Are you considering selling or buying a business? Keep an eye out for earn-out provisions

Have you ever signed an agreement without fully understanding its terms? According to a recent High Court case (Asher v Jaywing Plc, 12 April 2022), the consequences may be detrimental to all parties involved.

Share Purchase Agreements

Share Purchase Agreements (SPAs) are usually used when business owners sell shares of their company.

In some cases, instead of the purchase price being a fixed cost paid upon completion, a portion of the price is paid in the future and is based on how the business performs over a specified period of time after completion. This type of arrangement is known as an 'earn-out'.

Recently, the High Court held that the buyer had breached the terms of the SPA by failing to follow the instructions outlined in the SPA for the payment of the earn-out to the sellers .

The sellers, however, were not awarded any damages because no loss was found to have resulted from the breach (earn-out targets were not met) .

Disputes and judgment concerning the SPA

In the SPA in dispute, there were three possible earn-out payments depending on the performance of the target business.

The buyer argued that the conditions had not been met for the second and third earn-out payments and that no further payment should be made regarding second and third earn-outs.

The sellers argued that as a result of an oral agreement made at a meeting, the conditions for the payment of the second and third earn-outs had been amended, and therefore they were entitled to the relevant earnings.

SPAs, like many agreements, contain a requirement that any amendments to their terms be made in writing and signed by all parties.

It was determined by the Court that no agreement had been reached to vary the terms of the SPA, as there was no clear written evidence.

Under the earn-out provisions of the SPA, the buyer was required to provide the sellers with an audited statement of the buyer's calculations of the earn-out payment. Due to concerns about their independence, the buyer's auditors declined to act.

Instead, the buyer provided a statement drafted by its own chief financial officer with input from another accounting firm.

It was held that the buyer had breached the SPA provisions because the calculation was prepared by their Chief Financial Officer, despite the buyer's argument that another suitably qualified accounting firm could prepare the calculation.

What are the implications of this case for buyers and sellers?

Despite the Court's decision not to award damages, this case highlights the importance of an understanding and careful compliance with any post-completion payment procedures by buyers and sellers.

Moreover, before agreeing to any changes to the SPA, the buyer and seller should ensure that all relevant requirements of the SPA have been met.