In Lazard Technology Partners, LLC v. QinetiQ North America Operations LLC. (Del. Apr. 23, 2015), the Delaware Supreme Court upheld the plain meaning of an earn-out provision in a merger agreement and refused to allow the seller to rely on the implied covenant of good faith and fair dealing to impose an objective standard on buyers and get around the negotiated language in the provision itself.

In Lazard, QinetiQ North America Operations LLC (“QinetiQ”) had agreed to pay $40 million upfront to Cyveillance, Inc. (“Cyveillance”) and up to an additional $40 million in earn-out payments if certain revenue benchmarks were achieved. The merger agreement contained a covenant that prohibited QinetiQ from “taking any action to divert or defer [revenue] with the intent of reducing or limiting the Earn-Out Payment.” When the earn-out period ended, revenue had not reached the level required to generate the earn-out. Lazard Technology Partners (“Lazard”), who represented the stockholders of Cyveillance, argued that QinetiQ had breached the earn-out provision and violated the implied covenant of good faith and fair dealing by refusing to take certain actions that would have increased revenue to the level required to generate the earn-out payment.

The Court held that the earn-out provision required Lazard to prove that QinetiQ had the intent to reduce or limit the earn-out payment in order to succeed on its claim. Even if representatives of QinetiQ acted with the knowledge that their actions would reduce the likelihood that the earn-out would be due, Lazard still had to prove that it was the buyer’s intent to cause that specific result. The Court also held that the covenant of good faith was not applicable because it is used to fill interpretive gaps in a document and there were no such gaps in the merger agreement. Cyveillance, via Lazard, had the burden to prove that QinetiQ intentionally violated the earn-out provision and the Court believed that the language in the earn-out provision left QinetiQ free to conduct its business in any way it chose postclosing, so long as it did not intentionally reduce or limit the earn-out payment.

A key factor in the Court’s decision was that Cyveillance had attempted to negotiate a range of affirmative post-closing obligations of the buyer, all of which were rejected. In the end, the seller was only able to negotiate the post-closing obligation that the buyer could not take any action with the intent of reducing or limiting the earn-out payment. In addition, there was no best-efforts covenant or other efforts-related language, which is sometimes included in similar provisions. The Court ruled that there was not sufficient basis to find that QinetiQ had violated the earn-out provision because, under the final purchase agreement, QinetiQ only had a duty to refrain from conduct taken with the intent to reduce or avoid the earn-out.

The Lazard decision has many implications for buyers and sellers and how they negotiate postclosing operations covenants related to earn-outs. Sellers should consider that the court will look very closely at the language of any earn-out-related covenant in the context of the specific negotiations that took place. Absent any affirmative post-closing operation covenants, such language might be construed very narrowly, particularly if negotiations involved discussions of affirmative covenants that were ultimately rejected. Sellers should be reluctant to solely rely on the implied covenant of good faith to expand a buyer’s obligations, as this decision suggests that any such implied covenant will not be used to save a seller from a poorly negotiated earnout provision.