Delaware Court Of Chancery Dismisses Claims For Breach Of Earnout Provision
On April 22, 2021, Vice Chancellor Joseph R. Slights III granted a motion to dismiss filed by defendants ID Experts Holdings, Inc. and its acquiror Identity Theft Guard Solutions, Inc. (together, “ID Experts”), dismissing breach of contract claims filed by Plaintiff Obsidian Finance Group, LLC (“Obsidian”) that arose out of a merger earnout provision. Obsidian Finance Group, LLC. v. Identity Theft Guard Solutions, Inc., No. 2020-0485-JRS (Del. Ch. Apr. 22, 2021). Obsidian, which had been a security holder in ID Experts prior to its sale, sought payment on an earnout provision that was contingent upon a six-year extension of a cybersecurity contract with the U.S. government. In dismissing the case, the Court rejected Obsidian’s argument that they were entitled to the earnout, even though the contract had not been extended for six years, because a regulation prohibited six-year extensions for such contracts.
ID Experts was awarded a contract through the U.S. Office of Personnel Management (“OPM”) to perform cybersecurity services to the U.S. Naval Sea Systems Command. The ID Experts merger agreement included an earnout that was contingent upon the extension of the OPM contract for a period of at least six years. ID Experts then entered into a second OPM contract for a term of five and a half years. While Obsidian and ID Experts agreed that this constituted an extension under the earnout provision, ID Experts rejected the claim that the earnout was triggered because the extension was for less than six years. Obsidian thereafter discovered a section of the U.S. government’s Federal Acquisition Regulation (“FAR”), which governed both OPM contracts, that Obsidian claimed precluded contract extensions of six years or more.
Obsidian sued ID Experts for breach of contract, declaratory judgment, and/or reformation of the earnout provision based on mutual mistake. The Court analyzed the breach claim under the theories of impracticability and forfeiture. The Court was reluctant to allow Obsidian to use the defense of impracticability as an offensive claim, finding no authority for such a proposition, and concluded in any event that the parties should have been aware of the FAR at the time of the agreement. The Court also held that the FAR did not prohibit contracting periods of six years, but rather limited the number of base years to five years and allowed for “transition” periods of up to one year. Accordingly, because the OPM contract could have been extended by six years, performance was not impracticable. The Court also rejected the forfeiture argument, again finding no authority for Obsidian’s assertion “that a party to a merger agreement may be excused from satisfying a condition to an earnout on grounds of forfeiture.”
The Court further rejected Obsidian’s claim for reformation of the merger agreement, holding that Obsidian’s complaint contained no particularized facts detailing a specific prior understanding of the terms of the earnout that differed materially from the written agreement. The Court noted this was particularly true because the OPM contract could have been extended by six years. Accordingly, the Court granted ID Experts’ motion to dismiss all three claims.