There are often post-closing calculations that must be made in an M&A deal. Examples are working capital and earnout calculations. Often the parties agree in advance to a dispute resolution procedure in the M&A documents in the event there is a disagreement over the calculation.
This case involved the stock acquisition of an Indiana engineering and consulting business. The purchase price was $21 million plus an earnout based upon EBITDA.
The buyer calculated no earnout in the 2nd and final post-closing year. The seller disputed the calculation and the dispute was submitted to E&Y for resolution pursuant to the stock purchase agreement. E&Y calculated a 2nd year earnout of $3 million. The buyer refused to pay, and the dispute ended up in an Indiana trial court which agreed with E&Y. The buyer appealed to Indiana’s intermediate appellate court.
The stock purchase agreement’s earnout dispute resolution procedure said that E&Y should review “all relevant matters as it deems appropriate” and then deliver its calculation “which shall be final and binding upon” the buyer and the seller. The trial court confirmed this calculation as an arbitration award. The buyer claimed that under controlling Delaware law, the earnout calculation performed by E&Y could be looked at by the court because the dispute resolution procedure used was not an arbitration but an expert determination.
The court said that under Delaware law, the resolution of this issue depended upon whether the parties intended E&Y to act as an expert (meaning that it had authority to resolve factual but not legal issues) or as an arbitrator (which gave it the authority to resolve both factual and legal issues.) The buyer wanted to win the expert determination argument to give it life to poke legal holes in E&Y’s earnout calculation. The buyer’s fight would stop if E&Y acted as an arbitrator because then E&Y’s legal conclusions were final and binding on the court.
The court ruled that E&Y acted as an arbitrator of the earnout calculation dispute: We “have little difficulty concluding that the parties clearly and intentionally agreed to arbitrate earnout disputes … Although the term ‘arbitration’ does not appear, the agreement here delegates to … (E&Y) … broad authority to consider evidence, make determinations, and conclusively resolve any earnout dispute …”
The buyer argued that the earnout dispute resolution language showed that the parties agreed that E&Y’s calculation would be an “expert determination” of earnout disputes. The court rejected this argument. “Specific limiting language providing that … (E&Y) … is acting ‘as an expert and not as an arbitrator’ clearly narrows the scope of … (E&Y’s) … role and evinces the parties’ intentions that the auditor’s decision constitute an expert determination and not an arbitration. … There is no such stipulation or limiting language in the parties’ agreement here, leaving only language that clearly gives … (E&Y) … full and complete authority to act as an arbiter and issue a final and binding decision as to an earnout dispute.”
This case is referred to as SGS North America, Inc. v. Mullholand, No. 19A-PL-1283, Court of Appeals of Indiana (November 14, 2019)
The bottom line is that the buyer did not get another shot to litigate the dispute in court. The judge noted what language in the purchase agreement would probably have won the buyer’s argument: “use of the expression `as an expert and not as arbitrator’ is now so common that it is difficult to conceive of a case in which a court would not treat those words as meaning exactly what they say.”
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