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Delaware Chancery: No Fiduciary Duty To Maximize Earn Out In Acquisitions

Fiduciary duties typically require one to act in the best interests of their beneficiary, even if those interests may conflict with their own.  This can present issues when part of the consideration for an acquisition is contingent on the future performance of the target, otherwise known as an “earn out.”  If the buyer completely controls the company, they may be motivated to prevent these goals from being met and thereby decrease the purchase price of the acquisition.  Recently, in Glidepath Ltd. v. Beumer Corp.1, the Delaware Court of Chancery held that although acquiring companies owe fiduciary duties to any remaining shareholders, this duty does not necessarily compel them to maximize payments to those shareholders by means of a previously negotiated earn out.

The Beumer Group is a large international company that manufactures “intralogistics systems” for airport baggage handling, among other things.2  Although they’d had great success globally, they struggled to penetrate the U.S. airport market.3  On the other hand, Glidepath, a company in the same industry, had established a solid American foothold but was struggling financially.4  Both parties felt that they could greatly benefit from the acquisition of Glidepath by Beumer and signed an agreement to that effect in 2013.5

Under the terms of the agreement, Beumer would acquire 60% of the company up front, share the ownership for a time, then purchase the remaining 40% for a price dependent on the company’s future performance.6  During the period of shared ownership, the company was managed according to an Operating Agreement agreed to by both parties, but Beumer exercised primary control.7  During this period, Beumer reoriented the company towards longer-term projects and invested in training their personnel, which, predictably, depressed the company’s short-term profits.8  When it became evident that the seller would not be entitled to much, if any, of the contingent consideration, the seller sued for breach of fiduciary duty, among several other theories.9  The seller contended that the duty was breached by “disloyally engaging in a scheme to depress revenues, increase expenses and divert business opportunities for their own benefit.”10

The court found that the buyer owed fiduciary duties both as a manager and as a controlling shareholder.11  However, the court was careful to differentiate between the standard of conduct and the standard of review that Delaware law applies in these situations.12  In terms of the standard of conduct, a fiduciary duty requires “that the best interest of the corporation and its shareholders takes precedence over any interest possessed by a director, officer or controlling shareholder and not shared by the shareholders generally.”13  In this case, the court held that, because Delaware LLCs exist perpetually, the default duty must be to “maximize the value of the LLC over a long-term horizon,” rather than maximizing the value of a beneficiary’s contractual claim against the buyer.14 Contract rights would have been necessary to impose that kind of obligation on the buyers.

Although there was no breach of the fiduciary duty to the seller, the court found that the deal structure nevertheless created a conflict of interest.15  As such, the applicable standard of review for buyer’s conduct was the entire fairness test.16  Under this test, fiduciaries are required to establish “to the court’s satisfaction” that their actions were “the product of both fair dealing and fair price.”17  Measuring the course of the buyer’s actions by their “success in promoting the value of the firm,” the court found that focusing on large-scale projects was a perfectly valid and rational business strategy.18  As a result, the buyer’s conduct was found to be entirely fair even though they did not maximize the value of the seller’s contingent consideration.19

  1. Glidepath Ltd. v. Beumer Corp., No. 12220-VCL, 2019 Del. Ch. LEXIS 58, at *2 (Feb. 21, 2019). 

  2. See About BEUMER Group, BEUMER Group, (last visited Mar. 29, 2019). 

  3. Glidepath, 2019 Del. Ch. LEXIS 58, at *4-5. 

  4. Id. at *5. 

  5. Id

  6. Id. at *9. 

  7. See id. at *13. 

  8. See id. at *16, 24. 

  9. Id. at *26. 

  10. Id. at *43. 

  11. Id. at *38. 

  12. Id

  13. Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del. 1993). 

  14. Id. at *39-41. 

  15. Id. at *41-42. 

  16. Id. at *42. 

  17. Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1163 (Del. 1995). 

  18. Id. at *43-44. 

  19. See id. at *45-46.