Earn-Out Clauses in Share Purchase Agreements: Risks, Validity, and Disputes

This article examines earn-out clauses inserted in share purchase agreements, with an emphasis on legal aspects related to their validity, enforcement, risks, and controversies arising from their interpretation. Common in mergers and acquisitions (M&A) transactions, these clauses tie part of the purchase price to the future performance of the company, frequently giving rise to disputes over accounting criteria, performance targets, and duties of cooperation. The study analyzes the legal treatment, recommended contractual parameters, and the case law that guides their practical application.

In share purchase transactions, especially in M&A deals, the use of earn-out clauses has become increasingly common. These clauses make part of the transaction price conditional upon the economic performance of the acquired company in a future period. This practice seeks to mitigate uncertainties regarding the company’s operational capacity and reduce the risk of information asymmetry between seller and buyer.

However, the implementation of earn-out mechanisms requires precise contractual provisions, under penalty of complex litigation involving the calculation of results, accounting manipulation, lack of cooperation between the parties, or frustration of legitimate expectations.

This article analyzes the legal structure of earn-out clauses, their contractual nature, the recommended safeguards for their drafting, and the main points of judicial conflict.

2. Concept and Legal Nature of the Earn-Out

The earn-out is an ancillary contractual clause whereby the parties agree that part of the purchase price for the equity interest shall be paid subsequently, on a variable basis, depending on agreed financial, operational, or strategic targets—usually after the closing of the transaction (post-closing).

Examples of targets include:

• Gross or net revenue;

• EBITDA (earnings before interest, taxes, depreciation, and amortization);

• Profit margin;

• Customer retention;

• Expansion of units/franchises.

Legally, the earn-out has the nature of a conditional and future obligation, governed by Articles 121 to 130 of the Brazilian Civil Code, and falls within the scope of the economic and distributive function of the contract (Articles 421 and 421-A of the Civil Code).

3. Purpose and Practical Applicability

Earn-out clauses aim to:

• Reduce uncertainties regarding valuation in companies with a short operating history, accelerated growth, or dependence on external factors;

• Align incentives between the former controlling party and the new buyer;

• Allow the seller to participate in future results, especially when there is growth potential.

This structure is common in:

• Emerging companies (startups, healthtechs, fintechs);

• Family businesses undergoing succession;

• Mergers involving gradual integration.

4. Risks and Common Sources of Disputes

The main causes of controversy in earn-out agreements include:

4.1 Ambiguity in performance criteria

• Vague metrics, incomplete formulas, absence of applicable accounting standards.

4.2 Manipulation of results

• Changes in accounting policies, revenue suppression, artificial cost increases.

4.3 Lack of cooperation or access to information

• Denial of access to financial documents required to assess performance.

4.4 Fraud or bad faith in post-closing management

• Deliberately hindering the achievement of targets to avoid payment.

“The earn-out clause must observe the principle of objective good faith and guarantee the seller reasonable access to the accounting information necessary to assess the agreed condition.” (TJSP, Civil Appeal 1037894-29.2021.8.26.0100, judged on 06/15/2023)

5. Contractual Requirements for Greater Legal Certainty

To avoid litigation, the contract should include:

• Objective and technical definition of performance indicators;

• Clearly defined assessment period;

• Applicable accounting standards (IFRS, BRGAAP, etc.);

• Audit or independent expert clause in case of disagreement;

• Seller’s right to access operational information;

• Penalty clause or fine for breach of the payment obligation;

• Rules concerning any changes in the business model (e.g., mergers or spin-offs during the earn-out period).

6. Case Law and Judicial Trends on Earn-Outs

Although there is no specific legislation on earn-outs in Brazil, case law has recognized their validity, provided there is no abuse, deviation of purpose, or bad faith in the company’s management after the sale.

“The earn-out clause is valid, provided that the criteria are clearly defined, and there is no right to payment if the target is not objectively met.” (TJMG, Civil Appeal 1.0024.19.264758-2/001, judged on 03/03/2023)

“The lack of transparency and cooperation between the parties, combined with unilateral accounting changes to frustrate the earn-out, justifies judicial review of the contract.” (STJ, REsp 1.942.013/SP, Justice Ricardo Cueva, judged on 11/18/2022)

7. Best Practices for Drafting and Executing Earn-Out Clauses

• Draft clauses with the support of specialized legal and accounting professionals;

• Include calculation simulations in the contract as an annex;

• Ensure the seller’s access to documentation during the assessment period;

• Avoid clauses that rely solely on the buyer’s discretionary actions;

• Include an arbitration or independent expert clause, with clearly defined deadlines and procedures for dispute resolution.

8. Final Considerations

Earn-out clauses represent a legitimate and efficient negotiation tool, provided they are structured with clarity, transparency, and contractual balance. Although useful for aligning expectations between buyer and seller, their success depends on the consistency of the adopted criteria, good faith in execution, and the predictability of the suspensive condition.

Failure to observe care in contract drafting, combined with unilateral management of business activities after the sale, may give rise to complex litigation and discussions regarding nullity, revision, or breach of the earn-out obligation.

The preventive role of the corporate lawyer—from due diligence to final contract drafting—is essential to ensure legal certainty, financial predictability, and protection of the interests of both parties involved in the transaction.