Chancery Addresses Earn-Out Dispute Involving Alleged Breaches of Fiduciary Duty and the Implied Covenant
Contingent payments based on an acquired business’s future performance are a frequent feature in M&A transactions. In this case, after selling control, the seller remained a minority member for a time period. Two holdings are noteworthy.
First, the decision holds that the buyer and its representatives did not breach any fiduciary duties while managing the company during the earn-out period. The buyer’s duties to the LLC and its members (a group that included the seller) did not include an obligation to take steps to ensure the seller received all the potential contingent consideration. As the decision explains, “[t]he fiduciary principle does not require that fiduciaries maximize the value of a beneficiary’s contractual claim against the firm.” Still, the buyer did face a conflict of interest between (i) its own interest in minimizing the amount of contingent consideration to the seller, which could create an incentive to let performance suffer during the earn-out period; and (ii) its fiduciary duties to the LLC and its members, which required maximizing the company’s value. Here, the conflict did not result in a breach of duty. As a factual matter, the buyer and its representatives properly pursued in good faith a business plan seeking to maximize the company’s long-term value. That was entirely fair to the company and thus not a breach.
Second, the decision holds that the buyer did not breach the implied covenant of good faith and fair dealing. According to the Court, the governing Operating Agreement gave the buyer control of the company’s operations, subject to sellers having the right to vote on certain transactions, and left no gap for the implied covenant to fill under the circumstances.Share