UK: Meaning Of "Diligently", "Actively" And "Consent Not To Be Unreasonably Withheld"

Last Updated: 16 January 2012
Article by Mark Alsop

(1) Porton Capital Technology Funds (2) Porton Capital Inc (3) Ploughshare Innovations Ltd v (1) 3M Holdings Ltd (2) 3M Company [2011] EWHC 2895

This case involved Acolyte Biomedica Limited which had developed a diagnostic assay used to detect MRSA. At the relevant time, the product had been fully approved for sale throughout the EU, but not the US or Canada.

In February 2007, 3M acquired the entire share capital of Acolyte pursuant to a share purchase agreement (SPA). The claimants were some of the vendors under the SPA, whose shareholdings represented 60.4%.

The consideration for the shares was an initial sum of £10.4million in cash, with an additional earn out payment based on net sales for the calendar year 2009. As is customary with earn out arrangements, the SPA contained certain express contractual obligations on the part of 3M intended to protect the Vendors' position. These included an obligation to diligently seek regulatory approval for the product in the US and Canada and an obligation to actively market the product.

The Acolyte's business was not successful however, and 3M decided to shut it down in late 2008, meaning there were no net sales in 2009. In accordance with the SPA, 3M sought the Vendors' consent to the cessation of the business and offered them a compensation payment of US$1.07 million in lieu of the loss of earn out.

The Vendors refused to give their consent unless they received the maximum potential earn out sum (which they estimated to be around £32 million). They also claimed that 3M was in breach of its contractual obligations under the SPA.

3M contended that it had always acted in good faith and in accordance with the SPA; that it was entitled to terminate the business in circumstances where it had requested consent and offered compensation and the Vendors had acted unreasonably in withholding their consent; and in any event, sales of the product in 2009 would only ever have been at a very low level.

The principal matters the court had to decide were, inter alia:

  • whether 3M was in breach of its contractual obligation diligently to seek regulatory approval for the product in the US and Canada;
  • whether 3M was in breach of its contractual obligation actively to market the product;
  • whether the Vendors had acted unreasonably in withholding their consent from 3M to terminate the business in late 2008;
  • how much the net sales of the product would have been in 2009 had 3M performed its obligations under the SPA and the business had continued throughout that year.

The High Court held that:

  • "diligently" in the context of the obligation to seek regulatory approval meant with reasonable application, industry and perseverance and did not involve any distinct requirement of reasonable care. On the facts, the initial conduct of the US trials involved no breach of the obligation diligently to seek regulatory approval. The initial trials produced poor results and had to be stopped in March 2008 to investigate the cause of the problems. However, the court found that the trials could have been continued after such investigation and had they done so, regulatory approval in the US would have been obtained by the beginning of February 2009. 3M was therefore in breach of the obligation from the end of March 2008 when it stopped the trials.
  • in relation to the obligation to market actively, the dictionary definition of the word "actively" was "characterised by action" and said this meant more than simply the taking of some active marketing steps. 3M's marketing efforts, when viewed overall, had to show it was acting in good faith with a view to marketing the product successfully in pursuit of the common commercial interest of both parties. On the facts, 3M was in breach of this obligation from various dates in respect of the various continents.
  • with regard to the claim that the Vendors unreasonably withheld their consent to the cessation of the business, the burden of proof fell on 3M. The Vendors did not need to show that their refusal was right or justified, only that it was reasonable. They were entitled to have regard to their own interests in maximising the earn out payment and they were not required to balance their own interests against those of 3M. The court considered the fact that the earn out payment was contemplated by the parties as being the principal part of the consideration and that the Vendors had little knowledge of and no involvement in the business following 3M's acquisition of Acolyte. Given that, at the time of the sale of Acolyte, there was a mutual belief amongst the parties that 2009 sales would be in the region of US$28 million, the court felt it was reasonable for the Vendors to be considerably surprised to be offered a compensatory payment of US$1.07million, and it was reasonable for them to suspect that the failure of the business was contributed to by 3M's breaches of the SPA. In the circumstances, the Vendors had not unreasonably withheld their consent.
  • the Vendors' claim was for lost profits for breach of contract. On the evidence presented to the court relating to the product's performance and suitability to the market, it would never have been a commercial success and future sales would have been limited, even if 3M had not breached the contractual obligations in the SPA. It was found that the total net sales for 2009 which would have been achieved had the SPA not been breached, were US$2,152,000 and the Vendors share therefore equated to $1,299,808.

This is an interesting case on the operation of earn out provisions post-completion. Usually, where there is an earn out, the vendors will continue to be involved with the target or its business after completion, for example they may remain on as employees. This was not so with this case, which highlights the vulnerability of the vendors to the buyer in an earn out situation (given the buyer may take steps after completion which have the effect of artificially reducing the earn out) and the importance of including tightly drafted restrictions on the buyer during the earn out period. It also shows how difficult it can be for a purchaser to close down a business if there are earn out provisions, even if the business is performing badly and losing money.

Note also the findings on the meanings of "diligently", "actively" and "consent not to be unreasonably withheld".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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