Share sale agreements will often include an ‘earn out clause’, under which some element of the consideration payable is linked to future performance. Such clauses are not without difficulty, however, as a recent decision of the UK High Court demonstrates.

The case concerned the sale of shares in a pharmaceutical company concluded in early 2007. The consideration payable was £10.4 million, with provision for a potential earn out of £41 million based on the net sales in 2009 of a product developed by the company. 

To protect their interests, the vendors required the purchaser to undertake that:

• It would actively market the product and diligently seek regulatory approval in certain key markets
• It would make adequate resources available for selling the product and that the sales representatives would be properly compensated and trained

The agreement further provided that the purchaser would not cease to carry on the business of the company without the written consent of the vendors, which was not to be unreasonably withheld. (For a more detailed consideration fo this aspect of the case, please click here to view – When is it Reasonable to Withold Consent in a Commercial Contract, contributed by Leo Moore and Brian McElligott.

At the outset, both parties believed that the company’s net sales in 2009 would be in the order of $20 million. However, as it happened, the business encountered a number of difficulties, which culminated in an understandable decision by the purchaser in late 2008 to terminate its entire operations. The vendors’ consent to the termination (on payment of $1 million) was sought, but refused, and legal proceedings ensued.

The UK High Court found that decisions taken by the purchaser in 2008 to stand down the sales teams and not to pursue US regulatory approval were in breach of the agreement. It further found that the vendors’ refusal to consent to the termination of the business was not unreasonable. The Court concluded that, but for the purchaser’s breach, sales of $2.1 million would have been achieved in 2009 and damages were awarded to the claimants, who were some of the vendors, in proportion to their original shareholding in the company.
 
While earn out clauses are common in share sale agreements, the vendor assumes a high level of risk where the potential earn out is a significant amount by reference to the ‘up front’ consideration.

Contributed by Brendan Heneghan.