Establishing Precedence Clauses in Cross-Border Earn out Agreements
Explicit precedence clauses in cross-border earn-out agreements prevent accounting schedules from overriding core legal risk allocations and governing law provisions.
Seller Protection Covenant
Meaning
Contractual promises made by a purchaser safeguard the departing owners from post-completion liabilities and operational claims arising from the acquired business. A seller protection covenant often limits the buyer’s ability to assert indemnity claims or restrict activities that could trigger earn-out payments. This provision applies for a specified period after the closing of the transaction.
The covenant ceases to apply once the indemnity survival period has expired.
Liability Limitation
The agreement restricts the buyer from bringing claims against the seller unless they exceed certain financial thresholds. These thresholds usually include a de minimis level for individual claims and an aggregate basket that must be reached before any liability arises. By incorporating a seller protection covenant, the sellers can distribute their sales proceeds to investors without the risk of sudden clawbacks.
This clause also caps the maximum liability of the seller at the total purchase price received. It provides the financial certainty required by private equity sellers.
Earnout Safeguard
Buyers are prevented from taking actions that would deliberately reduce the earnings of the acquired business during an earn-out period. If the buyer shifts revenues to other divisions or shuts down profitable product lines, it would breach the seller protection covenant. The covenant requires the buyer to run the business in a way that maximizes the chance of achieving the earn-out targets.
This duty ensures that the seller’s contingent consideration is not lost through post-acquisition manipulation. It establishes a standard of good faith for the buyer’s operational decisions. In many agreements, the buyer must consult with the former owners before making structural changes to the business, and any disagreement must be referred to an independent committee to ensure the earn-out calculation remains fair and unaffected by artificial corporate adjustments.
Claims Procedure
A strict process must be followed by the buyer to notify the seller of any third-party claims that could trigger an indemnity. The notification must be given within a short timeframe to allow the seller to participate in the defense. Failure to notify the seller within the specified period can release them from their indemnity obligations.
The seller often retains the right to assume control of the defense to minimize the potential payout. This procedure ensures that the seller is not forced to pay for poorly managed litigation.