Wrapsol Acquisition, LLC v. Otter Products, LLC 2:15cv725-DB (U.S. Dist. Utah)(2016) arises from the sale of a company that made and sold protective wraps and shields for portable devices. Buyer, a leader in the protective accessories market agreed to pay, among other things, a cash payment and potential “contingent” earn-out payments over four years. The agreement also states that “Sellers . . . acknowledge and agree that from Closing [Buyer] owns and controls . . . the [Seller] Business and, therefore, is entitled to operate the Business in whatever manner [Buyer] determines to be in [Buyer’s] best interest.”
Sellers alleged that buyers took many bad faith actions designed to intentionally lower the potential earn-out payments, including canceling major contracts, reducing marketing efforts, refusing to incorporate sellers’ products, and, eventually, closing the entire purchased-business a year before the end of the earn-out period. Buyers argued that in light of the best interest clause the alleged conduct was consistent with the express provisions of the contract and, therefore, there could not be any claim for breach of the covenant of good faith and fair dealing.
The Court found that because the agreement gave Buyer the “right to operate the Wrapsol Division according to its own interest, and provides that Contingent Payments are not guaranteed,” there were no set of facts under which Sellers could claim any breach of the implied covenant of good faith and fair dealing. Moreover, the best interest clause superseded even the obligation to keep the business running, which stated “[d]uring the [period through September 30, 2016], the Business shall be operated as a distinct business unit of Purchaser.” While many courts may find an inherit limit to “best interest” clauses, this ruling is notable because it provides that, at least under Utah law, buyers have no obligation of good faith or fair dealing concerning the ongoing operation of a company under an earn-out if Seller agrees that buyer can “operate the Business in whatever manner Purchaser determines to be in Purchaser’s best interest.”
The U.S. District Court for the District of Utah dismissed claims arising from an earn-out transaction by strictly applying the earn-out provisions of an asset purchase agreement. Wrapsol Acquisition, LLC v. Otter Products, LLC 2:15cv725-DB (U.S. Dist. Utah)(2016). Plaintiff was one of the owners of Wrapsol, a company that manufactured and sold protective wraps, shields, and pads for mobile devices. Defendant is Otter Products d/b/a OtterBox, one of the market leaders in protective accessories. OtterBox purchased the Wrapsol in 2012 under an Asset Purchase Agreement ("APA"), which included both a cash payment and potential earn-out payments over four years. Notably, the APA provided that “[Wrapsol seller] . . . acknowledge and agree that from Closing [OtterBox] owns and controls . . . the [Wrapsol] Business and, therefore, is entitled to operate the Business in whatever manner [OtterBox] determines to be in [OtterBox’s] best interest.” The APA also provided that OtterBox would calculate certain profits quarterly and, if Wrapsol did not timely object, OtterBox’s calculation of the quarterly profit “shall be final.” The earn-out ran through September 2016. The actual APA was unavailable, but there was no mention of any clause expressly disclaiming the duties of good faith and fair dealing.
Wrapsol asserted claims for accounting, breach of contract, breach of the implied covenant of good faith and fair dealing, and indemnity. In its complaint, Wrapsol alleged a “calculated plan” by OtterBox to eliminate Wrapsol as a competitor and deprive Wrapsol of its purchase price. Wrapsol claimed that OtterBox undertook a series of acts, such as transferring a key product to a different business (and thus excluding sales from the earn-out calculation), severing ties with Wrapsol’s top customers (including Staples, Wal-Mart, and others), changing marketing and packaging, nearly doubling prices, and, eventually, entirely closing the Wrapsol division a year before the earn-out period ended.
The Court summarily dismissed the accounting, contract, and indemnity claims because Wrapsol “did not object to any of the quarterly calculations” and thus “they waived their rights to challenge the past calculations.” The Court further stated that equitable claims, such as accounting, were unavailable where, as here, Wrapsol had an adequate remedy in the form of a contractual right, although that right had been waived here. Notably, there was no discussion about potential future calculations, such as the calculations running through September 2016. Nor did the Court address potential factual disputes or allegedly hidden facts.
In addressing the implied duty of good faith and fair dealing, the Court again keyed on the language of the APA. The Court first set forth two unremarkable legal points: (1) a covenant of good faith and fair dealing cannot circumvent the plain language of the agreement and (2) a party cannot use the implied covenant to rewrite the terms of a contract to make it more favorable. Using these maxims, the Court held that any conduct alleged by Wrapsol – implicitly including product changes, customer changes, and shutting the division – were necessarily within OtterBox’s right to “operate the Business in whatever manner [OtterBox] determines to be in [OtterBox’s] best interests” under the APA. As such, OtterBox had no duties of good faith or fair dealing in the operation and management of Wrapsol’s former business.
The ruling is significant for anyone negotiating post sale covenants or obligations. While a seller’s unilateral right to operate a purchased-business is well established, few Courts have expressly found that a “best interest” clause can eliminate all implied duties of good faith and fair dealing concerning the post-sale obligations.