Brown Rudnick’s M&A Litigation Team’s Success Provides a Guide for Limiting the Scope of Claims in a Post-Closing Earnout Dispute

In a recent case, Brown Rudnick’s M&A Litigation team successfully dismissed claims brought by a seller concerning allegations that the buyer caused over $11 million in damages related to breaches of certain post-closing covenants with respect to an earnout provision.[1] The New York Supreme Court’s decision reminds buyers and sellers that New York courts will not allow parties to avoid contractual limitations set forth in a purchase agreement simply by rehashing breach of contract claims as tort claims and that parties should carefully draft language to make clear that limitations of liability apply with equal force to earnout payments. 

Under the parties’ Asset Purchase Agreement (APA), the buyer agreed to pay the seller an earnout payment based on a percentage of the revenues derived from the seller’s products in the years following the closing. The APA also contained a limitation of liability provision which capped damages for any purported breach of the APA at $2 million. The limitation of liability provision applied broadly to “any alleged breach…of any representation, warranty, covenant or obligation” under the APA.

After closing, a dispute arose over the calculation of the earnout. Ultimately, the seller sued the buyer in New York Supreme Court alleging a variety of claims: (i) breach of the APA; (ii) breach of the covenant of good faith and fair dealing; (iii) specific performance; (iv) reformation; (v) fraudulent inducement; (vi) tortious interference; (vii) fraudulent omission; and (viii) breach of a confidential disclosure agreement. In its lawsuit, the seller sought more than $11 million in damages. 

Brown Rudnick moved to dismiss all of the seller’s claims. Brown Rudnick sought to dismiss the seller’s contract claims due to the limitation-of-liability provision and sought to dismiss the remaining claims as part of a thinly-veiled effort to evade the APA’s limitation of liability provisions. After briefing and oral argument, the New York Supreme Court promptly dismissed all of the seller’s tort claims.[2] 

Specifically, the Court dismissed the seller’s fraud claims because the seller had failed to allege that the buyer had no intent to perform the earnout when the parties entered into the APA and, therefore, the fraud claims were simply duplicative of the breach of contract claims.

Likewise, in dismissing the plaintiffs’ tortious interference claim against the buyer’s owner, the Court held that the parent-subsidiary relationship between the owner and the buyer protected the owner from the seller’s tortious interference claim under the economic interest doctrine. To this end, the Court relied on White Plains Coat & Apron Co., Inc. v. Cintas Corp, 8 NY3d 422 [2007] in holding that “[a] parent-subsidiary relationship is sufficient to invoke an economic interest.”[3] The Court found that the alleged instruction by a parent company to a subsidiary not to pay the alleged obligation to seller was insufficient to show the required “malice or illegality.” As a result, the Court found that the seller could not maintain a separate tort claim against a parent company simply by recasting a breach of contract claim against a subsidiary as a tortious interference claim against the parent company. 

However, the Court permitted the seller’s claims concerning the alleged breach of the APA to proceed because the Court found that the APA was ambiguous as to whether the $2 million limitation of liability applied to the earnout payments. During the oral argument, however, the Court advised the seller that it was skeptical of the seller’s interpretation of the limitation of liability provision, and that the seller should be wary going forward. 

The parties reached an amicable resolution of the parties’ dispute shortly after the Court’s decision.

The Court’s decision is an important reminder that courts will not permit parties to evade their agreed upon contractual limitations simply by recasting breach of contract claims as tort claims. In addition, while previous decisions regarding limitations of liability provisions have primarily related to alleged representation and warranty claims, courts will apply the same logic and reasoning to earnout claims. Therefore, parties should be clear in their contract whether limitations of liability apply to earnout payments. 

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^{[1] See Ordital Pty Ltd., et al. v. Prometheus Group Enterprises LLC, et al., Index No. 652162/2023, NYSECF Doc. No. 38, (N.Y. Sup. Ct. Nov. 29, 2023).} 

^{[2] The Court also dismiss plaintiffs’ claims for (i) specific performance; (ii) reformation; and (iii) breach of a confidential disclosure agreement.}

^{[3] Ordital Pty Ltd., et al. v. Prometheus Group Enterprises LLC, et al., Index No. 652162/2023, NYSECF Doc. No. 38 at 1 (N.Y. Sup. Ct. Nov. 29, 2023).}