What is an earn out?
An earn-out is a general expression covering any mechanism where, on a corporate acquisition, the purchase price is determined (in whole or in part) by reference to the performance of the target company or business over a specified period of time following completion of the acquisition.
Where a transaction involves an earn-out arrangement, the share purchase agreement will include provisions specifying the basis for calculating the earn-out consideration and the mechanics for agreeing or determining the amount of the earn-out payments. Clauses of this type will usually require one party (or its accountants) to carry out an initial calculation of the earn-out and to deliver a notice of that calculation to the other party within a specified period following completion.
Validity of earn out notice challenged
The Court of Appeal has recently considered in the case of Treatt plc v Barratt and others (2015) that a notice setting out the buyer's calculation of the earn-out consideration due under a share purchase agreement was invalid because the buyer had failed to comply with its contractual obligations when calculating the earn-out specified in the notice.
The 2015 decision of the Court of Appeal in Treatt plc v Barratt and others indicates that the courts will take a strict approach to construing such requirements, and that they will not be sympathetic to departures from the relevant contractual obligations, even if made in good faith.
The case highlights the importance of ensuring that an earn-out notice complies with all the appropriate requirements of a share purchase agreement.
When looking to draft an earn-out clause, it is important to ensure that the relevant party responsible for preparing the earn-out calculation is clear on what must be included in the notice of the calculation, and that from a practical perspective the relevant contractual requirements can be met.