United States District Court, S.D. New York
OPINION AND ORDER
would the executives (and former principals) of a
paddle-board division of a sports and recreation company
cause the company to make a one-time $60, 500 purchase of one
million stickers that the executives themselves immediately
attempted to repurchase from the company for approximately $4
million? The answer is that they thereby hoped to stick the
company with a $10 million "earnout" payment to the
executives, thus netting themselves a cool $6 million.
Thanks, however, to the age-old doctrine of good faith and
fair dealing, and similar legal protections, in the end it is
these executives who are stuck.
the Court are the motions, and cross-motions for summary
judgment of plaintiff Vista Outdoor Inc. ("Vista")
and defendants Reeves Family Trust, Michelle Wilkens, Jeremy
Wilkens, and Kyle Reeves. The crux of the dispute is whether
defendants, two of whom were formerly employed by Vista,
improperly entered self-dealing transactions to hit profit
targets and thereby receive compensation known as an
"earnout." Vista blocked the transactions before
they could be finalized. For the reasons set forth below, the
Court grants partial summary judgment for Vista imposing a
declaratory judgment that the attempted transactions were not
an appropriate means for Jeremy Wilkens, Michelle Wilkens,
and the Reeves Family Trust to generate profits for the
purposes of satisfying the earnout (Count I), and holding
further that defendants Jeremy Wilkens and Michelle Wilkens
breached the implied covenant of good faith and fair dealing
by attempting to enter such transactions (Count IV), that
Kyle Reeves tortuously interfered with the parties'
contract by intentionally procuring the breach by Michelle
Wilkens and Jeremy Wilkens (Count V), and that defendants
Reeves Family Trust, Michelle Wilkens, and Jeremy Wilkens are
in breach of Section 2.5 of the parties' Purchase
Agreement (Count VI). The Court also grants partial summary
judgment for defendants holding that the Reeves Family Trust
did not breach the covenant of good faith and fair dealing,
and otherwise grants summary judgment to both sides
dismissing the remaining claims and counterclaims.
collectively, these rulings dispose of all of the claims,
this Opinion and Order also directs the parties to submit
proposed calculations of prejudgment interest so that final
judgment may be promptly entered.
basic facts are not in dispute. Plaintiff Vista is a public
company specializing in outdoor sports and recreation
products. Vista Outdoors's Local Rule 56.1 Statement of
Undisputed Material Facts in Support of its Motion for
Summary Judgment ("PL's R. 56.1 Statement") at
¶¶ 1-3, ECF No. 73.On July 20, 2015, Vista acquired
Jimmy Styks, a manufacturer of stand-up paddle-boards
("SUPs"), cofounded by defendants Kyle Reeves and
Jeremy Wilkens. Id. at ¶¶ 40-41. Since
defendant Reeves was not personally an owner of Jimmy Styks,
he did not sign the agreement memorializing the acquisition
(the "Purchase Agreement"). Id. at
¶¶ 42-44, 47-49, 84. Instead, Vista signed the
Purchase Agreement with defendants Jeremy Wilkens and
Michelle Wilkens, husband and wife, and the Reeves Family
Trust, a Canadian irrevocable trust whose sole trustee is
defendant Reeves' mother. Id.
Purchase Agreement contains what is known as an
"earnout, " which defendants concede was designed
to allow Vista to "acquire Jimmy Styks by paying the
full value of the company in two parts." See
Wilkens Decl. at ¶ 11, ECF No. 64; see also
Reeves Decl. at ¶ 2, ECF No. 61 ("An earn-out was a
significant part of the consideration for the
acquisition."). As the Second Circuit has explained, an
"earnout permits parties to conclude a merger without
first agreeing as to the proper valuation of the target
company." Sec. Plans, Inc. v. CUNA Mut. Ins.
Soc, 769 F.3d 807, 810 (2d Cir. 2014). Instead,
"[t]hrough a contingent payment structure, the parties
agree to disagree and defer the ultimate valuation question
until a later point in time when the uncertainties with
respect to valuation have been resolved." Id.
to this arrangement, Vista paid defendants $40 million at
closing, and agreed to pay up to $40 million in additional,
contingent consideration if Jimmy Styks met or exceeded
targets during the three years after the acquisition.
PL's R. 56.1 Statement at ¶¶ 43-44, 47-49, 84.
For "year one, " defendants would receive a
baseline $1 million payment if gross profits equaled $9, 947,
684, with the potential payout increasing as gross profits
rose. Id. at ¶¶ 50-54. The year one
earnout reached a maximum of $10 million if gross profits
equaled or exceeded $12, 434, 605. Id. The Purchase
Agreement further specified that the parties will measure
gross profits using "generally accepted accounting
principles . . ., as applied by [Vista]." Fortney Decl.
Ex. 3 at 5, 7.
acquisition, issues arose as Vista worked to integrate Jimmy
Styks into its business. Vista hired defendants Reeves and
Wilkens, PL's R. 56.1 Statement at ¶¶ 114-117,
but in 2016, Jimmy Styks' two largest customers reduced
their anticipated orders. Id. at ¶¶
154-167. Vista further admits that it did a "poor"
job integrating Jimmy Styks into its larger corporate
structure, id. at ¶¶ 140-147, but alleges
(though it is not undisputed) that defendants Reeves and
Wilkens exacerbated these problems by repeatedly taking
combative stances with Vista's management in
profanity-laden emails. See id. at ¶¶ 124,
150, 153, 349. Regardless, it is undisputed that over the
course of year one, it became clear that an earnout payment
based on anticipated orders was unlikely. Id. at
defendants Reeves and Wilkens developed a plan to
"buy" the earnout. Id. at ¶¶
152, 199, 268. Defendants first considered purchasing a
sufficient number of fins, screws, or t-shirts from Jimmy
Styks to trigger the payment. Id. at ¶¶
197-198, 200. They ultimately settled on stickers because
they yielded the best profit margin. Id. at
¶¶ 201-203, 226. In April 2016, defendant Reeves
placed an order on behalf of (and billable to) Vista for one
million stickers, to be rush delivered to Jimmy Styks'
California office rather than Vista's distribution center
near Kansas City (which was the primary distribution center
for Jimmy Styks SUPs). Id. at ¶¶ 205-213,
222-223. Upon learning that the stickers were ready, Reeves
then emailed Wilkens stating: "Haha, this is real dude!
60k worth of stickers!!! We are going to go down in the
history books . . ." Id. at ¶
Defendant Wilkens later testified that he was
"sure" purchasing the stickers "would have
raised flags" within Vista, and had hoped that
"organic sales" would be sufficient to obtain the
earnout payment. Id. at ¶¶ 269-270.
extent that Jimmy Styks had previously distributed stickers
to its customers, it had provided them gratis. Id.
at ¶¶ 227-230. Nonetheless, on June 22, 2016, seven
business days prior to the end of the 2016 earnout period,
defendants attempted to purchase from Jimmy Styks
approximately 900, 000 stickers at $3.99 or $4.99 per sticker
for a total price of just under $4 million. Id. at
¶¶ 244, 251. Specifically, defendant Reeves
submitted three purchase orders on behalf of the Reeves
Family Trust, even though he was not the trustee and had no
authorization, id. at ¶¶ 251-256, and
defendant Jeremy Wilkens submitted three purchase orders on
his own behalf, id. at ¶ 251.
however, blocked the transaction, fired Reeves and Wilkens,
and filed a six-count complaint alleging, inter
alia, that defendants' attempted sticker purchase
breached the implied covenant of good faith and faith dealing
(Count IV), and that defendant Reeves tortuously interfered
with the Purchase Agreement by causing the other
defendants' breach (Count V). Id. at
¶¶ 253, 354-355, 362. Defendants answered with six
counterclaims, including that Vista blocked the transaction
in bad faith (Counterclaim III) and fired defendants in
violation of state and federal whistleblower laws
(Counterclaims IV-VI). Id. at ¶ 363. Vista
subsequently withdrew Counts II and III of its complaint.
See ECF No. 80. Vista now moves the Court to grant
summary judgment in its favor on Counts I, IV, V, and VI and
to dismiss defendants' counterclaims in their entirety.
Defendants cross-move for summary judgment in their favor on
Counterclaim III and to dismiss Vista's claims in their
Court begins with whether Vista is entitled to a declaratory
judgment that the sticker transactions were not an
appropriate means to generate gross profits for the purposes
of the earnout because defendants Michelle Wilkens, Jeremy
Wilkens, and the Reeves Family Trust attempted to enter the
transactions in breach of the implied covenant of good faith
and fair dealing (Counts I and IV, respectively). Under New
York law, "implicit in every contract is a covenant of
good faith and fair dealing which encompasses any promises
that a reasonable promisee would understand to be
included." N.Y. Univ. v. Continental Ins. Co.,
662 N.E.2d 763, 769 (N.Y. 1995) (citations omitted). Pursuant
to this principle, "neither party shall do anything
which will have the effect of destroying or injuring the
right of the other party to receive the fruits of the
contract." Sec. Plans, 769 F.3d at 817.
is no genuine dispute that the sticker purchase would have
defeated the purpose of the earnout. Defendants admit that
the earnout is not incentive compensation linked to one
year's profits. Instead, it reflects Jimmy Styks'
"full value" at the time of the acguisition.
See Wilkens Decl. at ¶ 11; Reeves Decl. at
¶ 2. If Jimmy Styks hit certain targets during the three
years after the acguisition, Vista agreed to pay up to $40
million on the assumption that the company was more valuable
than the parties anticipated. See Sec. Plans, 769
F.3d at 810.
parties would understand that this arrangement makes economic
sense only if Jimmy Styks generates its sales in the ordinary
course of its business. As noted, for year one, Vista agreed
to pay defendants $1 million if gross profits reached $9,
947, 684 and an additional $3.62 in compensation for every $1
in gross profits thereafter (up to a maximum earnout of $10
million). While Vista would technically "lose"
$2.62 for every $1 in gross profit over the threshold, Vista
in reality would suffer no detriment because the value of
Jimmy Styks as a company would increase simultaneously.
PI.'s R. 56.1 Statement at ¶¶ 104-106. This is
because past profits, when generated in a predictable way,
are likely to be repeated as future profits. Id. By
artificially increasing Jimmy Styks profit during a critical
period following the acquisition, defendants overstated the
"full value" of the company and caused Vista to
overpay to the tune of $10 million.
terms of the Purchase Agreement support this understanding.
Section 3.7(c) includes a representation by defendants that
Jimmy Styks' "accounts receivable . . . have arisen
from bona fide transactions entered ... in the ordinary
course of business consistent with past practice
(emphasis added)." Accordingly, if defendants had made
their $4 million sticker purchase prior to the acquisition,
these profits would not have counted toward Jimmy Styks'
overall valuation. No reasonable party would believe that
such purchases would count after the acquisition, given that
they are no more reflective Jimmy Styks' "full
value" after the purchase than before. Defendants
respond that the sticker transactions are permissible because
the profits from the sales would have been recognizable under
GAAP. There is no dispute that the Purchase Agreement
measures Jimmy Styks' gross profits using "generally
accepted accounting principles . . ., as applied by
[Vista]." Defendants, however, conflate GAAP with the
distinct issue of whether the defendants acted in bad faith
by arbitrarily and materially boosting
Jimmy Styks' revenue. Cf. United States v.
Rigas, 490 F.3d 208, 220 (2d Cir. 2007) (citing
United States v. Simon, 425 F.2d 796, 805-06 (2d
Cir. 1969)("It has been the long-held view in this
Circuit that GAAP neither establishes nor shields guilt in a
securities fraud case.")). As defendants' GAAP expert
testified, whether a transaction is made in bad faith has no
bearing on whether the revenue is recognizable under GAAP.
See Fortney Decl. Ex. 176, Ashe Tr. at
253:24-254:12, ECF No. 58. Conversely, compliance with GAAP
does not preclude the possibility that a transaction is made
in bad faith or otherwise contravenes the purpose of the
earnout provision. Id. at 251:13-253:14. Indeed, if
it were otherwise, defendants could have entered into
transactions that were forbidden by Vista policy - or even
illegal - but would still be entitled to their earnout if the
transactions would have resulted in GAAP revenue. See
id. at 168:17-170:14. No reasonable party would have
agreed to such an outcome, and the covenant of good faith and
fair dealing is implied by law precisely to prevent such
reliance on Judge Koeltl's recent decision in
Vysyaraju v. Mgmt. Health Sols., Inc., No. 12 CIV.
4420 JGK, 2013 WL 4437236 (S.D.N.Y. Aug. 19, 2013) is
misplaced. In Vysyaraju, the parties signed a
purchase agreement containing an earnout provision and
representations that the parties had prepared their
pre-closing financial statements in accordance with GAAP,
"consistent with past practice." Id. at
*3. The agreement further stated that the parties would
measure post-closing profits in accordance with GAAP, but did
not require adherence to "past practice."
Id. at *6. The plaintiff brought suit alleging bad
faith after the defendant changed its accounting policies,
but the court dismissed the claim, reasoning that the
purchase agreement addressed GAAP pre- and post-closing, and
"[w]here the parties wanted revenue calculated through
procedures other than those provided by GAAP they knew how to
do that." Id. at *8.
unlike in Vysyaraj u, the allegations concern the
types of transactions that parties may enter under the
Purchase Agreement - not the accounting method used to
measure such transactions. Furthermore, while the Purchase
Agreement in Section 3.7(c) specifies what types of
transactions are permissible pre-closing, it is silent
concerning post-closing transactions. The terms of
the Purchase Agreement are therefore no bar to Vista's
claim because the agreement leaves the issue to the
parties' discretion, which is bounded by the covenant of
good faith and fair dealing - the subject of the present
dispute. See Sec. Plans, 769 F.3d at
make two additional points that, while correct, are
immaterial. Defendants argue that the Purchase Agreement does
not prohibit them from purchasing Jimmy Styks products.
Defendants and Counter-Plaintiffs' Memorandum of Law in
Support of their Motion for Summary Judgment
("Defs.' Br.") at 18, ECF No. 51. Defendants also
add that the agreement allows Reeves and Wilkens to start new
product lines. Id. at 4. But there is no evidence
that this was what the defendants were about. On the
contrary, it is essentially undisputed that they were
entering into an artificial set of transactions solely so
that they could qualify for their earnout.
on the foregoing, there is no genuine dispute that defendant
Jeremy Wilkens, as a company insider who orchestrated the
sticker transaction, breached the implied covenant of good
faith and fair dealing. There is also no genuine dispute that
defendant Michelle Wilkens breached the covenant. While Mrs.
Wilkens was not an insider and did not submit purchase orders
in her own right,  she testified that Mr. Wilkens discussed
the sticker scheme with her and asked whether she was
"okay with it, " and that she subsequently used her
husband to make purchase orders on her behalf for the purpose
of "buying the earn-out." See Fortney
Decl. Ex. 16 at 138:10-139:10; see also id.
("Q. Did there come a time in 2016 when you and your
co-founders decided to place a series of purchase orders with
Vista . . . ? A. Yes. Q. When did you decide to place that
order? A. When Jeremy [Wilkens] decided to put the [purchase
order] in."). Mrs. Wilkens cannot now avoid liability
simply because she used her husband to buy the stickers
rather than purchasing them herself.
other hand, Vista has not shown that the Reeves Family Trust
acted in bad faith. It is undisputed that the trustee,
Eleanor Reeves, considers and generally follows the advice of
defendant Reeves in carrying out her duties. PI.'s R.
56.1 Statement at ¶ 25. However, Ms. Reeves did not
authorize the purchase orders made on behalf of the trust by
her son and had no knowledge of the purchase orders at the
time they were made. Id. at ¶¶ 253-255.
Vista further blocked the orders before Ms. Reeves could
ratify the ...