Background
Georgia Security Solutions, formerly ControlByNet, sold its video-monitoring business under a membership interest purchase agreement. The seller received approximately $13 million at closing, rollover equity valued at approximately $2 million, and a contingent right to an earnout of up to $6 million based on recurring revenue during the trailing 12 months ending December 31, 2023.
The agreement required the buyer to use commercially reasonable best efforts to retain employees and preserve customer goodwill, and prohibited actions intended, or having the primary effect, to prevent achievement of the earnout. The seller alleged that the buyer sidelined founder Ryan Strange, reassigned or lost experienced personnel, created accounting and billing problems, deferred revenue, and allowed customer service to deteriorate. The buyer ultimately reported recurring revenue of $2,436,639—below the $2.6 million earnout threshold—and no earnout payment.
After disputes arose over the calculation and the seller’s requests for supporting records, the seller sued for breach of express contractual provisions, breach of the implied covenant of good faith and fair dealing, and declaratory and equitable relief. The buyer moved to dismiss, arguing principally that the agreement required an independent accountant to resolve the disputes.
The Court’s Holding
The Court of Chancery denied the motions under Rules 12(b)(1) and 12(b)(3). It held that the independent-accountant procedure was an expert determination, not arbitration, despite language deeming the accountant’s decision an arbitration award. The accountant may resolve technical accounting questions and calculate recurring revenue, but the court must decide foundational legal issues, including compliance with the information right and earnout covenants. After those rulings, the accountant can apply them to the revenue calculation and determine any earnout.
On the Rule 12(b)(6) motion, the court held that the seller reasonably pleaded breaches of the information right, the commercially reasonable best-efforts covenants concerning employees and goodwill, the covenant barring conduct intended or primarily effective to thwart the earnout, and the obligation to include qualifying revenue. It dismissed the theory based on quarterly financial statements because the seller did not allege that it requested them, and it rejected the theory that revenue should be measured over the entire post-closing earnout period because the agreement unambiguously prescribed the trailing 12 months ending December 31, 2023.
The court also dismissed the implied-covenant claim. The agreement’s express provisions already governed the buyer’s operational discretion, cooperation obligations, accounting duties, and earnout process, leaving no contractual gap for the implied covenant to fill. The motion was otherwise denied, although the accountant must calculate recurring revenue before the court can adjudicate the corresponding payment obligation.
Key Takeaways
- An accountant true-up mechanism generally constitutes an expert determination when it delegates a limited technical calculation rather than judge-like authority over legal and factual disputes.
- A clause describing an accountant’s decision as an arbitration award does not by itself transform a narrowly defined expert determination into arbitration.
- Detailed allegations that a buyer sidelined key personnel, harmed customer goodwill, deferred revenue, and changed course after an earnout period can support claims for breach of express earnout covenants.
- The implied covenant cannot duplicate express contractual protections or add a generalized duty of cooperation where the agreement already addresses the challenged conduct.
Why It Matters
The opinion clarifies the division of responsibility between Delaware courts and independent accountants in post-closing earnout disputes. Accountants may resolve specialized accounting questions, but absent broader contractual authority, they do not decide covenant breaches, disclosure obligations, equitable remedies, or foundational questions of contract interpretation.
The decision also illustrates why acquisition agreements should specify both the decision-maker’s authority and the remedies available for earnout-related misconduct. Labels such as “arbitration” are less important than the powers and procedures the agreement actually assigns.