How a brokerage sale agreement can lead to a lawsuit

The price buyers pay for brokerage firms is often not set in stone but rather depends on the financial performance of the acquired business after it’s sold, and this can lead to disagreements that wind up in court, lawyers say.

Some mergers and acquisitions — in insurance and other sectors — involve earnout agreements, Stephen Gleave, a lawyer for Hicks Morley, told Canadian Underwriter last week.

In these situations, “the parties really can’t agree on a valuation at the date of sale,” Gleave said.  “The buyer says, ‘I think the business is worth X.’ The seller says, ‘No it’s higher, it’s Y.”’

Negotiations around earnout agreements can lead to disputes that wind up the courts, Gleave said, commenting in general and not on any case in particular.

In several instances of acquisition, a purchasing company wants to know that there’s going to be some value in the revenue stream going forward, said Toronto lawyer Jonathan Rosenstein, who was commenting in general and not on any particular case before the courts. “Often there is a deferred portion of the compensation saying, ‘If we meet certain targets, you get paid — and if we don’t, you don’t.’”

Legal disputes can arise when the target is not met. Typical targets include revenue, earnings before interest, depreciation, taxation and amortization (EBIDTA) or some other measure.

“The person who did the selling feels that they should have gotten their money and is upset that they didn’t,” Rosenstein said. “The company that was the buyer when the target wasn’t met feels that’s exactly why there was a deferred compensation in the first place.”

One such dispute before the Ontario Superior Court of Justice arose from the 2008 acquisition of commercial auto broker Safety Insurance Service (1959) Limited by Jones Deslauriers Insurance Management Inc.

Crescent (1952) Ltd.’s agreement to sell Safety to Jones Deslauriers included a “warranty period,” in which Jones Deslauriers paid Crescent “additional money if certain revenue targets arising from the book of business the plaintiff sold” were met over three years, Ontario Superior Court Justice Ruth Mesbur found in a ruling released Aug. 8, 2017.

Crescent filed a lawsuit in 2011 against Jones Deslauriers for $4.5 million, alleging the targets were met. Jones Deslauriers says the targets were not met.

Justice Mesbur’s ruling was not on the merits Crescent’s allegations against Jones Deslauriers but rather is a production order compelling Jones Deslauriers to hand over certain documents to the plaintiffs. A trial date has been set in November 2018.

Rosentein is representing Jones Deslauriers in the case, and Gleave is representing the plaintiffs.

Commenting generally on acquisition agreements with earnout periods, Gleave said that from a seller’s perspective, they are putting their business into the hands of a buyer for a certain period of time, trusting that it will be run in a way that will allow them to maximize their ultimate purchase price.

“What’s interesting now is the number of acquisitions going on right now with brokerages buying other brokerages on their own or through the assistance of an insurance company,” Gleave told Canadian Underwriter last week.