Treatt Plc v Barratt & Ors

An earn-out notice under a share-sale agreement must use the contractual basis specified by the definition of the earn-out, including any required audited accounts. A notice based on wholly irrelevant accounts is invalid, rather than merely containing a correctable error in calculation. The expert determination procedure is intended to resolve disputes arising from compliant calculations and underlying accounts. It does not convert a materially non-compliant notice into a valid one. An accidental mathematical error may be corrected where the notice is otherwise based on the contractually required accounts.

Treatt Plc appealed from a decision of Morgan J in the High Court, Chancery Division, Birmingham District Registry (BM30606). The dispute concerned deferred consideration payable under a share purchase agreement for the acquisition of shares in two corporate groups.

The buyer served an earn-out notice calculated by reference to consolidated audited accounts for a different period and management accounts, rather than the specified audited accounts for the relevant calendar years. The central issue was whether that departure made the notice invalid, or was merely an error capable of correction through the contractual expert determination procedure.

The Court of Appeal unanimously dismissed the appeal. Lord Justice Briggs gave the judgment, with Lord Justice Ryder and Lord Justice Longmore agreeing.

1. Meaning of “Earn-out”. The defined term retained the meaning assigned to it in clause 1 wherever it appeared in the agreement, including clause 3.2. The buyer therefore had to specify an amount calculated according to the contractual formula and by reference to the specified audited accounts.
2. Validity of the notice. The requirement in clause 3.2 to state the basis of calculation in reasonable detail required the contractual basis to be identified. A notice calculated wholly by reference to irrelevant accounts did not specify the contractual earn-out and was invalid. The departure was substantive because the audited-account requirement provided important protection by supplying objectivity, accounting explanations and independent professional verification.
3. Scope of expert determination. Clause 3.5 contemplated that the expert would resolve outstanding disputes by reference to the notice and the underlying relevant accounts. It did not require the expert to calculate the earn-out from scratch or undertake, in effect, a late audit where the required accounts had never been prepared.
4. Boundary between error and invalidity. An accidental mathematical error in a calculation based on the relevant accounts could be corrected through the expert procedure. The court recognised that the boundary might be difficult to define in the abstract, but held that the wholly non-compliant basis used here was plainly on the invalidity side of it.
5. Commercial construction. Where alternative constructions raised issues of practicability, the agreement was primarily to be construed by considering how it operated when the parties complied with it, rather than when one party ignored its contractual obligations. The respondents’ notice issues consequently did not require determination.

• Court of Appeal (Civil Division): In [2015] EWCA Civ 116, the court dismissed the buyer’s appeal. Lord Justice Briggs gave the judgment; Lord Justice Ryder and Lord Justice Longmore agreed.
• High Court, Chancery Division, Birmingham District Registry: Morgan J held that the purported earn-out notice was invalid because it was not calculated by reference to the audited accounts required by the share purchase agreement. The earn-out therefore remained to be determined by the expert accountant.