Misunderstanding Regarding Dates Does Not Provide Grounds to Reform Earn-Out Provision in Purchase Agreement, Rules Chancery Court
In Glidepath Limited v. Beumer Corporation, the Delaware Court of Chancery ruled against the sellers of a limited liability company, holding that the purchase agreement should not be reformed to correct the dates comprising the earn-out period for the transaction. The Court reasoned that while the seller was in fact mistaken about the terms of the agreement, there was neither a mutual mistake nor a unilateral mistake with knowing silence; additionally, the Court was unable to reform the contract because the parties did not come to a specific prior understanding that differed from the written agreement.
In the transaction giving rise to this dispute, Glidepath Ltd and Sir Ken Stevens, KNZM (“Sellers”) sold 60% of the equity in Glidepath LLC (the “Company”) to Beumer Corp. (the “Buyer”) pursuant to a Membership Interest Acquisition Agreement (the “Agreement,” and such transaction, the “Acquisition”). In initial turns of the Agreement draft, the parties anticipated that the Acquisition would close on April 1, 2013. However, the Buyer sought to postpone the closing of the Acquisition, citing concerns about funding and post-closing corporate governance. The Acquisition eventually closed in January 2014. The Agreement as executed contemplated a period of shared management ending March 31, 2016, during which the Company would be controlled by the Buyer, at the end of which a put-call mechanism would be available to the parties. Additionally, a portion of the consideration for the 60% interest sold consisted of an earn-out payment, to be calculated based on the time period from April 1, 2013 through March 31, 2016. Several months after the closing of the Acquisition, it became clear that (i) the Sellers would likely not receive any earn out payment due to poor Company performance, and (ii) the Sellers were assuming that the dates for the earn-out payment and other transaction mechanics had shifted to be commensurate with the shift in the closing date. Sellers commenced arbitration and litigation against the Buyers, asserting various claims and seeking reformation. The Court directed the parties to present the reformation issue first, because the success or failure of that claim would establish the time periods for the other claims.
The Sellers had the burden of proving their reformation claim by clear and convincing evidence. The Sellers must prove either (i) the existence of mutual mistake of fact that resulted in an erroneously drafted agreement, or (ii) a unilateral mistake of fact by the Sellers, coupled with knowing silence on the part of the Buyer.
Regarding mutual mistake, the record was clear that the Buyer did not share the Sellers’ view that the earn-out period changed. In a prior acquisition, a similar set of circumstances unfolded—a delayed closing and earn-out dates that were not updated to follow the delay in closing—and the earn-out began to run prior to closing with no objection from the sellers in that transaction. The Buyer credibly testified that they did not expect that the Acquisition would be any different, even though an earn-out period that starts before closing is unusual and potentially problematic. Nevertheless, the Buyer was found not to have held the same mistake that Sellers did, and so mutual mistake does not apply.
Regarding unilateral mistake, the party seeking reformation must prove both that it was mistaken and that the other party knew of the mistake but remained silent. While the Buyer did come to understand that the Sellers had made a mistake in thinking that the earn-out dates had changed, this realization occurred well after signing. The Sellers argued that once the Buyers did begin to suspect that the Sellers were operating under the false impression, the Buyers should have contacted the Sellers to correct the misunderstanding, but the Buyers believed that they had already communicated the workings of the earn-out and did not need to further communicate on the point. While there is some evidence that the Buyers could have or should have realized that the Sellers would not have agreed to have part of the earn-out period run during a time when the Company lacked the financial capacity to secure bids, which it did under Seller control, this did not provide clear and convincing evidence that the Buyers knew of Seller’s mistake.
Finally, the Court briefly discussed one further justification for finding against the Sellers. To reform a contract, the Court must be shown that the parties came to a specific prior understanding that differed materially from the written agreement. The only written evidence of a prior understanding was the letter of intent, which indicated the same dates reflected in the final Agreement. There was no meeting of the minds about how the dates would operating upon a delay of closing, so the Court could not reform the contract to reflect different dates.