SPAs: Validity of an earn-out notice

Print publication


In Treatt Plc v Barratt and Others [1], a share purchase agreement (SPA) provided for an earn-out to be calculated by reference to the pre-tax profits of the acquired group shown in the audited accounts for a specified period.

The buyer changed the financial year-end of the acquired companies so that the audited accounts required by the SPA were not available when the earn-out fell to be calculated. The buyer instead calculated the earn-out on the audited consolidated accounts for the buyer’s group for a different period, and from the management accounts of the acquired companies.

The seller sought a declaration that the buyer’s notice was not a valid earn-out notice on the grounds that the earn-out calculation in the buyer’s notice did not meet the requirements of the SPA. In response, the buyer argued that it was possible for an earn-out notice to be valid so long as it set out the basis of the calculation in reasonable detail (as required in the SPA), even though the figure specified did not conform to the requirements of how the earn-out was to be calculated.

The Court of Appeal held that the requirement for the earn-out to be calculated by reference to the audited accounts specified in SPA was a form of contractual protection of real importance to the sellers rather than a mere formality. The SPA defined the earn-out as an amount duly calculated in accordance with the contractual formula and by reference to the audited accounts that were specified in the definition. A notice which did not adopt that basis was not a valid earn-out notice.

The Court insisted on a distinction between a mathematical error in calculation where the calculation was based on relevant accounts, which would not invalidate an earn-out notice, and substantial departures from the applicable contractual provisions, which would.

WM comment
Courts will take a strict approach to construing earn-out notices, and they will not be sympathetic to departures from the relevant contractual obligations in the SPA, even if made in good faith.

When drafting an earn-out clause, the party responsible for preparing the initial earn-out calculation should ensure that it is clear on exactly what must be included in its notice of the calculation. The case highlights the benefit of aligning earn-out periods with the buyer’s accounting period.


[1] [2015] EWCA Civ 116