A Merger and Acquisition Lawyer Near Me Can Address Earnout Disputes

California Civil Code § 1655 provides that terms necessary to make a contract reasonable or consistent with usage may be implied when the agreement shows no contrary intent. California contract law also recognizes an implied covenant of good faith and fair dealing, which generally protects each party's right to receive the benefits of the agreement.

That principle does not allow a court to rewrite the parties' bargain. Express language concerning operational discretion, accounting rules, and earnout obligations remains central to the analysis.

Companies evaluating a transaction can also review broader Mergers & Acquisitions considerations before negotiating post-closing payment provisions.

An earnout analysis usually starts with the language the parties negotiated rather than with a general accounting assumption. Key provisions may include:

• Financial Metrics: Whether revenue, EBITDA, or another measure follows GAAP, modified GAAP, or a transaction-specific formula.
• Accounting Consistency: Whether the buyer must apply accounting policies consistently with historical practices.
• Operational Covenants: Whether the buyer must maintain staffing, marketing, production, or other aspects of the acquired business.
• Measurement Periods: When performance begins and ends and how partial periods are treated.
• Dispute Procedures: How objections must be made and whether unresolved issues go to an accountant, arbitrator, mediator, or court.

These provisions can determine both the amount in dispute and the forum authorized to resolve it.

A seller should first check the objection procedure in the purchase agreement. Some agreements provide only a short period to challenge an earnout statement and require the objection to identify disputed items with reasonable specificity.

Missing a contractual deadline may affect the seller's ability to contest the calculation. The agreement should therefore be reviewed before preparing a substantive accounting objection.

EBITDA-based earnouts can become difficult when the acquired company is integrated into a larger organization. Executive compensation, legal expenses, centralized IT costs, management fees, or other shared expenses may be allocated to the acquired business after closing.

The legal question is not simply whether an allocation reduced EBITDA. The agreement may expressly permit certain allocations, prohibit others, or require calculations to follow specified accounting principles or historical practices.

Revenue recognition can create similar problems. A change in billing practices, contract timing, customer assignment, or recognition methodology may alter the earnout result even when the underlying business remains active.

When the dispute depends heavily on the economic value of the acquired business or a financial component of the transaction, Business Valuation analysis may provide additional context.

Many acquisition agreements create a defined process for resolving disputed calculations. The parties may first exchange an objection notice, negotiate unresolved items, and then submit specified issues to an independent accounting firm.

The accountant's authority depends on the contract. One agreement may limit the accountant to mathematical or accounting questions, while another may provide broader authority over issues affecting the earnout calculation.

For that reason, an accounting referee clause should not automatically be treated as equivalent to arbitration. The agreement's wording determines the issues submitted, the procedures used, and the effect of the resulting determination.

An agreement may require the buyer to operate the acquired business consistently with past practice or comply with specific post-closing obligations. A violation of those provisions may support a breach-of-contract claim without relying solely on an implied duty.

The analysis changes when the agreement gives the buyer broad operational discretion. California's implied covenant of good faith and fair dealing can apply when one party exercises contractual discretion affecting another party's contractual benefits.

However, the implied covenant generally cannot prohibit conduct that clear contractual language expressly authorizes. Courts therefore begin with the parties' actual agreement rather than creating an operational obligation the contract does not contain.

Broader claims involving contractual performance, damages, or post-closing misconduct may also overlap with Business Litigation.

Assume a seller agrees to an earnout tied to annual recurring revenue during the twelve months after closing. The purchase agreement also requires the buyer to maintain a defined sales function during that period.

After closing, the buyer transfers most of that sales function to an unrelated product line. Revenue falls below the earnout threshold, and the seller disputes the resulting calculation.

The accounting question may involve whether the buyer calculated annual recurring revenue according to the agreed formula. A separate contract question may involve whether transferring the sales function breached the express post-closing covenant.

The dispute-resolution provisions would then determine which decision-maker has authority over each issue.

Parties should preserve the records needed to test the earnout calculation and the conduct affecting it. Relevant material may include monthly financial statements, general ledgers, revenue schedules, allocation methodologies, internal budgets, customer records, and communications concerning post-closing operational decisions.

These records can help separate a calculation disagreement from a broader claim involving contractual performance.

An accounting referee is often selected for specialized financial issues, but the precise scope of authority comes from the contract. An arbitrator may have broader authority when the arbitration clause covers contractual liability, damages, or other legal disputes.

The title given to the decision-maker is not enough to determine authority. The earnout clause, general dispute-resolution provision, governing-law clause, and contractual carve-outs should be read together.

Integrating an acquired company into a larger organization does not automatically establish a breach. The analysis depends on the buyer's express operational obligations, contractual discretion, earnout formula, and the conduct that allegedly affected performance.

If the agreement requires particular operating practices, conduct inconsistent with those requirements may support a contract claim. When the agreement gives the buyer substantial discretion, the analysis should also account for California's implied covenant without using it to contradict the express terms of the transaction.