Earnout disputes are among the most common forms of post-closing M&A litigation, and they are frequently among the most contentious and expensive. The fundamental dynamic of an earnout — a contingent payment that the buyer controls through its post-closing operational decisions — creates an inherent tension between the seller’s expectation of receiving the earnout and the buyer’s interest in operating the business according to its own judgment. When that tension produces a shortfall in earnout payments, sellers often find themselves in litigation or arbitration against buyers who have made operational decisions that, whatever their business justification, had the effect of preventing the earnout from being achieved. Understanding how these disputes arise, how they are resolved, and how they can be prevented through careful drafting is essential for any party considering an earnout structure.

Major Categories of Earnout Disputes

Earnout disputes fall into several recurring categories that practitioners have observed across many transactions and court decisions.

Integration disputes arise when the buyer integrates the acquired business into its larger organization in ways that make it impossible to measure the earnout metric or that effectively destroy the acquired business’s independent performance. When the buyer consolidates the acquired business’s operations with its own, eliminates the acquired brand, transfers the acquired company’s customers to other business units, or routes new business through the buyer’s channels rather than the acquired entity, the earnout metric cannot be fairly calculated. These disputes often turn on whether the purchase agreement’s operational covenants prohibited the specific integration activities that prevented earnout achievement.

Accounting disputes arise when the parties disagree about how the earnout metric should be calculated. Even a carefully defined EBITDA or revenue metric can be subject to genuine accounting disputes when specific items — the treatment of an acquisition by the combined company, the allocation of shared overhead, the timing of revenue recognition for a specific contract type — are not addressed in the purchase agreement’s definition. These disputes are often resolved through the accounting expert mechanism in the purchase agreement, but disagreements about the scope of the expert’s authority (whether it is limited to accounting questions or extends to contract interpretation) can themselves become grounds for dispute.

Bad faith disputes are the most contentious category: cases where the seller alleges that the buyer deliberately manipulated its operations to prevent the earnout from being earned. Examples include deferring contracts that would have qualified for the earnout period to a later period, restructuring the business in a way that depresses the earnout metric while increasing aggregate performance, and intentionally misclassifying revenues or expenses to reduce the earnout calculation. These disputes go beyond technical accounting disagreements to allege intentional wrongdoing, and they are resolved through litigation or full arbitration rather than the accounting expert process.

The Implied Covenant: When the Agreement Is Silent

A recurring theme in earnout litigation is the role of the implied covenant of good faith and fair dealing when the purchase agreement does not expressly address the specific conduct at issue. Courts have consistently held that the implied covenant applies to earnout provisions and requires buyers to refrain from conduct that, while not expressly prohibited, effectively deprives the seller of the benefit of the earnout bargain.

The implied covenant does not impose an affirmative obligation on the buyer to maximize the earnout payment or to operate the business in any particular way. The buyer retains its discretion to make business decisions in its own interest, including decisions that may reduce the likelihood of earnout achievement. The implied covenant is violated only when the buyer acts in bad faith — with a purpose of defeating the earnout — or when the buyer’s conduct is so clearly inconsistent with the reasonable expectations of the parties that it cannot be reconciled with honest dealing.

Courts have found implied covenant violations in earnout disputes where: the buyer deliberately under-resourced the acquired business during the earnout period, knowing that this would prevent earnout achievement; the buyer redirected customers from the acquired entity to a competing business unit without any legitimate business reason; the buyer delayed the implementation of a clearly beneficial business change until after the earnout period expired, with the transparent purpose of preventing the earnout target from being met; and the buyer applied accounting standards to the earnout calculation that were inconsistent with the standards used in the seller’s historical financial statements, without prior agreement or disclosure.

Accounting Expert vs. Arbitration: Choosing the Right Dispute Mechanism

The choice between an accounting expert determination and full arbitration as the dispute resolution mechanism for earnout disagreements is one of the most consequential structural decisions in earnout design. An accounting expert determination is typically faster, less expensive, and more procedurally streamlined than arbitration: the expert — usually an independent accounting firm — reviews the parties’ submissions, applies the contractual definition of the earnout metric, and issues a binding determination. The entire process can be completed in a few months.

However, the accounting expert process is limited in scope. The expert is typically empowered only to determine accounting questions — how a specific item should be classified or measured under the defined metric. The expert cannot determine legal questions such as whether the buyer breached its operational covenants, whether the buyer violated the implied covenant of good faith, or what remedy the seller is entitled to for the buyer’s wrongful conduct. These legal questions require arbitration or litigation.

Many earnout disputes involve both accounting questions and legal questions, and parties who have agreed to accounting expert determination as their sole dispute resolution mechanism often find that the expert process resolves only a portion of their dispute, leaving the legal questions unresolved and requiring a subsequent arbitration or litigation proceeding. The most effective earnout dispute resolution provisions clearly delineate the accounting expert’s scope (limited to accounting questions), provide for prompt arbitration to resolve legal and operational covenant disputes, and specify the remedies available (including damages and injunctive relief) for different categories of breach.

Lessons from Major Earnout Litigation

A review of major earnout litigation produces several consistent lessons for drafting and negotiation. First, operational covenants must be specific: general obligations to act in good faith or to use commercially reasonable efforts to achieve the earnout have proven difficult to enforce because they do not clearly define what specific conduct is required. Specific covenants — maintain existing sales team size, do not divert revenue attributable to specified customer accounts, apply defined overhead allocation methodology — are more likely to support a successful legal claim.

Second, the earnout metric should be insulated from the buyer’s integration activities: if the buyer is permitted to integrate the acquired business but the earnout metric depends on standalone performance of the acquired business, the contract must specify exactly how integration-related accounting adjustments will be made to produce a standalone earnout calculation. Without this specification, the integration will make the metric impossible to calculate accurately, and the dispute will be irresolvable.

Third, the earnout period should be as short as possible. The longer the earnout period, the more operational decisions the buyer will make, the more things will change, and the more opportunities for dispute will arise. Earnout periods longer than two to three years typically generate significantly more disputes than shorter periods, and sellers who are forced to accept long earnout periods to bridge a valuation gap should negotiate for robust operational covenants and strong dispute resolution provisions in return.