Parker v Harman International Industries Ltd.

Contractual earn-out provisions must be construed as a whole, having regard to the language used, the commercial purpose and the surrounding circumstances known to the parties. Where an agreement excludes payment on sales below a threshold, payment is ordinarily calculated only on the excess above that threshold if that gives the provision commercial coherence. A provision referring to monthly sales and carrying forward shortfalls may require a rolling monthly calculation rather than an annual average. For accounting purposes, sales arise when goods are both sold and delivered. Returns credited during the relevant period are deducted from the corresponding sales, but credits relating to earlier deliveries are not.

The claimant sold the shares in Digital Audio Research Ltd to the defendant under a 1998 agreement containing sales- and profit-related earn-out provisions. The parties later varied the profit-related provision for the second earn-out period by a letter dated 25 November 1999. A split trial was ordered, with liability to be determined before causation and quantum. The present hearing concerned preliminary questions of construction relating to the calculation and conditions of the revised earn-out.

1. Clause 2: threshold calculation. Construed with condition 4, the revised earn-out of 20 per cent was payable on net monthly sales above £130,000 and up to £180,000, rather than on all sales once the threshold was exceeded. Clause 4 was not merely an emphasis of the threshold. It excluded payment in respect of sales below £130,000. That construction also accorded with the commercial context, including the contemplated break-even point and contribution margin.
2. Monthly averaging. Condition 4 required a rolling monthly calculation. A shortfall below £130,000 in one month was carried forward and deducted from subsequent monthly sales. The claimant was therefore entitled to payment for a month once the relevant monthly calculation exceeded £130,000, subject to the carried-forward shortfall. The reference to average monthly sales above £180,000 was construed consistently with that monthly approach.
3. Meaning of net sales. For the purposes of the agreement, a sale required both sale and delivery. An invoice issued without delivery did not count. The figures were to be calculated by reference to the shipment date. Credits for goods returned and credited during the second earn-out period were deducted from the sales for the month of shipment. Credits made during that period for goods delivered before it were not deducted.
4. Contribution margin and costs. The question concerning the meaning of costs was resolved on the basis that the relevant figures were to be calculated monthly, as were sales. The supplied judgment text records that the defendant no longer pursued inclusion of stock write-downs, damaged stock or stock losses in “cost”.

Master Leslie ordered a split trial on 15 April 2003. Liability, including the preliminary construction issues, was to be tried first, followed by causation and quantum if necessary. The judgment supplied is the High Court’s determination of the preliminary issues.