When Qinetiq North America acquired Cyveillance, a cyber technology company, it paid $40 million up front and promised up to $40 million more if the company’s revenue reached a set level. During the negotiation the sellers asked for affirmative promises about running the business after closing: keep up existing business levels and customer relationships, give the company enough capital to reach the earnout, make reasonable commercial efforts to hire enough people, keep marketing and bidding for contracts as it had, and not divert contracts or opportunities to other entities. According to the Delaware Supreme Court’s 2015 opinion, which quotes the trial court’s findings, the buyer rejected all of them. The merger agreement instead barred the buyer from diverting or deferring revenue with the intent of reducing the earnout. Revenue never reached the level that would have triggered a payment.
The sellers’ representative sued, arguing that the clause also reached actions the buyer knew would hurt the earnout, and that the implied covenant of good faith supplied what the contract left out. The Supreme Court held that the clause meant intent: a decision breached it only if it was motivated at least in part by a wish to reduce the earnout, and knowing the effect was not enough. Because the sellers had sought objective limits on the buyer’s conduct and lost them in negotiation, the implied covenant did not restore them. The Court of Chancery had found after a trial that no business decision was shown to have that motive, and the Supreme Court affirmed. That was a 2015 ruling on one contract’s wording.
Read as a list, the rejected covenants are an inventory of the decisions that pass to the buyer at closing: how many people the company employs, how much capital it gets, which contracts it chases, and which entity books the revenue. A revenue earnout depends on all four. Each becomes the buyer’s call, and the buyer can have sound reasons for its decisions that are unrelated to the earnout. Under the standard the court applied, a decision made for such reasons is not a breach unless the sellers can also show it was motivated in part by a wish to reduce the earnout. What the former stockholders still controlled was the contract and the right to sue on it. Where the holders owed an earnout are not the people whose work drives it, as when investors own much of the stock, they do not even control the team’s effort, which the buyer directs after closing.
The buyer’s refusal can be reasonable. A buyer may be acquiring a company precisely to combine it with something, and covenants that fix staffing, bidding practice or the booking entity for the life of an earnout can block that combination, rank the acquired unit’s targets above the rest of the business, and expose every reorganization to a claim. A buyer that rejects them may be protecting the reason it is buying.
Granting that, the seller still decides what the earnout measures and how much of the price it carries. A metric can be built to survive integration. Revenue from a named product line or customer list, counted wherever the buyer books it, takes diversion out of the dispute. A product milestone with a written acceptance test can be paired with a single consent right matched to it: the engineers named in the plan stay on the work until the test is run. Where the buyer will not accept even that, the earnout is a payment whose size the buyer’s decisions largely set, and I would value it that way when comparing offers. Cyveillance’s earnout could have doubled the price.
The opinion does not say how the sellers valued the earnout when they signed, and I would not guess. It does show when the question became answerable: once the buyer rejected the staffing, capital and bidding covenants, reaching the revenue target depended mainly on choices the contract left to the buyer, limited only by the motive test.