Earnout Period Pitfalls–A Covenant to Operate “Consistent with Past Practices” Precluded Early Dismissal of an Earnout Claim (Edinburgh); A Delayed Closing Led to the Earnout Period Starting Before the Closing (Glidepath)
By: Andrew J. Colosimo, Warren S. de Wied, Steven Epstein, Christopher Ewan, Arthur Fleischer, Jr., Andrea Gede-Lange, David J. Greenwald, Randi Lally, Mark H. Lucas, Scott B. Luftglass, Brian T. Mangino, Philip Richter, Robert C. Schwenkel, David L. Shaw, Peter L. Simmons, Matthew V. Soran, Steven J. Steinman, Gail Weinstein, Maxwell Yim
Earnouts, while often used to bridge valuation differences during negotiation of an agreement to sell a company, frequently lead to post-closing disputes. Two Court of Chancery decisions issued in 2018 highlight pitfalls associated with the period during which an earnout is measured (the “Earnout Period”). In Edinburgh Holdings, Inc. v. Education Affiliates, Inc. (June 6, 2018), the court held that the covenant to operate the acquired business “consistent with past practices” during the Earnout Period precluded disposition of the earnout-related dispute at the early pleading stage of litigation. The court stated that the covenant necessitated a facts-intensive analysis of what past practices were and what the practices during the Earnout Period had been. In Glidepath Limited v. Beumer Corporation (June 4, 2018), the court rejected the plaintiffs' request for reformation of the acquisition agreement to change the dates of the Earnout Period based on the delay in signing and closing the agreement (which had led to the anomalous result of the Earnout Period commencing before the closing). In the attached Briefing, we analyze these decisions and offer earnout-related practice points.
