Florida earn-outs: dealmakers beware.

• Author: Silva, Effie D.
• Position: Business Law

When a potential buyer and seller disagree on how much a business is worth, an earn-out provision in the purchase agreement can help bridge the gap. An earnout is a contingent payment tied to the performance of the acquired business or asset going forward. This payment structure can be advantageous to both the buyer and the seller. If the seller is confident that its business is worth more than what the buyer is willing to pay, the earn-out period gives it the chance to prove it. For buyers short on cash, an earn-out can provide a means of financing the transaction with future profits. While the earn-out structure can be appealing to both buyer and seller when closing the deal, these transactions can easily give way to litigation down the road if the agreement is not drafted with clarity and precision. If the business falls short of its earn-out target post-acquisition, selling shareholders may attempt to lay blame at the feet of the buyers, claiming that new management didn't operate the business to achieve maximum profitability or that the buyer misrepresented its capabilities and resources. Typical claims in these disputes can include breach of contract, breach of the implied covenant of good faith, and fraudulent inducement.

Although Florida's jurisprudence in the area of earn-out litigation is limited, courts can look to Delaware precedent when adjudicating earn-out disputes. Delaware courts offer a wealth of corporate merger litigation experience, and Florida courts frequently look to Delaware caselaw for guidance when construing analogous corporate doctrines under Florida law. (1) The following cases represent the most recent and influential decisions in earn-out litigation that provide guidance for Florida dealmakers grappling with this rapidly expanding and contentious area of the law.

The Implied Covenant of Good Faith and Fair Dealing

In a typical earn-out agreement, a portion of the purchase price is contingent on the acquired company or asset achieving certain monetary or nonmonetary performance targets. When the business' post-closing operations are left solely in the hands of the buyers, the parties may disagree on the extent of the buyers' duty to ensure that the earn-out target is met. Even if the agreement does not explicitly require the buyer to take action in furtherance of achieving the earn-out target, seller-plaintiffs often argue that the implied covenant of good faith imposes this obligation. The implied covenant is inherent in all contracts governed by Florida and Delaware law and exists to fulfill the reasonable expectation of the parties that each will perform its contractual obligations in good faith. (2) However, both Florida and Delaware courts look primarily to the plain language of the contract when resolving these disputes and consistently reject litigants' attempts to use the implied covenant of good faith and fair dealing to rewrite agreements or impose extra-contractual obligations.

For example, in the Florida case of Meruelo v. Mark Andrew of the Palm Beaches, Ltd., 12 So. 3d 247 (Fla. 4th DCA 2009), a property owner sold a large parcel of land to developers planning to build a luxury condominium. The sale price included an additional $5 million post-closing payment to the seller in the event that the buyers were able to obtain approval of a site plan in excess of 600,000 square feet of air-conditioned, saleable space. (3) When the buyers failed to seek such approval, the seller brought suit for the $5 million payment, claiming that the implied covenant imposed a duty on the buyers to make a good-faith effort to obtain approval. (4) Florida's Fourth District Court of Appeal rejected the seller's claim and ruled in favor of the buyers. (5) Because the parties' agreement "did not expressly impose on the [b]uyers a duty to seek approval," the court held that "there can be no implied duty to act in good faith in seeking such approval." (6)

The Delaware courts have taken a similar approach. In Airborne Health, Inc. v. Squid Soap, LP, 984 A.2d 126, 132 (Del. Ch. 2009), a pharmaceutical company entered into an asset purchase agreement providing that the seller, Squid Soap, would receive an earn-out payment if certain financial targets were met. However, after a harmful news report concerning Airborne's flagship product, Airborne faced nationwide negative attention resulting in a number of widely publicized and financially damaging lawsuits. (7) As a result of these unforeseen expenses, Airborne failed to market Squid Soap's product, which ultimately led to Squid Soap's failure to obtain the negotiated earn-out in the contract. (8) Airborne sought a declaratory judgment that it was not liable for the earn-out payment under the asset purchase agreement, and Squid Soap counterclaimed for breach of contract and breach of the implied covenant of good faith and fair dealing. (9) The Delaware Court of Chancery ruled in favor of Airborne. Because the plain language of the merger agreement did not obligate Airborne to take any particular actions to market Squid Soap, the court held that Airborne did not breach the contract. (10) Furthermore, there was no breach of the implied covenant of good faith and fair dealing because Airborne's failure to expend resources on Squid Soap was not arbitrary or in bad faith, but rather was the result of a corporate crisis. (11) The court emphasized that Squid Soap had the right to insist on any specific contractual commitments at the time the agreement was made, but failed to do so. (12) Because the implied covenant was not "a means to re-write agreements," (13) Squid Soap lost on both counts and failed to obtain the earn-out.

Similarly, in Winshall v. Viacom Int'l Inc., 76 A.3d 808, 816 (Del. 2013), the Delaware Supreme Court held that the implied covenant does not give the plaintiff contractual protections that it failed to secure for itself at the bargaining table. Viacom, a widely known entertainment company, entered into a merger agreement with Harmonix that provided for an earn-out based upon financial...