Purchase agreement required working capital dispute to be resolved by arbitration not expert determination

Seller is a Delaware corporation involved in the enterprise risk intelligence software business. On October 16, 2017, Seller and Buyer entered into an asset purchase agreement under which Buyer purchased substantially all of Seller’s assets. The asset purchase agreement provided for a post-closing adjustment to the purchase price based on net working capital in case there are differences between the preliminary net working capital reported by Seller during negotiations and the closing date net working capital recorded by Buyer.

The asset purchase agreement created a process for Buyer and Seller to resolve any disputes about net working capital. The asset purchase agreement required Buyer to furnish to Seller a statement setting forth the net working capital as of immediately prior to the closing. The agreement required Buyer and Seller to work in good faith to resolve any disputes and allowed Seller to object to Buyer’s statement of net working capital within thirty days so long as Seller provided specific written notice (which must reasonably detail the basis of Seller’s objections and Seller’s proposed adjustments).

The asset purchase agreement provided a procedure to resolve disputes that Buyer and Seller could not resolve themselves. It required that the unresolved dispute must be submitted for arbitration by a nationally-recognized accounting firm that agreed to use its best efforts to complete such arbitration within 30 days. Under the procedure, both Buyer and Seller submit their respective net working capital calculations and the accounting firm must pick between the two calculations and the calculation picked by the accounting firm would be final, binding and unappealable and upon which a judgment may be entered by any court having jurisdiction of the dispute.

After the closing Buyer and Seller could not agree upon the amount of Seller’s net working capital as of the closing. Seller attempted to initiate arbitration. Buyer refused to participate in the arbitration process, arguing that Seller’s original objection was not sufficiently specific. Seller then sued Buyer in the Delaware Court of Chancery to force Buyer into binding arbitration of the net working capital dispute.

Buyer resisted arguing first that Seller and Buyer did not agree to submit the dispute to arbitration but to what it called “expert determination.” Buyer wanted the court to hold that the dispute resolution procedure was an expert determination (probably because the courts would be less deferential to an expert determination of net working capital calculation’s than to an arbitrator’s award of a calculation of a net working capital).

The court concluded that the language of the asset purchase agreement manifested an intent to require Buyer and Seller to submit the working capital dispute to arbitration not to expert determination.

Buyer then argued that it was up to the court to decide whether Seller complied with the dispute resolution procedure by providing a timely objection to Buyer’s calculation along with specific written notice (which reasonably detailed the basis of Seller’s objections and Seller’s proposed adjustments). Buyer argued that the court not the accounting firm must resolve this issue because it was in legalese a question of substantive arbitrability not a question of procedural arbitrability which should be decided by the accounting firm as arbitrator.

The court was unimpressed with Buyer’s argument saying that Buyer raised a classic question of procedural arbitrability; meaning that the arbitrator (the accounting firm) must decide whether Seller complied with the dispute resolution procedure by adequately stating its objections to Buyer’s calculation.

The bottom line: an accounting firm will determine if Seller complied with the dispute resolution procedure; and if it did the accounting firm will resolve the dispute by picking either Buyer or Seller’s closing net working capital amount.

This case is referred to Agiliance, Inc. v. Resolver Soar, LLC, No. 18-CV-4945 (JMF), Court of Chancery of Delaware, (Submitted: November 15, 2018. Decided: January 25, 2019).

Comment. Purchase price adjustments are a common way to deal with allocating the profit and losses from performance of the target business between negotiation and closing. And net working capital adjustments providing for an upward or downward adjustment to the purchase price based upon the net working capital of the target business between negotiation and closing are widely used.

Disputes often break out between buyer and seller over the calculation of the closing net working capital amount. These disputes are often subject to a dispute resolution procedure in the purchase agreement that provides for resolution by an accounting firm.

Clearly calling the dispute resolution procedure an arbitration in the purchase agreement as opposed to an expert determination will more likely keep the dispute out of court and in the hands of the accounting firm.

By John McCauley: I help people start, grow, buy and sell their businesses.

Email: jmccauley@mk-law.com

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