Earnout Disputes Surge in M&A as Courts Scrutinize Post-Closing Conduct

by Anika S. Keuning and Mark Xiao

Delaware Court of Chancery Rules Against Krafton

On March 16, 2026, Delaware’s Court of Chancery ruled that South Korean video game company Krafton Inc. (“Krafton”) had wrongfully terminated its subsidiary’s executives in breach of an Equity Purchase Agreement (“EPA”), a decision highlighting the dangers of substituting AI for experienced legal counsel.

In 2021, Krafton acquired the California-based subsidiary Unknown Worlds Entertainment (“Unknown Worlds”) for $500 million upfront plus $250 million in contingent earnout payments.  Earnouts are mechanisms in mergers and acquisitions (“M&A”) where a portion of the consideration, deferred as future payments, is contingent upon the achievement of specific post-deal milestones.  These milestones can be financial (e.g., achieving EBITDA targets) or non-financial (e.g., winning regulatory approval).

To secure the acquisition, Krafton Inc. agreed in the EPA that certain key employees of Unknown Worlds would retain operational control and could only be terminated for cause through the end of the earnout period, which was set to expire at the end of 2025.

“Project X” and the Dispute Over Subnautica 2

As Unknown Worlds prepared to release its highly anticipated sequel action-adventure survival game, Subnautica 2, which was projected to generate considerable revenue that would easily trigger the earnout, Krafton’s CEO, Kim Chang-han, expressed concerns that he had agreed to a “pushover” deal.  Kim consulted ChatGPT for advice.

Around June 2025, at ChatGPT’s direction, Kim devised “Project X,” a plan to either negotiate a deal on the earnout or initiate a “takeover” of the studio.  As a part of Project X, and through the counseling of ChatGPT, Krafton locked Unknown Worlds out of its own distribution platform to stop the release of Subnautica 2 and abruptly terminated Unknown Worlds’ key executives.

Shortly thereafter, Fortis Advisors LLC (“Fortis”) sued Krafton on behalf of the former stockholders of Unknown Worlds. The lawsuit claimed that Krafton had breached the terms of the EPA by firing key employees without cause.  As discovery commenced, Krafton altered its narrative, claiming the employees had downloaded confidential information and transitioned into “semiretirement,” to establish cause.

Delaware Court Orders Reinstatement

After an expedited trial, Delaware Vice Chancellor Lori W. Will ruled in favor of Fortis, stating: “When an employer faces a contractual payout it wishes to avoid, it is heavily ‘incentivized to go rummaging through the employee’s history to find any reason it can to announce that the termination was really for cause.’ That is precisely what happened here. Frustrated by the key employees’ refusal to forfeit operational control and facing a nine-figure liability, Krafton went searching for a pretext.”

The ruling provides that Krafton must reinstate the previously terminated CEO of Unknown Worlds and enjoins Krafton from impeding the launch of Subnautica 2. The earnout period is extended to September 15, 2026. The court’s willingness to impose equitable remedies here underscores the judicial tools available to address bad faith conduct in post-closing disputes.

Why Use Earnouts and How to Mitigate the Risk of Post-Closing Earnout Disputes

While earnouts can offer advantages to both buyers and sellers in an M&A transaction, especially as a solution to pricing a transaction in an uncertain economy, it is crucial to both fully understand and carefully structure earnouts to avoid disputes. Without meticulous drafting, earnouts can transform from value-bridging mechanisms to sources of prolonged and costly conflict.

1. Carefully Selected and Clearly Defined Milestones 
   Varying earnout metrics correspond with varying degrees of risk for post-closing disputes.  For example, “revenue-based” objective metrics can result in fewer disputes than EBITDA-based metrics. Vague language about seemingly minor details can translate into major disagreements.  Best practice in structuring earnout provisions is to clearly define performance metrics and specify the formulas for calculating such metrics.
2. Specify Resolution Mechanisms 
   Integrate potential dispute resolution procedures into purchase agreements, including steps each party should take before escalating the dispute to arbitration or litigation. This could look like a period of time designated as a mandatory negotiation period or an agreed-upon mediator. A tiered approach can encourage resolution at every step before falling back on litigation, preserving business relationships and reducing costs for all parties involved.
3. Seller Protections
   When buyers control the day-to-day operations post-closing and an earnout depends on company performance, an inherent conflict exists between the buyer and seller. Buyers are incentivized to minimize payout while sellers are incentivized to maximize earnout. To mitigate this conflict and protect a seller’s potential earnout payment, robust covenants can be structured into purchase agreements. These include requiring the buyer to operate the business consistent with past practice or use “commercially reasonable” efforts to achieve the earnout.

Ultimately, parties that carefully structure clear and nuanced earnout provisions early on can avoid the friction and potential steep costs associated with disruptive earnout-related disputes.

What does the Krafton ruling — and its CEO’s decision to bypass his own legal team and rely on ChatGPT for acquisition strategy — signal about the risks of using AI tools in place of experienced M&A and litigation counsel?

The Krafton case study underscores the risks surrounding outsourcing complex legal counseling to AI chatbots and the importance of experienced legal experts in structuring post-closing arrangements. Overreliance on AI can bypass the legal judgment and nuance of experts that are vital in complex corporate structures and may lead parties to overlook contractual restraints in favor of validating flawed or untenable strategies. Moreover, as the Krafton ruling spotlights, use of AI can expose corporate actors to evidentiary and reputational risk, as AI can be discoverable in litigation.

In this case, any potential savings from attempting to avoid the $250 million earnout were likely outweighed by Kim and Krafton’s reputational harm, which could have been mitigated by adhering to the terms of the EPA. Ultimately, while an AI chatbot may be able to assuage the anxieties surrounding corporate governance, it cannot shortcut the tailored guidance of experienced legal counsel.

Companies navigating complex M&A transactions, earnout structures, and post-closing disputes should work closely with experienced corporate and litigation counsel, such as the attorneys at Miller Shah LLP, to ensure agreements are carefully structured and business decisions remain aligned with contractual obligations and fiduciary responsibilities.