- Corporate Law and M&A
- Soraya el Kounchar - Pieter Dierckx - Leo Peeters
- M&A , mergers and acquisitions , earn-out clause
It is a clause whereby a portion of the purchase price depends on future results of the company
for a certain period after the transfer of the shares.
There is no legal definition of earn-out and also for the legal framework it has to be based on the general contract law and company law.
In this article, we focus on the advantages and disadvantages of the earn-out clause as well as on some elements that need to be taken into account when considering to stipulate such a clause.
Stipulating such a clause may result in some advantages for both the buyer and the seller of the shares.
The fee may serve to encourage the seller to remain active within the company for a certain
period in order to preserve the continuity of the company. It allows the buyer to engage the
expertise of the seller to maximize the results, to avoid competition from the vendor and to ensure
stability for the staff.
It is also a form of risk reduction. The buyer is therefor less likely to pay a too high price, in the event the seller's business has been proposed more positively then it really is.
A perfect way to keep the vendors genuinely involved in the evolution of the company
It is conceivable that it may be beneficial for the seller to negotiate an earn-out clause. This is for instance the case where a company has just experienced a difficult time financially. In this case, the offer price does not reflect the "real" value of the company. Therefore, an earn-out clause may offer comfort to spread the price over a longer (and hopefully more fruitful) period.
An earn-out clause may give rise to conflicts as the buyer and seller have opposing interests.
It is possible that the buyer will try to lower the price / earnings while the seller rather will
try to keep the price / earnings to a higher level.
The earn-out clause also brings uncertainty for the vendor, since he will receive a portion of the sale price only at achieving the stated objective.
To avoid potential conflicts, attention should be paid to the exact wording of the clause in accordance with the specific situation.
Please find below are the major concerns.
The buyer and vendor can include in their agreement a formula that provides all possible objective factors on which the price can be determined. It should actually be subjected to objective criteria and therefore cannot depend on the will of the buyer or seller. To avoid future conflicts over pricing, it is appropriate to provide for the appointment of an expert who can take a binding third party decision.
An agreement that depends on a pure potestative condition or, in other words, a condition the
realisation of which depends exclusively on the will of the one who has committed itself, is null
The buyer and vendor should ensure that the conditions under which the payment of the earn-out is bound cannot be classified as potestative, since the whole agreement will be null and void.
Conditions may not depend on the will of one party and the earn out may not be a hidden leonine clause
Pursuant Article 1178 of the Civil Code "The condition is deemed to be fulfilled when the
debtor who has committed itself under the condition, has prevented its fulfillment."
This means in the context of an earn-out clause that if the earn-out is not realised, the seller can still try to prove that the non-fulfillment of the conditions is attributable to the buyer himself.
The mandate of a director in a SA is revocable by the general shareholders' meeting at any
time without notice nor prior motivation. This means that the mandate of a director can be
terminated at any time. This is also an element to be taken into account in the agreement.
It may be provided that the buyer will not revoke the seller's mandate. Another option is a committment from the buyer that he will not vote in favour of revocation during the earn-out period.
The safest option seems to be to combine the mandate of director with a management agreement, which gives more garantees.
The spreaded transfer of shares contributes, as the previous point, to the anchoring of the
vendor in the company. A spreaded transfer of shares is usually combined with an option agreement,
pursuant to which Therefor the seller gets the right to sell the remaining shares at a certain
Particular attention should be given to compliance with Article 32 of the Code of Companies in the context of the prohibition of a leonine clause, to which we already refer in an earlier article that you can consult by clicking here. The Supreme Court ruled in 1998 that the mere fact of serving the corporate interest is the criterion for assessing if the contract is a potential leonine clause.
The earn-out clause is increasingly provided for share purchase agreements. It is a perfect way
to keep the vendors genuinely involved in the evolution of the company. The clause can also ensure
that companies, going through a more difficult period, can negotiate a fair price for their shares.
There are still important issues to be taken into account. To avoid conflicts, special attention should be paid to the pricing of the earn-out, as well as to the conditions for the achievement of the earn-out. For example, the conditions may not be pure potestative (depend on the will of one party) and the earn out may not be a hidden leonine clause. Furthermore, both the buyer and the vendor should comply with the terms of the earn-out in good faith.