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The stockholders of Cyveillance, Inc., sold their company for $40 million up-front and a $40 million earn-out if the company’s revenues reached a certain level. Section 5.4 of the merger agreement prohibited the buyer from “tak[ing] any action to divert or defer [revenue] with the intent of reducing or limiting the Earn-Out Payment.” When the earn-out period ended, the revenues had not reached the level required to generate an earn-out.

The seller representatives sued for breach of the merger agreement. The Court of Chancery found that the merger agreement meant what it said, which is that in order for the buyer to breach Section 5.4, it had to have acted with the “intent of reducing or limiting the Earn-out Payment.” The Court of Chancery found that the seller had not proven that any business decision of the buyer was motivated by a desire to avoid an earn-out payment.

The Court of Chancery also rejected the seller’s implied covenant claim. The Court of Chancery held that the merger agreement was complex and required a number of actions, including actions that would occur post-closing. It thus found that the merger agreement’s express terms were supplemented by an implied covenant. But as to whether conduct not prohibited under the contract was precluded because it might result in a reduced or no earn-out payment, the Court of Chancery held that, consistent with the language of Section 5.4, the buyer had a duty to refrain from that conduct only if it was taken with the intent to reduce or avoid an earn-out altogether.

The Delaware Supreme Court upheld the Chancery Court decision. By its unambiguous terms, that merger agreement term only limited the buyer from taking action intended to reduce or limit an earn-out payment. Intent is a well-understood concept that the Court of Chancery properly applied. The Supreme Court noted that the seller was seeking to avoid its own contractual bargain by claiming that Section 5.4 used a knowledge standard, preventing the buyer from taking actions simply because it knew those actions would reduce the likelihood that an earn-out would be due. As Section 5.4 is written, it only barred the buyer from taking action specifically motivated by a desire to avoid the earn-out.

The Delaware Supreme Court found the Court of Chancery was very generous in assuming that the implied covenant of good faith and fair dealing operated at all as to decisions affecting the earn-out, given the specificity of the merger agreement on that subject, and the negotiating history that showed that the seller had sought objective standards for limiting the buyer’s conduct but lost at the bargaining table. Therefore, the Court of Chancery correctly concluded that the implied covenant did not inhibit the buyer’s conduct unless the buyer acted with the intent to deprive the seller of an earn-out payment.


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