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In Trifecta Multimedia Holdings v. WCG Clinical Services, the Delaware Court of Chancery analyzed claims related to an M&A transaction involving an earn-out component. Earn-outs are a common feature of M&A transactions and purchase agreements, whereby a portion of the purchase price is contingent upon the earnings of the business following the transaction. Buyers will often make extra-contractual promises to sellers about how they will operate the business post-closing to meet the earnings necessary for earn-out payment. Buyers are wary of drafting specific promises into the purchase agreement to maintain flexibility over the operations of the acquired business. In Trifecta, the court denied the defendant’s motion to dismiss, finding that certain extra-contractual promises were specific enough to form the basis for a fraud claim, while others were inactionable puffery. The court also analyzed whether the implied covenant of good faith and fair dealing could provide relief.
In 2020, WCG Clinical Services LLC (WCG) purchased healthcare technology company, Trifecta Multimedia Holdings, Inc. (Trifecta). Pursuant to the terms of the Membership Interest Purchase Agreement (the Purchase Agreement), part of the purchase price was contingent upon Trifecta reaching revenue milestones in 2021, 2022, and 2023, as outlined by the Purchase Agreement (the Earnout Provision).
Prior to and during negotiations, WCG made numerous promises about how it would operate Trifecta’s business post-closing to meet those milestones, including in WCG’s letter of intent and orally during negotiations of the Purchase Agreement. Those extra-contractual promises included: (i) that WCG shared in Trifecta’s vision for growth; (ii) that Trifecta’s acquired divisions could maintain autonomy over their work and operate independently; (iii) that the owner of Trifecta would work “shoulder-to-shoulder” with WCG following the transaction; (iv) that WCG would support Trifecta with over 100 sales and marketing staff; and (v) that Trifecta’s uniquely integrated suite of products would not be in competition with WCG’s own products and would serve as a “front door” for clients. These promises were not memorialized in the Purchase Agreement.
Upon review of the WCG’s draft of the Purchase Agreement, Trifecta requested that an express provision obligating WCG to make good faith efforts (the Efforts Provision) to achieve the revenue milestones set forth by the Earnout Provision. WCG countered that the provision was unnecessary because WCG already was obligated to make those efforts under Delaware’s implied covenant of good faith and fair dealing. Ultimately, the good faith efforts provision was not drafted into the Purchase Agreement.
Shortly after the transaction, WCG backtracked on many of its promises. For example, WCG did not support Trifecta’s business with any of its own sales force, and WCG prevented Trifecta from offering its product as an integrated solution and promoted its own competing product to clients. Trifecta did not meet the revenue milestones set by the earn-out provision.
Trifecta filed suit against WCG on July 11, 2023, alleging four causes of action. In its opinion on WCG’s motion to dismiss, the Chancery Court primarily focused on Trifecta’s fraud and breach of the implied covenant of good faith and fair dealing claims.
The court’s analysis of Trifecta’s fraud claim focused primarily on three elements: (i) the existence of a false representation; (ii) scienter; and (iii) reasonable reliance.
False representation. The court distinguished between false representations and puffery, finding, for example, WCG’s promise to “support the Company with over 100 sales and marketing staff” to be puffery, while the promise to use Trifecta’s unique integrated product “as a means to unify WCG applications” was sufficiently specific.
Scienter. The court found the allegations that WCG stopped performing under the contract right after the closing, including by failing to hire a replacement sales force and preventing Trifecta employees from speaking with potential customers.
Reliance. The court found that the integration clause in the Purchase Agreement alone was insufficient to bar a fraud claim because the Purchase Agreement lacked a corresponding anti-reliance clause, based on Abry Partners V, L.P. v. F & W Acq. LLC and its progeny.
The Court then turned to its analysis of the claim for good faith and fair dealing, which it ultimately dismissed. Trifecta alleged WCG breached the implied covenant by engaging in activities intended to frustrate Trifecta’s ability to reach the revenue milestones. The implied covenant of good faith and fair dealing is a gap-filling theory that generally provides that, if no explicit contractual language governs a situation, the parties must act reasonably so as to not frustrate either party’s reasonable expectations. Delaware will not use the implied covenant to fill a gap if (i) there is no gap, or (ii) the parties negotiated a term and it was rejected. Here, Trifecta proposed, but the parties did not include, a provision obligating WCG to use good faith efforts to achieve the milestones. The court noted, however, that the provision was not rejected, but was not included because the parties agreed that Delaware law already obligated WCG to use good faith efforts. As a result, the court found Trifecta’s claim was more akin to a breach of contract claim. However, the court found that the complaint did not state a claim because the claim relied on parol evidence. The court also suggested that Trifecta could have pled a fraud claim based on the same facts, but that the complaint did not include facts showing that WCG knew its statement about Delaware law was false.
Authored by Allison M. Wuertz and Molly Balan.