Update: earn-outs and deferred consideration across borders

Earn-out clauses are, by design, deferred arguments. The price agreed at signing unravels slowly over a measurement period – and when the buyer and seller sit in different jurisdictions, the risk of that unravelling accelerates.

Cross-border earn-outs governed by Hong Kong law or routed through a Hong Kong holding vehicle require alignment across three distinct axes: the measurement mechanics in the sale and purchase agreement, the governing law and dispute-resolution clause, and the clearance or approval position in each jurisdiction where the business operates. A mismatch on any axis converts a commercial bridge into a litigation trigger.

This briefing states what is driving the current wave of disputes and renegotiations, who sits in the path of that risk, and the immediate steps available to parties on both sides of a cross-border earn-out.

What is driving disputes right now

Two forces have converged in cross-border deals with Greater China or offshore-holding exposure.

First, earn-out periods agreed in 2021 and 2022 are now reaching maturity. Those deals were structured in conditions very different from today's operating environment. Sellers who accepted deferred consideration in lieu of a higher headline price are now measuring performance against targets set before significant currency, supply-chain and regulatory shifts. Buyers are resisting payment on grounds that EBITDA definitions or revenue-recognition conventions in the agreement do not reflect the agreed commercial intent.

Second, the cross-border clearance picture has shifted. Deals with Mainland China exposure require attention to foreign-investment approval, foreign-exchange settlement and, in some sectors, national-security review. Where completion accounts or earn-out calculations depend on figures generated by a Mainland operating entity, access to that entity's books – and the timeline for producing compliant accounts – becomes a structural problem, not merely an accounting one.

In our cross-border practice, we see both forces operating together in transactions where the holding structure sits in Hong Kong, the BVI or the Cayman Islands, and the operating assets are principally on the Mainland or in South-East Asia. The earn-out mechanism agreed at signing was calibrated for a single-jurisdiction deal. The cross-border layer was not fully absorbed into the drafting.

Who is affected and what to do now

Any party to a cross-border transaction with an earn-out period currently running, or a deferred-consideration tranche not yet paid, should conduct an immediate review across three questions.

First, the measurement mechanism. Does the earn-out definition in the sale and purchase agreement specify which accounting standards apply, and in which jurisdiction? A definition that reads coherently under Hong Kong Generally Accepted Accounting Principles may produce a different result when the underlying numbers come from a Mainland entity preparing accounts under Chinese Accounting Standards. The gap between the two is not merely technical; it determines whether a payment obligation arises at all.

Second, the governing law and dispute-resolution clause. Cross-border earn-out disputes are among the harder categories to resolve in litigation, because the measurement evidence sits inside the target business and access to it requires cooperation from the party most likely to be resistant. Arbitration – with a well-drafted Hong Kong seat and HKIAC-administered rules – gives a claimant access to interim measures in both Hong Kong and the Mainland under the arrangement in force since 1 October 2019. A court-litigation clause does not. If the agreement contains a court clause for a jurisdiction without a mutual-recognition treaty, the enforcement position against Mainland assets will be materially weaker.

Third, the clearance and settlement position. Deferred consideration payable from a Mainland entity to an offshore seller requires foreign-exchange settlement through the Mainland banking system. That step has its own timeline and documentation requirements. Earn-out structures that ignore this create a payment-mechanics failure even where both parties agree the figure is due. We regularly advise on the sequencing of settlement approvals alongside the earn-out measurement process, and the two need to run in parallel, not in series.

For parties approaching the end of an earn-out period, a rapid structural read of the agreement against the current operating and regulatory position is the immediate action. For parties in live disputes, the question of forum – arbitration, expert determination, or court – needs to be resolved before the measurement dispute is argued, because the forum determines the evidence-gathering and interim-relief options.

For background on the acquisition vehicle and holding structure that typically frame these arrangements, see our overview of acquiring a Cayman Islands target through a Hong Kong vehicle and our M&A practice page at lockhartyip.com/practices/ma-transactions/. Minority-protection and joint-venture considerations that frequently arise alongside earn-outs are addressed in our briefing on minority protections in BVI joint ventures.

For a preliminary read on your earn-out or deferred-consideration position across the relevant jurisdictions, email info@lockhartyip.com.

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This publication is general information and does not constitute legal advice. For advice on your situation, contact info@lockhartyip.com.