Selling or Buying a Business? Beware of Earn-Out Provisions!
Have you ever signed an agreement without fully understanding the terms? A recent High Court case highlights the consequences this could have on all parties involved.
Share Purchase Agreements
When business owners sell their business by way of a share sale, the terms of the sale are usually documented in a share purchase agreement (SPA). Sometimes, rather than the purchase price being a fixed price paid at completion, part of the price is paid in the future and is linked to the performance of the business over an agreed period of time from completion. Such an arrangement is called an 'earn-out'.
In a recent case (Asher v Jaywing Plc), the High Court concluded the terms of the SPA had been breached by the buyer as it had failed to comply with the procedure set out in the SPA for the payment of the earn-out to the sellers. However, as no loss was found to have arisen from the breach as the earn-out targets had not been met, the sellers were not awarded damages.
Disputes over the SPA
The SPA which was in dispute referred to three possible earn-out payments depending on the performance of the target business.
The buyer argued that the conditions relating to the payment of the second and third earn-out payments had not been met and no further payments should be made. The sellers argued the conditions for the payment of the second and third earn-outs were amended by an oral agreement made at a meeting so they were entitled to the relevant earn-out payments.
There Are Two Issues to Be Considered:
1. Amendment to SPA
Without any specific minutes of the meeting to evidence it and with limited documented correspondence, the Court had to rely heavily on witness accounts of the meeting. Many of the witnesses proved unreliable through lack of memory which led to inconsistencies in their accounts of the events.
In any event, the SPA, like many agreements, contained a provision requiring any amendments to its terms to be in writing and signed by all parties. Without clear written evidence to demonstrate such a variation, the Court found that no agreement to vary the terms of the SPA was reached.
2. Procedure contained in SPA
The next question was whether the buyer was in breach of the terms of the SPA and specifically, whether it failed to follow the process laid out in the SPA for calculating and agreeing the amount of the earn-out payments.
The earn-out provisions in the SPA required the buyer to deliver to the sellers a statement prepared by the buyer's auditors showing its calculation of the earn-out payment. The buyer's auditors declined to act due to concerns about their independence. The buyer delivered a statement drafted by its own chief financial officer with some input from another accountancy firm instead. Although the Court accepted the buyer's argument that another suitably qualified accountancy firm could prepare the calculation, it was held that the buyer had breached the SPA as the calculation was prepared by the chief financial officer.
What Does This Case Mean for Buyers and Sellers?
Although the Court decided that no damages would be awarded, this case nonetheless confirms the importance of a buyer and a seller understanding the terms contained within an SPA and ensuring that any procedures relating to post-completion payments are carefully followed. Additionally, when agreeing changes to the SPA, the buyer and the seller should check that all relevant requirements of the SPA are satisfied.