In mergers and acquisitions (M&A), especially in complex transactions or those involving foreign investment, the use of earnout clauses is common. An earnout is a price adjustment mechanism where a portion of the payment for the acquired company is conditioned on achieving future financial or operational goals. To ensure agility, cost reduction, and specialized technical knowledge, contracts frequently delegate any disagreements over these calculations to an independent accountant.
However, a recurring issue often brings these dispute resolution mechanisms to the courts, frustrating the parties’ expectations of efficiency: what is the limit of this professional’s authority? Do they act solely as an accounting expert or do they possess the powers of an arbitrator to decide complex legal issues?
A recent decision by the Delaware Court of Chancery in the United States—a jurisdiction with strong global influence on corporate litigation and M&A practices, including in Brazil—drew an important dividing line on the subject. The court reaffirmed that the parties’ intent, expressed in the structure and mechanics of the contract, prevails over isolated labels.
The Case and the Contractual Divergence
In the case of Georgia Security Solutions, LLC v. NewCBN, LLC, the sale of a video monitoring company included a potential earnout of millions of dollars tied to recurring revenue. The purchase agreement established limits on the buyer’s conduct during the measurement period, guaranteed information rights to the seller, and determined that unresolved disputes regarding the earnout be submitted to an independent accountant for a binding determination. The contract described this determination as being “deemed an arbitral award”.
When the buyer reported revenue just below the threshold required to trigger the additional payment, the seller objected. The allegation was that the buyer had removed the founder from the operation, relocated essential employees, and intentionally caused accounting problems, constituting a breach of contract.
Faced with this, the seller resorted to the court. The buyer, in turn, filed a motion to dismiss the lawsuit, arguing that the dispute belonged exclusively to the accountant, who would be acting in the capacity of an arbitrator. The court, however, rejected this interpretation.
The Distinction Between Expert and Arbitrator
The Delaware decision highlighted that the appointment of an accountant, the provision of an informal procedure, and the restriction of the analysis to strictly accounting issues indicate the choice for an expert determination, rather than full arbitration. The court concluded that the simple use of the label “arbitral award” in the contract text did not expand the professional’s scope of action to cover questions of law.
Thus, it was up to the accountant to apply generally accepted accounting principles (GAAP), measure the qualified revenue, and interpret terms strictly linked to this mathematical calculation. On the other hand, the court reserved for itself the jurisdiction to judge the allegations of breach of contractual obligations (covenants), violations of information rights, and the respective financial reparations arising from these wrongful acts.
The court also noted that an “exclusive remedy” clause did not alter this division of competencies, especially since other provisions of the contract itself provided for the possibility of enforcement and judicial measures for other purposes.
Practical Implications for M&A Transactions
This precedent reinforces the importance of precision in drafting business contracts, a critical point of attention also for cross-border transactions between Brazil and the United States. The delegation of disputes to third parties must be clear regarding the nature of the professional’s role and the exact limits of their authority.
- Clear Definition of Roles: The contract must expressly state whether the accountant will act as an independent expert or as an arbitrator.
- Scope of Authority: It is essential to detail who has the power to decide whether a specific dispute falls within the third party’s authority, which contractual terms they are permitted to interpret, and what legal remedies they can grant to the parties.
- Procedural Rules: If the intention is for accountants or other experts to function effectively as arbitrators, with powers to decide questions of fact and law, the contract must explicitly provide for this, authorize this broader jurisdiction, and specify the applicable rules of the arbitral institution.
Furthermore, the dispute resolution structure must be tested against the chosen applicable law, since courts in different jurisdictions vary in how they treat the label of “arbitration” and determine whether a process actually constitutes an arbitration under the relevant legislation.
Imprecise drafting can result in fragmented litigation on two fronts—before the court and before the accountant—generating the exact risks of complexity, error, uncertainty, and procedural delay that these alternative mechanisms seek to avoid.
This content is for informational purposes only and does not constitute legal advice. For guidance on specific matters, consult a qualified lawyer.
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