Good Leaver and Bad Leaver Clause: how to protect investments and align interests in M&A deals

In M&A transactions, it is common for founders to remain in the corporate structure and management of the company for a period after the investor joins and for their exit — including from the corporate structure — to occur gradually, as goals are met and the transition is consolidated. It is also common for long-term incentive plans (such as vesting and call options) to grant equity interest to executives as a form of gratification and alignment of interests. But what happens when one of these shareholders exits — or is removed—from office ahead of schedule? Without clear rules, a management issue can quickly become a corporate conflict – a risk that investors should consider from the outset of the transaction.

It is in this context that the Good Leaver and Bad Leaver Clause arises: a contractual mechanism that defines, in advance and objectively, the corporate and economic consequences when a shareholder ceases to perform their duties — whether on his own initiative or at the initiative of a third party — and, through it, the obligation of such shareholder to sell their equity interest to others is established. Depending on the circumstances of the exit, different effects apply to the pricing of the equity interest that will be sold to the other shareholders.

The key is not in the label "good" or "bad", but in the logic that this mechanism materializes: aligning incentives and disciplining behaviors through previously agreed consequences, reducing disputes when the parties' relationship comes under strai For investors who invest capital in Brazilian companies, this contractual predictability is essential to mitigate risks and preserve the value of the investment.

A well-constructed clause usually addresses three blocks: (i) framing hypotheses; (ii) procedure; and (iii) pricing criteria. Regarding the framing hypotheses, it is necessary to define which events characterize the Good Leaver or Bad Leaver scenarios, with triggers that need to be consistent with the context of the operation and minimally verifiable.

In general terms, the definition of Good Leaver usually covers hypotheses such as death, permanent disability, dismissal without cause, and other scenarios of exits considered legitimate, not attributable to reprehensible conduct. On the other hand, the definition of Bad Leaver generally involves termination for cause, breach of relevant contractual obligations, and breach of fiduciary duties, in the case of a statutory officer.

As important as listing the characterization criteria is ensuring that the definitions are objective. Vague and subjective triggers open space for discussion about classification and, consequently, about the price to be paid for the equity interest, as will be discussed below. This is an area where specialized legal advice can make a significant difference: the precise wording adapted to Brazilian corporate law avoids ambiguities that could compromise the execution of the clause.

Regarding the calculation and transfer procedure, the dynamics tend to follow a simple script: the exit event occurs; the event is classified according to the agreement; and, from then on, the agreed consequences regarding the sale of the equity interest and the applicable pricing mechanism take effect.

Here, the procedure matters as much as the content: who recognizes the event, how and when it is notified, what deadlines apply, how any right of first refusal is exercised among the other shareholders and if any of them has priority over the others, how the transfer is formalized and what is the mechanism for resolving disputes. Without this operational design, the clause can be triggered and still generate an impasse in the execution.

Finally, price fixing and economic differentiation depending on the configuration of Good Leaver or Bad Leaver is what will bring practical effect to the mechanism and make it possible to reward or penalize the executive who will leave the company according to the reason for his or her exit.

An example of differentiated pricing for the payment of the executive's equity interest is to establish that the Bad Leaver will be required to sell at a price calculated with a lower multiple of the economic indicator (such as EBITDA) to the detriment of the multiple established for the benefit of the Good Leaver, who will benefit from more favorable conditions.

In a context of growing international investor appetite for the Brazilian market, properly structuring these clauses is a competitive advantage in negotiation and a factor of legal certainty for all parties involved. For this mechanism to fulfill its role, robust contractual structuring is necessary, as detailed above, ensuring that the clause becomes an instrument that generates predictability and makes it possible to address scenarios involving a shareholder's exit from his position in the company in a simple way.

The Good Leaver/Bad Leaver Clause is a legitimate contractual tool to organize the exit of executive shareholders from their positions, protect the company against misalignments that may diminish its value, and keep ownership and decision-making power concentrated among the shareholders who continue to work in the company, as well as serve as a mechanism of punishment or economic protection, reinforcing long-term incentives and reducing potential litigation. Our M&A team has extensive experience in structuring this type of mechanism in transactions with foreign investors, offering tailored solutions that reconcile the best international practices with the particularities of the Brazilian legal system.