Two spreadsheets, two honest readings of the same numbers, one very expensive disagreement — the earn-out dispute pattern that recurs most often has nothing to do with bad faith and everything to do with an agreement that never said whose accounting policy actually governs.
Key takeaways
An earn-out dispute almost never starts with someone accusing the other side of lying. It starts with two people applying two different, individually defensible accounting judgment calls to the same set of facts, and discovering the agreement never said which judgment call wins.
A treadstonelaw.ca note on post-closing disputes names the actual battleground directly: “the fights are about accounting policy: whether a receivable is collectible, how inventory is valued, whether an accrual should have been booked.” What decides the outcome is not who is right in the abstract, but “which accounting policies apply, and which prevails when the specified policies conflict with GAAP” — and “that conflict is where most true-up money is won and lost.” An earn-out clause that says only “calculated in accordance with GAAP, consistently applied” has not actually answered the question, because GAAP itself permits more than one defensible treatment of most of the line items in dispute.
A companion treadstonelaw.ca article on earn-out disputes lists where these disagreements concentrate: “disagreement over accounting methods used to calculate the earn-out metric (revenue recognition, allocated costs, one-time items)” and “ambiguity in how the purchase agreement actually defines the target or the measurement period.” Revenue recognition timing alone — when a sale actually counts — can move a measured EBITDA meaningfully in either direction depending on which policy a buyer applies after closing.
The same source names the underlying tension precisely: a buyer “changes pricing, product lines, or service offerings in ways that depress the metrics the earn-out is measured against.” And the post-closing note is blunt about which kind of dispute actually dominates: earnouts “produce the ugliest fights, and almost always about how the business was run after closing rather than about arithmetic” — because “once the deal closes, the buyer runs the business — pricing, staffing, marketing spend, product mix, which customers to prioritize — while the seller remains financially exposed to those operational decisions without input.”
Treadstonelaw.ca notes that Canadian law requires contractual discretion to be exercised honestly and in good faith — but is equally direct that demonstrating a breach of that duty “is far harder and far more expensive than drafting around it.” The practical lesson for a fund principal on either side of the table: don’t rely on the general duty of good faith to police a buyer’s post-close discretion. Write the specific operating covenants instead.
Where a genuine disagreement does arise, the standard mechanic is “referral of financial disputes to an independent accountant, or arbitration or litigation for broader disputes.” Sellers are protected furthest upstream of any of that by “covenants requiring the buyer to operate the business in good faith, in the ordinary course, or without taking actions specifically intended to reduce the earn-out payment” — language that gives the independent accountant something concrete to apply, rather than asking them to adjudicate reasonableness from scratch.
Where to specify the accounting policy before signing
Whatever the accounting-policy dispute ultimately resolves the payment amount to be, the tax timing question is separate. ITA s. 40(1)(a)(iii) lets a vendor claim a reserve on proceeds payable after the year of disposition, capped at the lesser of a reasonable reserve and 1/5 of the gain multiplied by the years remaining in an ordinary five-year maximum spread. That formula runs on when the proceeds are actually payable, not on which accounting policy determined how much they turn out to be — two genuinely separate questions that a first-time seller often conflates.
A worked example. A share purchase agreement sets the earn-out at 1× the target’s Adjusted EBITDA above $2,000,000 in year one, “calculated per the Company’s historical accounting policies.” Post-close, the buyer’s finance team recognizes a class of service revenue on contract completion rather than on the milestone basis the target used pre-closing — a change that pushes roughly $180,000 of revenue, and the margin attached to it, into the following fiscal year. Measured EBITDA for year one comes in $95,000 lower than it would have under the historical policy. Because the agreement named “historical accounting policies” specifically, the seller refers the dispute to an independent accountant under the named referral mechanic, who restates year one on the milestone basis and confirms the $95,000 belongs in the earn-out calculation — a result the agreement’s own drafting made straightforward to reach, not a result that depended on proving the buyer acted in bad faith.
Not necessarily — GAAP itself permits more than one defensible treatment of the specific items that recur in these disputes (revenue recognition, inventory valuation, accrual timing). The agreement needs to say which policy applies and which prevails on conflict, not just cite GAAP generally.
Referral of the financial dispute to an independent accountant, or arbitration or litigation for broader disputes — supported by covenants requiring good-faith, ordinary-course operation. It is not automatically a lawsuit for bad faith, which is genuinely hard and expensive to prove. See choosing the metric an earn-out is measured on for how the metric itself changes this exposure.
No — the reserve runs on the proceeds actually payable after the year of disposition, per its own statutory formula. It is a separate timing question from whatever accounting policy determines the dollar amount owed.
A short call walks through where your specific SPA language leaves the accounting policy ambiguous.
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