s analysis of the standard under Rule 12(b)(6) for a motion to dismiss, as opposed to its analysis of specific terms of the merger agreement that might be replicated in other merger agreements with earn-out provisions such that the court’s analysis of merger terms would be applicable in other cases.

Rather, the court explained that in a motion to dismiss, the movant can only prevail if its proffered interpretation of the merger agreement is the only reasonably interpretation.  In this case, however, the interpretations of the merger agreement by each of the parties were both reasonable, and therefore, as a procedural matter the court found that granting the motion to dismiss was inappropriate.

The court explained in detail why the interpretation of each of the parties was reasonable because of an ambiguity in the provisions of the agreements on which the motion to dismiss was based.  Because the court determined that additional discovery is needed and a fuller record would need to be examined at trial in order to determine the intent of the parties in connection with the terms in the merger agreement that were disputed, a determination prior to trial about whether or not there was a breach of the agreement regarding the Milestone Payments was premature.

The recent Delaware Supreme Court decision in Exelon Generation Acquisitions, LLC v. Deere & Company, No. 28,2017 (Del. Supr., Dec. 18, 2017), reversed the trial court ruling and rejected an earn-out claim based on the application of well-settled contract interpretation principles.

The specific contract terms that were interpreted are fairly sui generis and not widely applicable, in terms of the factual aspects of the trigger for the earn-out payment, but several contract interpretation principles are noteworthy for their wide-spread applicability.

Background Facts: In this case, Excelon agreed to make earn-out payments to Deere if it reached certain milestones in the development of three wind farm projects that were underway at the time of sale.  One of the projects became impossible to develop due to local ordinances that were passed.  The issue arose about whether the development of another wind farm 100 miles away, that was not referenced in the applicable agreements, could satisfy one of the milestones that would trigger the earn-out payment.

Key Contract Interpretation Principles: Several basic contract interpretation principles in this decision have widespread applicability:

  • Delaware adheres to an objective theory of contracts. Contract construction should be that which is understood by an objective, reasonable third party.
  • If a contract is unambiguous, extrinsic evidence may not be used to interpret the intent of the parties, to vary the terms of the contract, or to create an ambiguity.
  • One contract may incorporate discrete parts or terms from another contract without necessarily incorporating the entire contract. See footnote 33 (citing 11 Richard A. Lord, Williston on Contracts § 30: 25, at 234, 238 (4th ed. 1999)).
  • Extrinsic evidence cannot be used to interpret the intent of the parties or to vary the terms of the contract unless the contract suffers from ambiguity.
  • In interpreting an earn-out provision, the parties’ post-closing conduct may be used to determine whether there is a breach, but post-closing evidence cannot be used as an aid to interpreting the meaning of the contract when the contract is unambiguous.

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.

Lazard Technology Partners, LLC v. Qinetiq North America Operations LLC, No. 464, 2014 (Del. Supr., Apr. 23, 2015). The Delaware Supreme Court interpreted a post-closing earn-out provision and determined that the Court of Chancery was correct when it held that there was no breach of the implied covenant of good faith and fair dealing; plus, there was no evidence that the requirement in the applicable provision had been met, to demonstrate that the buyer intentionally evaded the trigger for an earn-out to be paid. This decision may be unprecedented in its brevity for an en banc  Supreme Court opinion, but nevertheless should be required reading for anyone with an issue involving an earn-out provision under Delaware law.

Practice point: drafters should make sure the standard by which an earn-out provision will be reviewed is capable of easy, objective measurement.

American Capital Acquisition Partners, LLC v. LPL Holdings, Inc., C.A. No. 8490-VCG (Del. Ch. Feb. 3, 2014).

This Court of Chancery opinion addresses a recurring theme of many cases in this court: disputed earn-out provisions that allow for potential additional consideration that would be due to the sellers of a company post-closing dependent upon the acquired company satisfying various milestones or performance targets. The claims that survived a motion to dismiss in this case related to allegations that clients and opportunities of the acquired company were diverted, post-closing, from the acquired entity to another subsidiary of the acquirer in order to thwart any opportunity for the acquired entity to meet performance guidelines that would have otherwise entitled the sellers to additional compensation.

Noteworthy about this opinion is that it is one of the few in which a claim for breach of the implied covenant of good faith and fair dealing survives a motion to dismiss, in connection with allegations that revenue was diverted to other affiliates in order to avoid the milestones or goals that would have triggered the earn-out provisions. See Slip op. at 18.

This is the archetype of an opinion on which Chancery’s reputation was based. After a thorough review of the facts the court analyzes the legal claims in a scholarly manner with efficiency.

Comet Systems, Inc. v. Miva, Inc., (Del. Ch., Oct. 22, 2008), read opinion here. This Chancery Court opinion involves the interpretation of an earnout provision and a change-of-control bonus in a merger agreement. The Court’s own introductory overview of the the factual background and the issue addressed is the most efficient means to summarize this case and it will also allow the reader to determine if it sparks enough interest to download the whole decision at the above link. What follows is a quote from the first page of the Court’s 20-page decision:

This breach of contract case arises out of a dispute between the former stockholders of a software company and a successor entity which purchased that company over the interpretation and performance of the earnout provisions of the merger agreement in which those stockholders were bought-out. The former stockholders have moved for partial summary judgment as to the first count of their verified complaint, and the purchasers have cross-moved for summary judgment on all counts.

The central issue presented by these motions is whether a change-of-control bonus paid to the employees of the target corporation prior to the closing of the merger is a “one-time, non-recurring expense” that should be excluded from the target’s costs for the purpose of computing the earnout. If the bonus payment is excluded from the cost calculation, the former stockholders will be entitled to an additional payment of approximately $1.67 million under the earnout. The court finds that this is a pure question of law, on which the former stockholders are entitled to summary judgment. The court also concludes that, as a result of a delay in payment, the former stockholders are entitled to an award of interest on the portion of the earnout they already received, as well as on the portion which the court finds they should have gotten.

 In LaPoint v. AmerisourceBergen Corp., (Del. Ch., Sept. 4, 2007),  read opinion here, the Chancery Court ruled that a merger agreement was breached in connection with an "earnout provision", and awarded former shareholders of the acquired company $21 million in damages.  Amerisource has vowed to appeal, as reported by Bloomberg News here. The Chancellor provided an introductory overview of the case that deserves to be quoted, as follows:

This case falls into an archetypal pattern of doomed corporate romances. Two companies—Bridge Medical, Inc. and AmerisourceBergen Corporation–agree to merge, each convinced of a happy future filled with profits and growth. Although both partners harbor some initial misgivings, the merger agreement reflects these concerns, if at all, in an inaccurate and imprecise manner. After some time, the initial romance fades, the relationship consequently sours, and both parties find themselves before the Court loudly disputing what the merger agreement “really meant” back in its halcyon days. If this case is different, it is only in the speed with which the ardor faded. 

UPDATE: Here  is the affirmance by the Delaware Supreme Court in a 7-page Order dated April 8, 2008,  upholding the Chancellor’s opinion.