Delaware Court Of Chancery Allows Claim That Purchaser Altered Target’s Business Plan To Avoid Paying Earnout Consideration To Proceed
M&A and Corporate Governance Litigation
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  • Delaware Court Of Chancery Allows Claim That Purchaser Altered Target’s Business Plan To Avoid Paying Earnout Consideration To Proceed

    On June 7, 2021, Vice Chancellor Joseph R. Slights of the Delaware Court of Chancery denied a motion to dismiss a breach of contract claim against defendant Albertsons Companies, Inc. brought by a representative of former shareholders of DineInFresh, Inc. (the “Company”) in the wake of its acquisition by defendant.  Shareholder Representative Services LLC v. Albertsons Companies, Inc., No. CV 2020-0710-JRS (Del. Ch. June 7, 2021).  The merger agreement contained an earnout provision whereby the shareholders of the Company would be paid additional consideration contingent upon the Company reaching specified revenue milestones.  The merger agreement provided that defendant had complete discretion over the operation of the Company post-closing, except that it was prohibited from taking any action with the “intent of decreasing or avoiding” the earnout.  Plaintiff alleged that defendant immediately caused the Company to shift its focus away from its revenue-generating e-commerce business.  The Court held that the complaint adequately pleaded that it was “reasonably conceivable that [defendant’s] decision to focus almost exclusively on . . . brick-and-mortar business, despite having knowledge that such a decision would almost certainly cause the company to miss the earnout milestones, was the product of an intent to avoid the earnout.”

    The Court explained:  “To plead a buyer’s intent to avoid an earnout, the goal of avoiding the earnout need not be the buyer’s sole intent; rather, a plaintiff may well-plead that the buyer’s actions were motivated at least in part by that intention.”  The Court noted that defendant had acknowledged that if it had supported the Company’s business as it allegedly told representatives of the Company it would before the deal, the earnout targets would have been achieved.  Relying on alleged statements by defendant’s executives after the acquisition, the Court found that the complaint adequately alleged a “scheme” in which defendant “deliberately hid” that it was acquiring the Company for certain assets and had no interest in the Company’s revenue-generating e-commerce business and no intention of supporting or growing that business.  The Court also found that the complaint sufficiently alleged that defendant knew that the change in focus would cause the Company to miss the milestones.  The Court held that it was reasonable to infer that defendant acted “in part with the purpose” of causing the Company to miss the earnout milestones and this is enough at the pleading stage to support the breach of contract claim.

    However, the Court dismissed plaintiff’s claims for breach of the implied covenant of good faith and fair dealing and fraud.  As to the former, the Court found that “there is no gap for the implied covenant to fill” because the merger agreement permitted defendant to operate the Company at its discretion but limited that discretion by prohibiting actions with the intent to impair the earnout.  As to the fraud claim—which was premised on defendant’s alleged misstatements about “future intent” regarding its operation of the Company—the Court found that plaintiff could not demonstrate justifiable reliance.  Specifically, the Court explained that the plain terms of the merger agreement, which allowed defendant to operate the Company at its discretion, contradicted the alleged misrepresentations.  Moreover, plaintiff could not reasonably rely on the oral representations because there was an integration clause providing that the merger agreement constituted the entire agreement between the parties.
    CATEGORY: Deal Disputes