In Lazard Technology P’rs, LLC v. QinetiQ North America Operations LLC, 114 A.3d 193 (Del. Apr. 23, 2015), the Delaware Supreme Court affirmed the Court of Chancery’s post-trial bench ruling and held that defendant-below did not breach an earn-out provision in a merger agreement or the implied covenant of good faith and fair dealing.
In 2009, QinetiQ North America Operations, LLC (the “buyer”), a defense and security technology company, acquired Cyveillance, Inc. (the “company”), a cyber-technology company. The buyer paid $40 million for the company up front and was obligated to make additional earn-out payments of up to $40 million if the company achieved certain revenue targets over a defined period. Section 5.4 of the merger agreement prohibited the buyer, post-closing, from “tak[ing] any action to divert or defer [revenue] with the intent of reducing or limiting the Earn-Out Payment.” At the close of the earn-out period, revenues had not reached the level required to generate an earn-out.
Lazard Technology Partners, LLC, which represented former stockholders of the company (collectively, the “seller”), filed suit in the Court of Chancery on August 29, 2011 (C.A. No. 6815-VCL) against the buyer. The seller alleged that the buyer breached both Section 5.4 of the merger agreement and the implied covenant of good faith and fair dealing by failing to take actions to achieve revenue sufficient to generate an earn-out. In a bench ruling following post-trial argument, the Court of Chancery entered judgment in favor of the buyer on both claims. With respect to the breach of contract claim, the Court concluded that the literal terms of Section 5.4 required a showing of intent, which the seller could not establish. The Court construed the implied covenant of good faith and fair dealing to prohibit only conduct undertaken with intent to reduce or avoid an earn-out payment altogether, consistent with the language of Section 5.4.
The Delaware Supreme Court affirmed. The Court agreed that Section 5.4 employed an intent standard, not a knowledge standard, and rejected the seller’s assertion that the contract precluded conduct by the buyer that the buyer knew would compromise the seller’s ability to receive an earn-out payment. On the implied covenant claim, the Court noted both the specific standard in Section 5.4 and the negotiating history (in which the seller had sought tighter objective controls on the buyer’s post-closing conduct, but had failed to obtain them), stated that the Court of Chancery “was very generous in assuming that the implied covenant of good faith and fair dealing operated at all as to decisions affecting the earn-out,” and held that the Court of Chancery had correctly concluded that the implied covenant “did not inhibit the buyer’s conduct unless the buyer acted with the intent to deprive the seller of an earn-out payment.”