Earn‑outs are supposed to bridge valuation gaps. In practice, they often create them.

A recent North Carolina Business Court decision, Child Care Inc. v. LJ Schools (Carolina), Inc., 2026 NCBC 8, is one of the clearest judicial statements in years on how courts will treat earn‑out provisions that grant the buyer discretion over post‑closing calculations.

The message is direct and uncomfortable for sellers:

If you agree to “sole discretion” in an earn‑out, courts are likely to enforce it exactly as written.

Below are the key lessons from the decision and why it matters for anyone drafting, negotiating, or approving M&A agreements.

The Dispute in Plain English

The transaction involved the sale of multiple childcare centers. The purchase price included an earn‑out tied to post‑closing EBITDA.

The agreement gave the buyer:

  • Sole discretion to determine the variables used in calculating EBITDA
  • Authority to classify certain revenue as “non‑recurring”
  • An earn‑out formula governed by an entire agreement clause

During the earn‑out period, the buyer received COVID‑era government grants under the American Rescue Plan Act. The buyer classified some of those grants as non‑recurring revenue, which materially reduced EBITDA and eliminated the earn‑out payment.

The sellers sued, arguing that:

  1. The buyer’s discretion rendered the earn‑out illusory
  2. The buyer exercised discretion in bad faith
  3. The grants should have counted toward EBITDA

The Business Court rejected all three arguments and entered summary judgment for the buyer.

The Court’s Core Holding

The court held that:

  • A contract granting a party sole discretion over earn‑out inputs is enforceable
  • Such discretion is limited only by the implied covenant of good faith and fair dealing
  • A disagreement over accounting treatment does not equal bad faith
  • Courts will not rewrite negotiated earn‑out provisions to save a disappointed seller

In other words, “good faith” is not a fairness override. It is a narrow constraint against dishonesty or arbitrariness, not a tool to rebalance economics after the fact.

Why This Case Matters More Than It Looks

This decision is not just about childcare centers or pandemic grants. It is about risk allocation.

Earn‑outs are one of the few places where post‑closing control and economics collide. This case confirms that courts will enforce the allocation of that risk when it is clearly expressed, even if the outcome is harsh.

For deal lawyers, that has real consequences.

Key Takeaways for Buyers

If you represent buyers, this case is quietly powerful.

  1. “Sole discretion” still means something. Courts are willing to enforce discretionary earn‑out language, even when it results in a zero payout.
  2. Entire‑agreement clauses matter. The court refused to consider negotiation history or seller expectations. What mattered was the four corners of the agreement.
  3. Good faith is not a veto. As long as the buyer used a rational, text‑based interpretation and did not act dishonestly, the court would not second‑guess the result.

Practice tip: If discretion is important, say so explicitly. Pair it with clear merger language and avoid side letters or informal assurances that contradict the text.

Key Takeaways for Sellers

For sellers, the lesson is sharper.

  1. Good faith is not protection. Courts treat the implied covenant as a backstop, not a substitute for negotiated terms.
  2. Undefined terms are dangerous. “Non‑recurring revenue” sounded reasonable until it became decisive. Undefined accounting concepts will almost always favor the party with discretion.
  3. Earn‑outs are not price guarantees. They are contingent compensation. Courts will enforce that contingency.

Practice tip: If the earn‑out matters, sellers must negotiate:

  • Objective accounting standards
  • Specific inclusions and exclusions
  • Caps, floors, or examples
  • Audit or dispute‑resolution mechanics

Absent those protections, sellers are betting on the buyer’s business judgment and goodwill.

A Broader Trend in Business Court Decisions

This case fits within a broader pattern in the North Carolina Business Court and elsewhere:

  • Courts increasingly favor contractual certainty over equitable adjustment
  • Sophisticated parties are expected to live with the risks they negotiate
  • Judges are reluctant to turn earn‑out disputes into accounting second‑guessing exercises

For transactional lawyers, that trend should influence how earn‑outs are discussed with clients. Earn‑outs are often sold as compromise tools. In reality, they are risk‑shifting devices, and courts will treat them that way.

Final Thought

The most important lesson from Child Care Inc. is not about EBITDA or pandemic grants. It is about drafting discipline.

Earn‑outs do not fail because courts are hostile to sellers. They fail because the agreement does exactly what it says it does.

If you want fairness, negotiate it. If you want discretion, own it. And if your agreement states “sole discretion,” do not expect a court to rewrite it later.

LEGAL DISCLAIMER

The information herein is not legal advice. The information is in the form of legal education and is intended to provide general information about the matter discussed.  The above is not, nor is it intended to be, legal advice and does not create an attorney/client relationship.  Consult your attorney with questions.