Chancery Court Holds That Buyer Could Not Withhold Earnouts for Suspected Fraud Without Express Provisions in the Merger Agreement

On October 31, 2017, in Greenstar IH Rep, LLC and Segal v. Tutor Perini Corp., the Delaware Court of Chancery held that the plaintiff seller was entitled to earnouts as a matter of law, where buyer Tutor Perini withheld payment after it suspected the earnout calculation was fraudulently inflated. After several years of making earnout payments under the merger agreement, Tutor Perini came to suspect that the seller’s former CEO – who later became CEO of one of the target’s subsidiaries and an interest holder – supplied false information to raise its reported profits and therefore the earnouts owed. The Court held that Tutor Perini could not withhold an earnout payment on that basis, and should have anticipated such an issue and specifically contracted for its ability to withhold payment based on perceived inaccuracies in the seller’s information. The earnout provision as agreed only provided a dispute resolution mechanism where the *seller *objected to the buyer’s calculation. This case underscores the need to specify procedures for earnout provisions that consider each party’s potential burdens, and highlights the potential issues of relying on information from seller employees who remain employed post-closing and are especially incentivized to receive higher earnouts.