Court of Appeal holds SPA earn-out unenforceable as an agreement to agree

The Court of Appeal has rejected a seller’s claim that he was entitled under a sale and purchase agreement (“SPA”) to provide consultancy services to the target company for a further period after an initial four year earn-out. Applying settled principles, the court held that an agreement to provide consultancy services for “such further period as shall reasonably be agreed” was not enforceable because it was an agreement to agree: Morris v Swanton Care & Community Ltd [2018] EWCA Civ 2763.

Though each case will turn on the words used in the specific contract, the decision illustrates that where parties seek to account for future uncertainty by stipulating that the parties will ultimately have to reach further agreement, the courts will be slow to find that either party has an enforceable right in relation to the terms or even the existence of that further agreement. The same is true of a clause requiring parties “reasonably” to agree, or to use best or reasonable endeavours to agree. Such formulations cannot turn an unenforceable provision into an enforceable agreement.

As this case shows, there is a fundamental difference between parties postponing agreement (which, commercially, may be justified given uncertainties surrounding what may happen in the future) and parties actually reaching agreement in relation to future terms of their relationship, albeit with gaps to be resolved between them based on objective criteria capable of assessment by the court. The former does not give rise to any enforceable obligations; the latter may be enforceable, provided that the gaps do not give rise to such uncertainty as to call into question whether there has been a meeting of minds at all.

In the particular context of earn-out provisions in SPAs, parties should be careful to ensure that the relevant provisions preserve sufficient flexibility for the parties to react to future developments but without creating such uncertainty as to render the clause unenforceable. Since each SPA turns on its own terms, it is impossible to adopt a one size fits all approach; however, it is at least clear that if the SPA provision leaves open the possibility of parties agreeing or disagreeing (whether reasonably or not), the courts will be slow to give such a provision binding contractual effect. The Court of Appeal’s judgment also makes clear that if parties wish to create an enforceable agreement by reference to an objective framework which can fill in any gaps later, they are well advised to set out in detail how this objective framework should operate and what factors should, or should not, be taken into account, insofar as these are known at the time the SPA is signed.

John Ogilvie, Neil Blake and Andrew Cooke consider the decision further below.

Background

For present purposes, the facts can be shortly stated. In 2006, Mr Morris sold shares in Glenpath Holdings Limited to Swanton Care & Community Limited. Together with initial consideration of approximately £16 million, Swanton agreed to pay Mr Morris earn-out consideration to be calculated in accordance with an earn-out schedule to the SPA. The earn-out schedule provided a formula for assessing the amount of such earn-out consideration in consideration for Mr Morris providing ongoing consultancy services in relation to Glenpath.

The earn-out schedule provided that Mr Morris “shall have the option” to provide consultancy services for a period of four years after completion and “following such period such further period as shall reasonably be agreed between Mr Morris and [Swanton]”.

Mr Morris supplied the relevant services for four years and was paid approximately £4 million by way of earn-out consideration. In 2010, Mr Morris purported to give formal notice of his request for a “reasonable extension” to the earn-out period. Swanton rejected the extension on the basis that there was “no appetite in the business for an extension”.

Mr Morris issued proceedings in 2015, claiming that he had a contractual entitlement to a further earn-out period during which he would have earned additional earn-out consideration. He argued that the wording of the relevant clause was mandatory because it provided that he “shall” have an “option” for a further period, and that his exercise of this option had been wrongly rejected by Swanton.

Decision

The High Court and the Court of Appeal both found that Mr Morris did not have an enforceable right to provide consultancy services during any earn-out period other than the initial period of four years. Insofar as the clause related to a further period, this was an unenforceable agreement to agree. The reference to the parties “reasonably” agreeing the further earn-out period did not save the clause because the word “reasonably” was used as an adverb to describe the manner in which the parties were required to reach agreement, not to mandate them to reach an agreement which was reasonable. Ultimately, for there to be any further period, there had first to be agreement between the parties which, the Court of Appeal held, was the “very paradigm of an agreement to agree” which could not be enforced.

The Court of Appeal contrasted the drafting in this case with a hypothetical clause which provided for an extension of time for a reasonable period – in that case, there would at least have been an existing agreement for a reasonable period which the courts might be able to enforce (as to which see below), whereas in Mr Morris’s case the parties had not reached any agreement (and could not be compelled to reach any agreement) as to an extension.

Because the clause in this SPA contemplated that the parties would be free to agree or disagree about any extension (even if they acted reasonably when discussing a potential extension), it was void for uncertainty.

Mr Morris did not allege that Swanton had acted unreasonably in denying the extension but, even if Swanton had acted unreasonably, Mr Morris would still not have a claim because it was open to the parties to disagree even if they acted reasonably.

Even if the clause had provided for a further extension for a reasonable period, rather than requiring the parties reasonably to agree a further period, this would still have been unenforceable.

The Court of Appeal agreed with the High Court that the SPA did not provide any framework to determine the reasonable length of the period. It rejected Mr Morris’s contention that the SPA did make provision because “reasonable” imported an objective framework which the court could apply to quantify the duration of his extension “option”. The mandatory language of the clause (“shall”) did not assist and nor did reference to Mr Morris’s “option” because the character of the option was too uncertain to be enforced.

In any event, there was nothing in the performance of the SPA in the initial four years after completion from which a court could extrapolate a reasonable period of an extension. Though Mr Morris sought to identify relevant factors, all of them were commercial factors for the parties to factor into a commercial negotiation, in which they could agree or disagree to an extension, not factors permitting a court to determine the reasonable period of an extension.

John Ogilvie
John Ogilvie
Partner
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Neil Blake
Neil Blake
Partner
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+44 20 7466 2755
Andrew Cooke
Andrew Cooke
Senior associate
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+44 20 7466 7566

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