Earn out Covenants

Operational Freedom

Target company operational autonomy during the earn out period requires precise boundaries regarding corporate restructuring, asset sales, and overhead allocations. Buyers often agree to refrain from diverting corporate opportunities away from the acquired unit or shifting personnel to other subsidiaries. Breach of these operational obligations creates liability for damages equal to the lost contingent consideration.

Buyer discretion remains subject to implied duties of good faith and fair dealing unless expressly excluded by clear agreement language.

Calculation Standard

Accounting definitions governing performance targets must specify whether earnings before interest, tax, depreciation, and amortization or net revenue metrics govern the final payout. Adjustments for intercompany charges, corporate overhead, and extraordinary expenses must be explicitly defined to prevent artificial reduction of performance figures. Earn out covenants require buyers to maintain separate financial books and records for the target unit throughout the calculation window.

Statements of earnings must be delivered to seller representatives within set timeframes after fiscal period ends.

Dispute Mechanism

Valuation disputes regarding metric calculations trigger specialized resolution procedures involving independent accounting referees. Submission of written objections by seller representatives stays final payment distributions until the independent expert renders a binding determination. The designated expert evaluates underlying accounting entries against contractually defined rules rather than broad equity principles.

Decisions rendered by accounting referees bind both buyer and seller in the absence of fraud or manifest error. Cost allocation rules typically obligate the party whose position deviates farthest from the referee’s final figure to pay the professional fees incurred.