Mergers And Acquisitions Alert: Lazard V. Qinetiq: Important Lessons For Structuring Earn-Outs

Overview

A recent Delaware Supreme Court case authored by Chief Justice Strine upholds the literal meaning of an earn-out provision that limited the buyer from taking action "intended to reduce or limit an earn-out payment." The court rejected the argument that buyer's actions, which it likely knew would reduce the likelihood of an earn-out payment, met the intent-based standard the parties had agreed on in lieu of various affirmative post-closing covenants that had been rejected by the buyer. The court also rejected the seller's argument that it could rely on the implied covenant of good faith and fair dealing to impose an objective standard and thereby avoid the burden to prove that the buyer intentionally violated such provision. The case has implications for buyers' and seller's negotiating strategies around post-closing operations covenants related to earn-outs and as to the impact of such covenants on the interpretation of the implied covenant of good faith and fair dealing. The case is Lazard Technology Partners, LLC, v. Qinetiq North America Operations LLC, April 23, 2015, Strine, L., 2015 WL 1880153, and it can be found at http://business.cch.com/srd/LazardTechnology-v-Qinetiq.pdf

Background

The case arose out of an acquisition by Qinetiq North America Operations, LLC ("buyer") of Cyveillance, Inc. ("seller"). Buyer had agreed to pay $40 million up-front and, if certain revenue targets were achieved, additional amounts of up to $40 million.

The earn-out provision in the merger agreement (Section 5.4) provided that buyer was prohibited from "tak[ing] any action to divert or defer [revenue] with the intent of reducing or limiting the Earn-Out Payment." When the earn-out period ended, the revenues had not reached the level required to generate an earn-out.

Lazard sued as the seller's stockholders' representative, arguing that the buyer had breached Section 5.4 of the merger agreement and violated the implied covenant of good faith and fair dealing by failing to take certain actions (such as signing of a reseller agreement) that the seller contended would have resulted in an earn-out payment.

Court of Chancery

Vice Chancellor Laster framed the case as follows: "Given the language of 5.4, to succeed on its contract claim Lazard had to prove at trial that buyer had the intent to reduce or limit the earn-out payment. Absent this bad intent, actions that diverted or deferred opportunities would not violate Section 5.4." The court ruled in...