Business Buyer Makes Implied Promise To Continue To Invest

Massachusetts business buyers may be surprised to learn courts may require them to continue to invest in the business after the purchase if the contract includes an earnout for the seller based on future results. This is true even when the contract says nothing about it.

Recently the 1st U.S. Circuit Court of Appeals overturned summary judgment in favor of a buyer, which had been sued by the selling founder. The buyer bought the business in 2001 for $3.5 million at closing and agreed to potential annual earnout payments up to an additional $3.5 million over fiveyears if certain product sales targets were met each year between 2001 and 2006. The contract did not say how the buyer should run the business or what resources if any it was required to devote to meet the sales targets that would trigger the earnout.

The acquired business was a failure. Between 2001 and 2004, only one unit was sold and no amounts were paid under the earnout provisions. In September 2004, the buyer sold the acquired assets and closed the business.

The founding seller said the failure to reach the earnout targets was the buyer s fault and sued for breach of the implied covenant of good faith and fair dealing and unfair and deceptive business practices. It claimed the buyer had breached an implied obligation to use reasonable efforts to develop and promote the technology, nowhere mentioned in the agreement.

The trial court granted summary judgment to the buyer, dismissing the seller s claims because the contract included no obligation to invest in the acquired business post closing or to operate the business in any particular way.

Although the 1st Circuit agreed that the express terms of the contract were not breached, it disagreed that the buyer had no implied obligation to promote the business. The court found that, because the agreement contemplated a fiveyear earnout and there was no language in the agreement negating an obligation to promote the product or conferring absolute discretion on the buyer to decide how to run the business, the buyer had an implied obligation to use "reasonable efforts" to try to support the business during the earnout period.

The contingent nature of the additional compensation supported its argument that a "reasonable efforts" term was implicit. The court also found that the amount of the earnout compensation in relation to the upfront payment each amounting to 50 percent of the total potential consideration supported an implied obligation to use best efforts. The court also commented that because a large portion of the upfront payment actually went to the preacquisition creditors and did not benefit the shareholders directly, the asset purchase agreement contemplated a campaign to market the technology as the primary consideration for the shareholders to do the deal.

Lastly, the court found that the absence of language in the agreement negating an obligation by the buyer to use reasonable efforts, or conferring on the buyer absolute discretion as to the operation of the business, pointed to an implied obligation to use reasonable efforts to develop and promote the acquired business.