Is my earn-out compromised by Covid-19?

Due to the corona era, chances are that a recently sold/acquired company will not achieve its financial objectives. In certain cases, this could mean that the conditions for an earn-out might not be (completely) fulfilled, which in turn results in the seller missing out part of the purchase price. Although under Belgian law there might be civil law principles that might help a seller in these cases, a common-sense approach is often recommended.

Earn-out

Within the framework of a transaction, the purchase price is often the most important element for both parties. In practice, it happens that (the payment of) a part of the purchase price is subject to future financial and/or non-financial conditions. This price structure is typically referred to as an ‘earn-out’.

Example: Party A was 100% owner of a family business until he decided to sell his company at the beginning of 2019. After weeks of negotiation, the parties, by mid-2019 agreed on an initial price of 25 million euros (locked box, no closing accounts) payable at closing of the deal (which occurred in July 2019). Additionally, the seller is entitled to a variable amount of the purchase price (the earn-out) and should remain on board at least until the end of 2021 as CEO (i.e. non-financial condition). The amount of the earn-out is linked to certain EBITDA targets for FY19, FY20 and FY21 (i.e. financial condition).

In principle, the earn-out mechanism serves to align the interest of both the buyer and the seller. It creates a clear-cut incentive resulting in a win-win situation for both parties.

Covid-19

Due to the outbreak of the Covid-19 virus, it is apparent that, aside from having an unprecedented impact on people’s health and their daily lives, inevitable economic consequences are to be expected. It goes without saying that these economic repercussions in most cases will have an impact on the agreed financial earn-out conditions (and perhaps also on the non-financial earn-out conditions).

Can this be rectified?

Parties can always rely on contractual clauses (if any) or (try to) invoke civil law legal principles to rectify a situation. The purpose of invoking civil law legal principles (such as (temporary) force majeure or abuse of rights) could be to extend the period during which certain targets must be achieved. This is not an easy, and highly unpredictable, exercise and will depend on several elements (the nature of the earn-out conditions, the type of company and its activity, the will of the parties, etc.).

This does not mean that one cannot or should not take any other action…

Negotiating and mediation as alternative

It is important to bring the situation into perspective and to proactively engage in discussions with all parties involved. The seller, on the one hand, will want to retain his earn-out compensation and the buyer, on the other hand, will need a motivated CEO (especially in present times where good leadership is required). Neither of the parties is open to initiate a long-lasting legal battle with an unpredictable outcome, as it is unknown how the courts will react to the Covid-19 situation.

From these conversations a settlement/amendment agreement may arise, which could still result in a win-win scenario (e.g. a temporary suspension for achieving the targets and/or an extension of the (management) period imbedded in the earn-out) for both parties.

Your usual contact person at EY Law will be pleased to be at your service should you have any questions or in case you would like to further explore this path.

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