Purchase Price Adjustment and Earn-Out Clause Pack - California

PURCHASE PRICE ADJUSTMENT AND EARN-OUT CLAUSE PACK

State of California

Prepared for Use in: Stock Purchase Agreements, Asset Purchase Agreements, Merger Agreements
Governing Law: State of California
Date: [__/__/____]

PART I: OVERVIEW AND PURCHASE PRICE MECHANICS

Section 1.01 — Purchase Price Structure

The aggregate consideration for the Acquired Business (the "Purchase Price") shall consist of:

☐ (a) Base Cash Consideration. An amount equal to $[________________________________] (the "Base Purchase Price"), payable at the Closing by wire transfer of immediately available funds to an account designated by Seller, subject to adjustment as provided in Part II of this Clause Pack;

☐ (b) Closing Adjustment. A dollar-for-dollar adjustment to the Base Purchase Price based on the difference between Closing Net Working Capital and Target Net Working Capital, as set forth in Section 2.01;

☐ (c) Earn-Out Consideration. Contingent consideration in the form of one or more Earn-Out Payments, subject to and in accordance with Part III of this Clause Pack, in an aggregate maximum amount not to exceed $[________________________________] (the "Earn-Out Cap");

☐ (d) Seller Note. A promissory note in the principal amount of $[________________________________], bearing interest at [____]% per annum, payable on the terms set forth in Exhibit [____];

☐ (e) Equity Rollover. [________________________________] shares/units of Buyer or its parent entity, valued at $[________________________________] per share/unit, subject to the terms of the Rollover Agreement attached as Exhibit [____];

☐ (f) Escrow Amount. $[________________________________] of the Base Purchase Price shall be deposited in escrow with [________________________________] (the "Escrow Agent") to secure Seller's obligations under Article [____] (Indemnification) and Section 2.01 (Working Capital Adjustment), to be held and disbursed pursuant to the Escrow Agreement attached as Exhibit [____].

Section 1.02 — Funds Flow

At the Closing, the Base Purchase Price shall be disbursed in accordance with the funds flow memorandum (the "Funds Flow") to be agreed upon by the Parties not fewer than [____] Business Days prior to the Closing Date, which shall reflect the following:

(a) Payment of all Closing Indebtedness to the holders thereof;

(b) Payment of all unpaid Transaction Expenses to the payees thereof;

(c) Deposit of the Escrow Amount with the Escrow Agent;

(d) Payment of any estimated Closing adjustment amount pursuant to Section 2.02;

(e) Distribution of the remaining balance to Seller (or the equityholders of Seller, as applicable).

Section 1.03 — Cash-Free, Debt-Free Basis

The Purchase Price is calculated on the assumption that the Company will be delivered at Closing on a cash-free, debt-free basis, with a normalized level of Net Working Capital. Accordingly:

(a) Cash. All Cash of the Company as of the Effective Time shall be for the account of Seller and shall be distributed to Seller at or prior to Closing, or the Purchase Price shall be increased dollar-for-dollar by the amount of any Cash remaining in the Company at Closing;

(b) Indebtedness. All Closing Indebtedness shall be repaid at or prior to Closing from the Purchase Price, and the Purchase Price shall be reduced dollar-for-dollar by the amount of any Closing Indebtedness outstanding as of the Effective Time;

(c) Transaction Expenses. All unpaid Transaction Expenses shall be paid at or prior to Closing from the Purchase Price.

PART II: WORKING CAPITAL ADJUSTMENT

Section 2.01 — Target Net Working Capital

(a) The Parties agree that the target Net Working Capital of the Company is $[________________________________] (the "Target Net Working Capital"), which represents the normalized level of Net Working Capital necessary for the ordinary course operation of the Business.

(b) The Target Net Working Capital has been determined based on the average monthly Net Working Capital of the Company for the [____]-month period ending [__/__/____], calculated in accordance with the Accounting Principles and the Sample Working Capital Calculation set forth on Schedule [____].

Section 2.02 — Estimated Closing Statement

Not fewer than [____] Business Days prior to the anticipated Closing Date, Seller shall deliver to Buyer a good faith estimate of Closing Net Working Capital (the "Estimated Closing Net Working Capital"), together with a reasonably detailed calculation thereof (the "Estimated Closing Statement"), prepared in accordance with the Accounting Principles. The Base Purchase Price payable at Closing shall be:

(a) Increased dollar-for-dollar by the amount, if any, by which the Estimated Closing Net Working Capital exceeds the Target Net Working Capital; or

(b) Decreased dollar-for-dollar by the amount, if any, by which the Target Net Working Capital exceeds the Estimated Closing Net Working Capital.

Section 2.03 — Post-Closing Adjustment Procedures

(a) Closing Statement Delivery. Within [____] days after the Closing Date, Buyer shall prepare and deliver to Seller a statement (the "Closing Statement") setting forth Buyer's good faith calculation of:

• (i) Closing Net Working Capital;
• (ii) Closing Cash;
• (iii) Closing Indebtedness; and
• (iv) Transaction Expenses unpaid as of the Closing.

The Closing Statement shall be prepared in accordance with the Accounting Principles and in the same format as the Sample Working Capital Calculation.

(b) Review Period. Seller shall have [____] days after receipt of the Closing Statement (the "Review Period") to review the Closing Statement. During the Review Period, Buyer shall provide Seller and its Representatives with reasonable access during normal business hours to the books, records, work papers, and personnel of the Company as reasonably requested by Seller.

(c) Dispute Notice. If Seller disagrees with any item or amount set forth in the Closing Statement, Seller shall, on or before the last day of the Review Period, deliver to Buyer a written notice (the "Dispute Notice") specifying in reasonable detail:

• (i) Each item or amount in dispute;
• (ii) The amount of such dispute, item by item; and
• (iii) Seller's proposed resolution of each disputed item, together with reasonable supporting documentation.

Any items not specifically identified in the Dispute Notice shall be deemed accepted by Seller and shall be final and binding.

(d) Resolution Period. If a Dispute Notice is timely delivered, the Parties shall negotiate in good faith during a period of [____] days after Buyer's receipt of the Dispute Notice (the "Resolution Period") to resolve the disputed items. If the Parties are unable to resolve all disputed items within the Resolution Period, either Party may submit the remaining disputed items to the Independent Accountant for resolution in accordance with Section 6.01.

(e) Final Determination. The Closing Net Working Capital, as finally determined pursuant to this Section 2.03 (whether by failure to deliver a timely Dispute Notice, agreement of the Parties, or determination by the Independent Accountant), shall be the "Final Closing Net Working Capital."

Section 2.04 — True-Up Payment

(a) If the Final Closing Net Working Capital exceeds the Estimated Closing Net Working Capital, Buyer shall pay to Seller the amount of such excess (the "Upward Adjustment") within [____] Business Days after the final determination of the Closing Statement.

(b) If the Estimated Closing Net Working Capital exceeds the Final Closing Net Working Capital, Seller shall pay to Buyer the amount of such excess (the "Downward Adjustment") within [____] Business Days after the final determination of the Closing Statement.

(c) Any Downward Adjustment shall first be satisfied from the Escrow Amount, and any excess shall be paid directly by Seller to Buyer by wire transfer of immediately available funds.

(d) Any payment made pursuant to this Section 2.04 shall include interest at a rate equal to [____]% per annum (or the prime rate published in The Wall Street Journal on the Closing Date, plus [____]%), calculated from the Closing Date through the date of payment. California constitutional and statutory limitations on interest rates should be considered.

Section 2.05 — De Minimis Threshold

Notwithstanding anything to the contrary in this Part II, no adjustment payment shall be required if the absolute value of the difference between Final Closing Net Working Capital and Estimated Closing Net Working Capital is less than $[________________________________] (the "De Minimis Amount"). If the De Minimis Amount is exceeded, the full amount of the adjustment (not merely the excess) shall be payable.

PART III: EARN-OUT PROVISIONS

Section 3.01 — Earn-Out Milestones and Payment Schedule

Subject to the terms and conditions of this Part III, Buyer shall pay (or cause to be paid) to Seller the following contingent consideration amounts (each, an "Earn-Out Payment"):

☐ (a) Revenue-Based Earn-Out:

☐ (b) EBITDA-Based Earn-Out:

☐ (c) Milestone-Based Earn-Out:

☐ (d) Hybrid Earn-Out. A combination of financial and operational milestones as set forth on Schedule [____].

Section 3.02 — Earn-Out Definitions

For purposes of this Part III:

(a) "Earn-Out Revenue" means the net revenue of the Business recognized during the applicable Earn-Out Period, calculated in accordance with the Accounting Principles, excluding:

• (i) Revenue from acquisitions consummated by Buyer after the Closing Date, unless [________________________________];
• (ii) Intercompany revenue between the Business and Buyer or its Affiliates;
• (iii) Revenue from [________________________________] (one-time or non-recurring items);
• (iv) [________________________________].

(b) "Earn-Out EBITDA" means, for the applicable Earn-Out Period, the net income of the Business, calculated in accordance with the Accounting Principles, before deduction of:

• (i) Interest expense (net of interest income);
• (ii) Income tax expense (federal, state, and local);
• (iii) Depreciation expense;
• (iv) Amortization expense;

and further adjusted to exclude:

• (v) Any management fees, shared services charges, or corporate allocations charged by Buyer or its Affiliates in excess of the amounts set forth on Schedule [____];
• (vi) Any transaction costs, restructuring charges, or integration expenses incurred by Buyer;
• (vii) Any non-cash stock-based compensation expense;
• (viii) Any purchase accounting adjustments arising from the transactions contemplated by the Agreement;
• (ix) [________________________________].

(c) "Earn-Out Period" means each period identified in Section 3.01 during which performance is measured for purposes of determining whether an Earn-Out Payment has been earned.

Section 3.03 — Earn-Out Statement and Dispute Resolution

(a) Earn-Out Statement. Within [____] days after the end of each Earn-Out Period, Buyer shall prepare and deliver to Seller a written statement (each, an "Earn-Out Statement") setting forth Buyer's good faith calculation of the applicable performance metric for such Earn-Out Period, together with reasonable supporting detail.

(b) Access and Review. During the [____]-day period following delivery of each Earn-Out Statement (the "Earn-Out Review Period"), Buyer shall provide Seller and its Representatives with reasonable access during normal business hours to the books, records, work papers, and personnel of the Business.

(c) Earn-Out Dispute Notice. If Seller disagrees with any aspect of the Earn-Out Statement, Seller shall deliver to Buyer, within the Earn-Out Review Period, a written notice (the "Earn-Out Dispute Notice") specifying:

• (i) Each item in dispute and the dollar amount thereof;
• (ii) Seller's basis for each such dispute;
• (iii) Seller's proposed calculation of the applicable performance metric.

Any items not specifically identified in the Earn-Out Dispute Notice shall be deemed accepted by Seller.

(d) Resolution. The Parties shall negotiate in good faith for [____] days to resolve any disputes. Unresolved disputes shall be submitted to the Independent Accountant (for financial metrics) or to the dispute resolution process set forth in Part VI (for milestone-based disputes).

Section 3.04 — Payment of Earn-Out Amounts

(a) Each Earn-Out Payment, as finally determined, shall be paid by Buyer to Seller within [____] Business Days after the final determination of the applicable Earn-Out Statement, by wire transfer of immediately available funds.

(b) Each Earn-Out Payment shall be made without setoff, counterclaim, or deduction, except as expressly provided in Section 3.07.

(c) Late payments shall bear interest at the rate of [____]% per annum (or the maximum rate permitted by applicable California law, whichever is less) from the date due until paid. The California Constitution, Article XV, and Cal. Civ. Code § 1916-1 et seq. impose limitations on interest rates.

Section 3.05 — Acceleration Events

The entire unpaid Earn-Out Cap (less any Earn-Out Payments previously made) shall become immediately due and payable upon the occurrence of any of the following events (each, an "Acceleration Event"):

☐ (a) A Change of Control of Buyer or any direct or indirect parent entity of Buyer;

☐ (b) A sale of all or substantially all of the assets of the Business;

☐ (c) A merger, consolidation, or similar business combination involving the Business in which the Business is not the surviving entity;

☐ (d) A dissolution, liquidation, or winding-up of the Business;

☐ (e) A material breach by Buyer of Section 5.02 (Buyer Operational Covenants) that remains uncured for [____] days after written notice from Seller;

☐ (f) [________________________________] (additional acceleration triggers).

Acceleration Payment. Any Acceleration Payment shall be made within [____] Business Days after the occurrence of the applicable Acceleration Event, calculated as follows:

☐ (i) Full Acceleration: Payment of the Earn-Out Cap less previously paid Earn-Out Payments;

☐ (ii) Pro-Rata Acceleration: Payment based on the pro-rata achievement of the applicable performance metric through the date of the Acceleration Event, annualized for incomplete periods;

☐ (iii) Negotiated Formula: [________________________________].

Section 3.06 — Pro-Rata and Interpolated Earn-Out Payments

☐ (a) Linear Interpolation. If the applicable performance metric falls between the threshold and the target, the Earn-Out Payment shall be calculated by linear interpolation.

☐ (b) Tiered Achievement. The Earn-Out Payment shall be calculated on a tiered basis as set forth on Schedule [____].

☐ (c) All-or-Nothing. No Earn-Out Payment shall be payable unless the full target is achieved.

Section 3.07 — Right of Setoff

☐ (a) No Setoff. Buyer shall have no right to set off, recoup, or reduce any Earn-Out Payment on account of any indemnification or other claim against Seller.

☐ (b) Limited Setoff. Buyer may set off against Earn-Out Payments only amounts in respect of:

• (i) Final and non-appealable indemnification determinations under Article [____];
• (ii) Claims for which Buyer has provided Seller with an indemnification claim notice at least [____] days prior to the date such Earn-Out Payment becomes due.

☐ (c) Full Setoff. Buyer may set off against Earn-Out Payments the full amount of any pending or resolved indemnification claims, subject to the limitations set forth in Article [____].

Setoff Procedure. Any setoff shall be exercised by written notice to Seller specifying the amount and basis of the setoff. Seller may dispute any setoff per Part VI. Disputed setoff amounts shall be placed in escrow pending resolution.

CALIFORNIA PRACTICE NOTE: Under California law, setoff provisions in earn-out agreements must be drafted carefully. California courts may construe ambiguous setoff rights against the drafter under Cal. Civ. Code § 1654. Sellers should consider prohibiting setoff entirely or limiting it to final, non-appealable determinations.

PART IV: ACCOUNTING STANDARDS AND PRINCIPLES

Section 4.01 — Accounting Principles

For purposes of this Clause Pack, "Accounting Principles" means GAAP as in effect on the date of the Agreement, applied using the same accounting methods, practices, principles, policies, and procedures (including classification, judgment, and estimation methodology) used in the preparation of the Reference Financial Statements, applied on a basis consistent with the Reference Balance Sheet dated [__/__/____] (the "Reference Balance Sheet").

Section 4.02 — Hierarchy of Accounting Principles

In the event of any conflict among accounting standards, the following hierarchy shall apply:

(a) First, the specific accounting principles, methodologies, and sample calculations set forth on Schedule [____] (the "Agreed-Upon Procedures");

(b) Second, the accounting methods, practices, principles, policies, and procedures used in the preparation of the Reference Financial Statements (the "Historical Practices");

(c) Third, GAAP as in effect on the date of this Agreement.

Section 4.03 — GAAP Consistency Requirements

(a) All calculations under this Clause Pack shall be prepared in accordance with GAAP, consistently applied with the Historical Practices, and without giving effect to:

• (i) Any changes in GAAP occurring after the date of this Agreement;
• (ii) Any change in accounting methods implemented by Buyer after the Closing;
• (iii) Any purchase accounting adjustments or fair value adjustments arising from the transactions contemplated by the Agreement;
• (iv) Any new reserves or accruals not reflected in the Historical Practices;
• (v) Any write-downs or impairments of assets not consistent with Historical Practices.

(b) Non-GAAP Adjustments. The Parties acknowledge that the Agreed-Upon Procedures may include adjustments that depart from GAAP where such departures are expressly identified on Schedule [____]. In such event, the Agreed-Upon Procedures shall control.

Section 4.04 — Permitted Adjustments

The following adjustments shall be permitted in calculating Earn-Out EBITDA or Earn-Out Revenue (as applicable):

(a) Elimination of Buyer Overhead. Exclusion of any management fees, corporate allocations, or shared services charges imposed by Buyer or its Affiliates in excess of the amounts set forth on Schedule [____];

(b) Normalization of Related-Party Transactions. Adjustment of any transactions between the Business and Buyer or its Affiliates to reflect arm's-length terms;

(c) Exclusion of Non-Recurring Items. Exclusion of extraordinary, unusual, or non-recurring items;

(d) Exclusion of Purchase Accounting Effects. Exclusion of any amortization of intangible assets, inventory step-up costs, or other adjustments arising from the application of ASC 805 (Business Combinations).

PART V: EARN-OUT PROTECTIONS AND OPERATIONAL COVENANTS

Section 5.01 — Implied Covenant of Good Faith and Fair Dealing (California)

(a) California's Strong Implied Covenant. The Parties acknowledge that California law imposes a strong implied covenant of good faith and fair dealing in every contract. Under California law, there is implied in every contract a covenant of good faith and fair dealing that requires each contracting party to refrain from doing anything to prevent the other party from receiving the benefit of the bargain. See Foley v. Interactive Data Corp., 47 Cal. 3d 654 (1988); CACI No. 325 (2025 edition).

(b) Contra Proferentem Rule. Under Cal. Civ. Code § 1654, in cases of uncertainty not removed by other rules of interpretation, contract language shall be interpreted most strongly against the party who caused the uncertainty to exist. In earn-out agreements, ambiguities in the definition of financial metrics, Buyer's operational obligations, or measurement methodologies may be construed against the drafter.

(c) Application to Earn-Out — Enhanced Scrutiny. The Parties acknowledge that California courts have held that the implied covenant of good faith and fair dealing is particularly applicable where one party has discretionary power affecting the other party's contractual rights. In the earn-out context, where Buyer controls the post-closing operations that determine whether Earn-Out milestones are achieved, California law imposes a heightened obligation on Buyer to exercise its discretion in good faith and consistently with Seller's reasonable expectations.

(d) Specific California Obligations. Without limiting the generality of the foregoing, the implied covenant under California law requires that Buyer:

• (i) Not exercise discretion conferred by this Agreement in a manner that frustrates the purpose of the earn-out;
• (ii) Not take actions, or fail to take actions, with the primary purpose of reducing or avoiding Earn-Out Payments;
• (iii) Not withhold benefits of the Agreement from Seller or seek to prevent performance;
• (iv) Act consistently with the reasonable expectations of the Parties at the time of contracting.

(e) Limitation. Nothing in this Section 5.01 shall be construed to require Buyer to operate the Business in a manner that is commercially unreasonable, to the detriment of Buyer's other businesses or investments, or to subordinate Buyer's legitimate business interests solely for the purpose of maximizing Earn-Out Payments. The implied covenant does not create obligations inconsistent with the express terms of this Agreement.

CRITICAL CALIFORNIA PRACTICE NOTE: California's implied covenant of good faith and fair dealing is among the strongest in the nation. Unlike some jurisdictions (such as Texas, which limits the implied covenant to special relationships), California applies the covenant broadly to all contracts. For Buyers, this means that overly broad grants of discretion may be scrutinized under the implied covenant even if not expressly addressed in the agreement. For Sellers, this means that the implied covenant provides a meaningful backstop beyond the express operational covenants. Practitioners should draft earn-out provisions with California's heightened standard in mind and should include specific operational covenants (Section 5.02) that minimize ambiguity.

Section 5.02 — Buyer Operational Covenants

During each Earn-Out Period and for [____] days thereafter, Buyer covenants and agrees that, unless Seller provides prior written consent (not to be unreasonably withheld, conditioned, or delayed), Buyer shall:

☐ (a) Operate in Ordinary Course. Operate the Business in the ordinary course consistent with past practice and in substantially the same manner as conducted during the twelve (12) months prior to Closing;

☐ (b) Maintain Adequate Resources. Devote adequate financial, personnel, and operational resources to the Business, in a manner no less favorable than the resources devoted to the Business during the twelve (12) months prior to Closing;

☐ (c) Maintain Separate Books. Maintain separate books and records for the Business sufficient to permit the calculation of Earn-Out Revenue and Earn-Out EBITDA in accordance with the Accounting Principles;

☐ (d) Preserve Business Relationships. Use commercially reasonable efforts to preserve the relationships of the Business with customers, suppliers, vendors, licensors, and other business partners;

☐ (e) Retain Key Employees. Use commercially reasonable efforts to retain the Key Employees identified on Schedule [____] through the end of the applicable Earn-Out Period;

☐ (f) No Diversion. Refrain from intentionally diverting customers, contracts, revenue opportunities, or business lines from the Business to Buyer or any of its Affiliates for the primary purpose of reducing or avoiding Earn-Out Payments;

☐ (g) Pricing and Terms. Refrain from materially changing the pricing, terms of sale, or customer discount programs of the Business in a manner inconsistent with past practice, except as reasonably required by competitive conditions;

☐ (h) Capital Expenditures. Make capital expenditures for the Business at levels no less than the average annual capital expenditures during the [____]-year period preceding the Closing;

☐ (i) No Asset Stripping. Refrain from transferring, selling, or otherwise disposing of material assets of the Business outside the ordinary course;

☐ (j) No Unreasonable Charges. Refrain from imposing management fees, shared services charges, corporate allocations, or intercompany charges on the Business that exceed the amounts expressly agreed upon in Schedule [____];

☐ (k) Insurance. Maintain insurance coverage for the Business substantially equivalent to the coverage in effect as of the Closing Date;

☐ (l) Compliance. Operate the Business in compliance with all applicable Laws in all material respects;

☐ (m) California Employment Laws. Operate the Business in compliance with all applicable California employment laws, including but not limited to the California Labor Code, FEHA (Cal. Gov. Code § 12900 et seq.), and wage and hour requirements, which may materially affect the Business's cost structure and Earn-Out EBITDA.

Section 5.03 — Anti-Manipulation Provisions

(a) Prohibited Actions. The following actions shall constitute a breach of Buyer's obligations under this Part V if undertaken with the primary purpose of reducing or avoiding Earn-Out Payments:

• (i) Accelerating or deferring the recognition of revenue or expenses of the Business outside the ordinary course;
• (ii) Changing the fiscal year or accounting period of the Business;
• (iii) Causing the Business to enter into below-market transactions with Buyer or its Affiliates;
• (iv) Terminating or materially modifying material customer contracts without commercially reasonable justification;
• (v) Reassigning key personnel from the Business without commercially reasonable justification;
• (vi) Eliminating product lines or service offerings of the Business without commercially reasonable justification;
• (vii) Imposing unreasonable restrictions on the Business's ability to compete or pursue business opportunities.

(b) Burden of Proof. In any dispute arising under this Section 5.03, Seller shall bear the initial burden of demonstrating that Buyer's actions were taken with the primary purpose of reducing or avoiding Earn-Out Payments. If Seller makes a prima facie showing, the burden shall shift to Buyer to demonstrate a legitimate business purpose.

(c) California Bad Faith Standard. The Parties acknowledge that under California law, a breach of the implied covenant of good faith and fair dealing may give rise to contract damages. The tort of bad faith breach of the implied covenant is generally limited to the insurance context under California law. See Foley v. Interactive Data Corp., 47 Cal. 3d 654 (1988).

Section 5.04 — Reporting and Transparency

During each Earn-Out Period, Buyer shall provide Seller with:

(a) Monthly financial statements of the Business within [____] days after the end of each calendar month;

(b) Quarterly summaries of the applicable performance metric within [____] days after the end of each calendar quarter;

(c) Prompt written notice of any event that could reasonably be expected to have a material adverse effect on the Business or the achievement of any Earn-Out milestone;

(d) Such additional information as Seller may reasonably request in connection with monitoring the Earn-Out.

Section 5.05 — Remedies for Breach of Earn-Out Covenants

(a) Specific Performance. The Parties acknowledge that the Business is unique and that a breach of the covenants in this Part V would cause irreparable harm not adequately compensable in money damages. Accordingly, Seller shall be entitled to seek equitable relief, including specific performance and injunctive relief, without the necessity of proving actual damages or posting a bond (to the extent permitted by California law under Cal. Civ. Proc. Code § 526).

(b) Damages. Seller shall be entitled to recover actual damages resulting from Buyer's breach, including the amount of any Earn-Out Payment that would have been earned but for such breach.

(c) Acceleration. A material uncured breach of the covenants in this Part V shall constitute an Acceleration Event under Section 3.05(e).

PART VI: DISPUTE RESOLUTION

Section 6.01 — Independent Accountant

(a) Selection. If the Parties are unable to resolve any dispute relating to the Closing Statement or any Earn-Out Statement within the applicable Resolution Period, either Party may submit the unresolved items to a nationally recognized independent accounting firm mutually agreed upon by the Parties (the "Independent Accountant"). If the Parties are unable to agree within [____] days, either Party may request that the American Arbitration Association appoint the Independent Accountant.

(b) Scope. The Independent Accountant shall act as an expert (and not as an arbitrator) and shall determine only those items that remain in dispute. The Independent Accountant shall not assign a value to any disputed item outside the range defined by the Parties' respective positions.

(c) Procedures. Each Party shall submit to the Independent Accountant, within [____] days of engagement, a written statement of its position. The Independent Accountant shall render its determination within [____] days.

(d) Binding Effect. The determination of the Independent Accountant shall be final and binding, absent manifest error or fraud. Under California law, the distinction between an expert determination and an arbitration may affect the scope of judicial review. If the Parties intend the determination to be an expert determination (not an arbitration under Cal. Civ. Proc. Code § 1280 et seq.), the engagement letter and the Agreement should expressly so state.

(e) Fees and Expenses. The fees and expenses of the Independent Accountant shall be allocated proportionally based on the relative merit of each Party's position as described in Section 6.01 of the Alaska template above.

Section 6.02 — Arbitration

☐ (a) Arbitration of Non-Accounting Disputes. Any dispute arising under or relating to this Clause Pack that is not subject to resolution by the Independent Accountant shall be resolved by binding arbitration administered by JAMS (or the AAA) in accordance with its Comprehensive Arbitration Rules.

(b) California Arbitration Act. Arbitration under this Section 6.02 shall be governed by the California Arbitration Act, Cal. Civ. Proc. Code § 1280 et seq.

(c) Arbitrator Selection. The arbitration shall be conducted before a single arbitrator with substantial M&A experience. If the Parties cannot agree on an arbitrator within [____] days, the arbitration service shall appoint one.

(d) Location. The arbitration shall take place in [________________________________], California.

(e) Discovery. Discovery shall be limited to document production and depositions of up to [____] witnesses per side. California's expansive discovery rules under Cal. Civ. Proc. Code § 1283.05 may apply to the extent the arbitration agreement does not otherwise limit discovery.

(f) Award. The arbitrator shall issue a reasoned written award within [____] days. Judgment may be entered in any court of competent jurisdiction in California.

(g) Confidentiality. The arbitration proceedings shall be confidential except as required by law.

(h) Attorneys' Fees. The prevailing Party shall be entitled to recover its reasonable attorneys' fees and costs from the non-prevailing Party, unless the arbitrator determines otherwise. [Note: California permits contractual attorneys' fees provisions under Cal. Civ. Code § 1717, which also makes such provisions reciprocal.]

Section 6.03 — Judicial Reference

☐ (California Alternative) In lieu of arbitration, the Parties may elect to resolve disputes by general judicial reference under Cal. Civ. Proc. Code § 638, with a referee appointed by the Superior Court of [________________________________] County, California.

Section 6.04 — Injunctive Relief and Provisional Remedies

Nothing in this Part VI shall prevent either Party from seeking injunctive or other equitable relief from a court of competent jurisdiction in California to prevent irreparable harm. Under Cal. Civ. Proc. Code § 1281.8, a Party may seek provisional relief in connection with an arbitrable dispute.

PART VII: TAX TREATMENT

Section 7.01 — Tax Treatment of Purchase Price and Earn-Out

(a) Installment Sale Treatment (IRC § 453). The Parties acknowledge that the Earn-Out Payments may constitute contingent consideration under Treas. Reg. § 15a.453-1(c). Unless the Parties agree otherwise, Seller shall report the Earn-Out Payments using the installment method under IRC § 453, subject to the following:

• (i) Maximum Selling Price. If the Agreement establishes the Earn-Out Cap, it shall be treated as the maximum selling price under Treas. Reg. § 15a.453-1(c)(2);
• (ii) Fixed Period. Seller shall recover basis ratably over the payment period per Treas. Reg. § 15a.453-1(c)(3);
• (iii) No Maximum/No Fixed Period. Basis shall be recovered ratably over fifteen (15) years per Treas. Reg. § 15a.453-1(c)(4);
• (iv) Interest Charges. IRC § 453A may impose an interest charge on deferred tax on installment obligations exceeding $5,000,000 where the sales price exceeds $150,000.

(b) Characterization. The Parties shall treat all Earn-Out Payments as additional purchase price (and not as compensation for services) for all federal, state, and local tax purposes, except as required by applicable Law.

Section 7.02 — IRC § 338 Elections

☐ (a) Section 338(h)(10) Election. If the transaction is a qualified stock purchase, the Parties shall jointly make a Section 338(h)(10) election and cooperate in filing IRS Form 8023 and California Form 100 (or successor form) to reflect the election.

☐ (b) Section 338(g) Election. Buyer may, in its sole discretion, make a unilateral Section 338(g) election.

(c) Allocation. The deemed asset sale price shall be allocated per IRC § 1060 and Treas. Reg. § 1.338-6 and 1.338-7.

Section 7.03 — Purchase Price Allocation (IRC § 1060)

(a) The Purchase Price shall be allocated per IRC § 1060 and Treas. Reg. § 1.1060-1.

(b) Each Party shall file IRS Form 8594 and supplemental forms for Earn-Out Payment years.

(c) Neither Party shall take any inconsistent tax position absent a final determination under IRC § 1313(a).

Section 7.04 — Golden Parachute Payments (IRC § 280G)

(a) If any payment to a "disqualified individual" would constitute an "excess parachute payment" under IRC § 280G(b)(1):

☐ (i) Gross-Up;
☐ (ii) Cutback;
☐ (iii) Shareholder Approval per Treas. Reg. § 1.280G-1, Q&A 7.

Section 7.05 — California State Tax Considerations

(a) California Income Tax. California imposes an individual income tax with a maximum rate of 13.3% (Cal. Rev. & Tax. Code § 17041) and a corporate income tax at 8.84% (Cal. Rev. & Tax. Code § 23151), plus a minimum franchise tax of $800 (Cal. Rev. & Tax. Code § 23153). Capital gain is taxed at ordinary income rates in California — there is no separate capital gains rate for state purposes.

(b) California Sales and Use Tax. The sale of tangible personal property in connection with an asset sale may be subject to California sales tax. The occasional sale exemption under Cal. Rev. & Tax. Code § 6006.5 may apply if: (i) the seller does not hold or use the property in activities requiring a seller's permit; or (ii) the transfer constitutes a sale of substantially all property held in the business and there are fewer than three such sales within twelve months. If the seller holds a seller's permit, the exemption is generally unavailable. The statewide base sales tax rate is 7.25%, with local additions bringing the total to approximately 7.25% to 10.25% depending on location.

(c) Bulk Sale Notice. California has not adopted UCC Article 6 (Bulk Sales) but imposes a tax clearance notice requirement under Cal. Rev. & Tax. Code § 6811 et seq. Buyers should request a tax clearance certificate from the California Department of Tax and Fee Administration (CDTFA) to avoid successor liability for unpaid sales taxes.

(d) California Withholding. California imposes withholding on payments to nonresident Sellers. Under Cal. Rev. & Tax. Code § 18662, the buyer may be required to withhold 7% of the total sales price allocated to California if the seller is a nonresident.

(e) IRC § 453 Conformity. California generally conforms to federal installment sale treatment under IRC § 453, but practitioners should confirm current conformity status and any California-specific modifications.

(f) Property Tax Reassessment. If the transaction involves the transfer of real property in California, the transfer may trigger a reassessment of the property's value for property tax purposes under Cal. Rev. & Tax. Code § 60 et seq. (change in ownership). Certain exclusions may apply for transfers between parent and child (Proposition 19, effective February 16, 2021, significantly limited the prior Proposition 58/193 exclusions).

PART VIII: STATE-SPECIFIC CONSIDERATIONS — CALIFORNIA

Section 8.01 — California Contract Law and Implied Covenant

(a) One of the Strongest Implied Covenants. California recognizes one of the broadest and strongest implied covenants of good faith and fair dealing in the United States. Under California law, there is implied in every contract a covenant by each party not to do anything that will deprive the other party of the benefits of the contract. See Foley v. Interactive Data Corp., 47 Cal. 3d 654 (1988); CACI No. 325 (2025).

(b) Contract vs. Tort. In California, a breach of the implied covenant gives rise to a contract cause of action. The tort of bad faith breach of the implied covenant is generally limited to the insurance context. Foley v. Interactive Data Corp., 47 Cal. 3d 654 (1988). In M&A earn-out disputes, the claim will be contractual.

(c) Contra Proferentem. Cal. Civ. Code § 1654 provides that in cases of ambiguity, a contract shall be construed most strongly against the party who caused the uncertainty. This is particularly relevant in earn-out agreements drafted primarily by Buyer's counsel.

(d) Discretionary Powers. California courts scrutinize the exercise of discretionary powers under contracts. Where a party has discretion that affects the other party's contractual rights, the implied covenant requires that the discretion be exercised in good faith and consistently with the reasonable expectations of the parties.

(e) Key California Precedent:

• Foley v. Interactive Data Corp., 47 Cal. 3d 654 (1988) — foundational case on California's implied covenant; limited tort liability to insurance context;
• Carma Developers (Cal.), Inc. v. Marathon Development California, Inc., 2 Cal. 4th 342 (1992) — implied covenant does not impose obligations contradicting express contract terms;
• Guz v. Bechtel Nat'l, Inc., 24 Cal. 4th 317 (2000) — application of implied covenant in employment and discretionary provisions;
• Third Story Music, Inc. v. Waits, 41 Cal. App. 4th 798 (1995) — implied covenant used to protect expectation of receiving royalties, analogous to earn-out protections.

Section 8.02 — Statute of Limitations

(a) The statute of limitations for breach of a written contract under California law is four (4) years (Cal. Civ. Proc. Code § 337).

(b) The statute of limitations for breach of an oral contract under California law is two (2) years (Cal. Civ. Proc. Code § 339).

(c) The limitations period generally commences upon the occurrence of the breach. For earn-out disputes, this is typically when the Earn-Out Payment becomes due or when the breach of an operational covenant is discovered.

(d) Delayed Discovery Rule. California applies a delayed discovery rule that may toll the statute of limitations until the plaintiff discovers or should have discovered the facts constituting the breach.

Section 8.03 — Choice of Law Considerations

(a) California courts generally enforce choice-of-law provisions, subject to certain limitations. Under Cal. Civ. Code § 1646.5, parties to a contract relating to a transaction involving an aggregate consideration of at least $250,000 may agree that the contract shall be governed by the law of California.

(b) California courts may refuse to enforce a choice-of-law provision if: (i) the chosen state has no substantial relationship to the transaction; (ii) application of the chosen law would be contrary to a fundamental California policy; and (iii) California has a materially greater interest in the determination of the issue. See Washington Mutual Bank, FA v. Superior Court, 24 Cal. 4th 906 (2001).

(c) California's strong implied covenant of good faith and fair dealing may be considered a fundamental public policy that California courts will not permit the parties to evade through a choice-of-law provision selecting a jurisdiction with a weaker implied covenant.

Section 8.04 — California Arbitration Framework

(a) California has adopted the California Arbitration Act at Cal. Civ. Proc. Code § 1280 et seq.

(b) Under Cal. Civ. Proc. Code § 1286.2, a court shall vacate an arbitration award if: the award was procured by corruption, fraud, or other undue means; there was corruption in any of the arbitrators; or the rights of a party were substantially prejudiced by misconduct of a neutral arbitrator.

(c) California courts have broad authority to review arbitration awards that exceed the arbitrator's powers.

(d) Under Cal. Civ. Proc. Code § 1281.8, a party to an arbitration agreement may petition a court for provisional relief, including temporary restraining orders and preliminary injunctions.

PART IX: PRACTICE NOTES AND DRAFTING GUIDANCE

Section 9.01 — Key Drafting Considerations

☐ Define All Financial Metrics Precisely. Ambiguity in the definition of Revenue or EBITDA is the single greatest source of earn-out disputes. Under California's contra proferentem rule (Cal. Civ. Code § 1654), ambiguities may be construed against the drafter — typically Buyer. Include detailed calculation methodologies, sample calculations, and a reference balance sheet.

☐ Specify the Efforts Standard. Specify "commercially reasonable efforts," "reasonable best efforts," or "best efforts." In Himawan v. Cephalon, Inc., C.A. No. 2021-0459-LWW (Del. Ch. Apr. 30, 2024), the court held that "commercially reasonable efforts" is measured objectively. In Airborne Health, Inc. v. Squid Soap, LP, C.A. No. 4410-VCL (Del. Ch. 2010), the court found no obligation to spend minimum amounts where the agreement did not expressly require it.

☐ Address California's Strong Implied Covenant. Because California applies a robust implied covenant, Buyers should include express provisions limiting obligations and confirming Buyer's right to exercise business judgment. Sellers should resist overly broad disclaimers that could be deemed to waive the implied covenant, as California courts may not enforce such waivers.

☐ Address Common Manipulation Scenarios. Expressly address revenue shifting, acceleration or deferral of revenue recognition, changes in pricing, management fee and cost allocation, and asset transfers.

☐ Coordinate with Indemnification. Determine whether setoff is permitted.

☐ Tax Planning. California taxes capital gain at ordinary income rates (up to 13.3%). Plan accordingly.

☐ Security for Payment. Consider requiring Buyer to establish an escrow or letter of credit.

Section 9.02 — California-Specific Practice Considerations

☐ Capital Gain Tax Rate. California does not provide a preferential tax rate for capital gains. Individual Sellers face a maximum combined federal and state rate of approximately 37% (federal, including NIIT) plus 13.3% (California), for a combined rate that can exceed 50%.

☐ Property Tax Reassessment. If real property is involved, consider the impact of reassessment under Proposition 19 (effective February 16, 2021).

☐ Sales Tax on Asset Sales. Confirm whether California sales tax applies to the transfer of tangible personal property and whether the occasional sale exemption is available.

☐ CDTFA Tax Clearance. Obtain a tax clearance certificate from the CDTFA to avoid successor liability.

☐ Nonresident Withholding. If Seller is a nonresident, confirm the 7% withholding obligation under Cal. Rev. & Tax. Code § 18662.

☐ Employment Law Impact. California's extensive employment law framework (including meal and rest break requirements, overtime rules, and the ABC test for independent contractor classification under AB 5) may materially affect the Business's cost structure. Consider how these requirements interact with the Earn-Out EBITDA calculation.

☐ Attorneys' Fees. Under Cal. Civ. Code § 1717, a contractual attorneys' fees provision is made reciprocal. If the Agreement provides that one Party may recover attorneys' fees, the other Party is also entitled to recover fees if it prevails.

Section 9.03 — Due Diligence Checklist for Earn-Out Provisions

☐ Historical financial statements for the applicable measurement period
☐ Sample working capital calculations and reference balance sheet
☐ Customer concentration analysis
☐ Key employee identification and retention risk assessment
☐ Pending or threatened litigation
☐ Material contracts with change-of-control provisions
☐ Insurance policies and coverage adequacy
☐ Capital expenditure history and requirements
☐ Related-party transaction analysis
☐ Tax structure analysis (S corp, C corp, partnership, LLC)
☐ California sales tax and CDTFA clearance status
☐ California employment law compliance review
☐ Real property reassessment risk analysis

PART X: DEFINITIONS

Section 10.01 — Selected Definitions

"Acceleration Event" has the meaning set forth in Section 3.05.

"Accounting Principles" has the meaning set forth in Section 4.01.

"Affiliate" means, with respect to any Person, any other Person that directly or indirectly controls, is controlled by, or is under common control with, such Person.

"Business" means [________________________________].

"Business Day" means any day other than a Saturday, Sunday, or day on which commercial banks in Los Angeles, California are authorized or required to be closed.

"Cash" means cash and cash equivalents of the Company as of the Effective Time, net of outstanding checks issued but not yet cleared, and including deposits in transit.

"Change of Control" means (i) any merger, consolidation, or similar transaction in which the equityholders of Buyer immediately prior to such transaction hold less than [____]% of the voting securities of the surviving entity, (ii) any sale of all or substantially all of the assets of Buyer, or (iii) any transaction in which a Person or group acquires beneficial ownership of more than [____]% of the outstanding voting securities of Buyer.

"Closing Indebtedness" means, without duplication, all outstanding: (i) indebtedness for borrowed money; (ii) obligations under capital leases; (iii) drawn and undrawn letters of credit; (iv) deferred purchase price obligations (other than trade payables in the ordinary course); (v) guarantees of the foregoing; (vi) accrued and unpaid interest; and (vii) prepayment premiums, penalties, and breakage costs payable at Closing.

"Company" means [________________________________].

"Effective Time" means 11:59 p.m. (Pacific Time) on the Closing Date (or such other time as the Parties may agree).

"Independent Accountant" has the meaning set forth in Section 6.01.

"Key Employees" means the individuals listed on Schedule [____].

"Net Working Capital" means, as of any date of determination, the Current Assets of the Company minus the Current Liabilities of the Company, calculated per the Accounting Principles and Schedule [____], excluding Cash, Closing Indebtedness, and Transaction Expenses.

"Person" means any individual, corporation, partnership, limited liability company, trust, governmental authority, or other entity.

"Representatives" means, with respect to any Person, such Person's officers, directors, managers, members, partners, employees, agents, advisors, and other representatives.

"Transaction Expenses" means, without duplication, all fees, costs, and expenses incurred in connection with the transactions contemplated by this Agreement, to the extent unpaid as of the Closing, including: (i) professional advisory fees; (ii) change-in-control and transaction bonuses; (iii) employer payroll taxes on such payments; (iv) IRC § 280G gross-up amounts; and (v) [________________________________].

SOURCES AND REFERENCES

1. California Statutes:
   - Cal. Civ. Code § 1654 (Contract Interpretation Against Drafter)
   - Cal. Civ. Code § 1655 (Stipulations Implied by Law)
   - Cal. Civ. Code § 1717 (Reciprocal Attorneys' Fees)
   - Cal. Civ. Proc. Code § 337 (Statute of Limitations — Written Contracts)
   - Cal. Civ. Proc. Code § 339 (Statute of Limitations — Oral Contracts)
   - Cal. Civ. Proc. Code § 526 (Injunctive Relief)
   - Cal. Civ. Proc. Code § 638 (Judicial Reference)
   - Cal. Civ. Proc. Code § 1280 et seq. (California Arbitration Act)
   - Cal. Civ. Proc. Code § 1281.8 (Provisional Relief in Arbitration)
   - Cal. Com. Code § 1304 (Obligation of Good Faith — UCC)
   - Cal. Rev. & Tax. Code § 6006.5 (Occasional Sale Exemption)
   - Cal. Rev. & Tax. Code § 6811 et seq. (Bulk Sale / Tax Clearance)
   - Cal. Rev. & Tax. Code § 17041 (Individual Income Tax Rates)
   - Cal. Rev. & Tax. Code § 18662 (Nonresident Withholding)
   - Cal. Rev. & Tax. Code § 23151 (Corporate Income Tax Rate)
   - Cal. Rev. & Tax. Code § 60 et seq. (Change in Ownership / Property Tax)

2. Federal Tax Authorities:
   - IRC § 280G, § 338, § 453, § 453A, § 1060, § 4999
   - Treas. Reg. § 1.280G-1; § 1.338-4 through 1.338-7; § 1.1060-1; § 15a.453-1(c)
   - IRS Publication 537

3. Accounting Standards:
   - ASC 805 (Business Combinations)
   - ASC 480-10 (Distinguishing Liabilities from Equity)

4. Key Case Law:
   - Burnet v. Logan, 283 U.S. 404 (1931) (open transaction doctrine)
   - Foley v. Interactive Data Corp., 47 Cal. 3d 654 (1988) (California implied covenant)
   - Carma Developers v. Marathon Development, 2 Cal. 4th 342 (1992) (implied covenant limitations)
   - Guz v. Bechtel Nat'l, Inc., 24 Cal. 4th 317 (2000) (implied covenant in discretionary provisions)
   - Third Story Music, Inc. v. Waits, 41 Cal. App. 4th 798 (1995) (protecting contractual royalty expectations)
   - Himawan v. Cephalon, Inc., C.A. No. 2021-0459-LWW (Del. Ch. Apr. 30, 2024) (commercially reasonable efforts)
   - Airborne Health, Inc. v. Squid Soap, LP, C.A. No. 4410-VCL (Del. Ch. 2010) (earn-out obligations)
   - CACI No. 325 (2025) (Breach of Implied Covenant — Essential Factual Elements)

5. Secondary Sources:
   - ABA Business Law Today, "The Ins and Outs of Earn-Outs: A Delaware Perspective" (March 2022)
   - Byron F. Egan, "Earnouts in M&A Transactions," Jackson Walker LLP (2020)
   - Proposition 19 (California, effective February 16, 2021)

This template is provided by ezel.ai for informational purposes only and does not constitute legal advice. It must be reviewed and customized by a qualified attorney licensed in California before use. Laws and regulations change frequently; verify all citations before relying on them.