Target Incorrectly Applies New Accounting Standard – May Cost Buyer $38 Million

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Target’s estimate of tangible net worth at closing for purposes of a purchase price adjustment was $38 million too low because it was based upon an incorrect application of a new accounting standard. Buyer has uphill fight to avoid making a $38 million purchase price adjustment payment to seller.

M&A Stories

March 04, 2021

Introduction

Purchase price adjustments based upon a post-closing calculation of a target’s closing tangible net worth is very common and also a source of post-closing disputes.

The deal

This deal was a strategic acquisition in the health insurance industry. The seller agreed to sell the target for a base price of $750 million and an adjusted purchase price based upon the target’s tangible net worth.

The lawsuit

The merger agreement provided for a purchase price adjustment based on whether the target’s tangible net worth at closing exceeded or fell short of the target established at signing. The seller calculated the targeted tangible net worth.

After the closing, the buyer determined that the target’s tangible net worth at closing was actually $38 million more that the seller’s estimate. Most of the difference was explained by the target’s incorrect application of a new accounting standard that it used in calculating its estimate.

The buyer therefore calculated the closing tangible net worth consistent with the target’s incorrect application of the new accounting standard, even though the calculation was clearly in breach of the merger agreement.

The seller balked and initiated the merger agreement’s dispute resolution procedure which would call for binding arbitration by KPMG. The buyer countered by asking the Delaware Court of Chancery to order KPMG to calculate the target’s tangible net worth consistent with the target’s earlier incorrect application of the new accounting standard.

The court refused the buyer’s request because the merger agreement clearly mandates that KMPG correctly apply the new accounting standard in calculating the target’s closing tangible net worth. That means that the buyer will likely pay the seller $38 million for tangible net worth that in fact did not exist.

This case is referred to as Golden Rule Financial Corporation v. Shareholder Representative Services LLC, C.A. No. 2020-0378-PAF, Court of Chancery of Delaware, (Submitted: October 30, 2020. Decided: January 29, 2021). 

Comment

In 20/20 hindsight, the buyer should have had its accounting team verify the accuracy of the target’s calculation of the estimated closing tangible net worth before signing the merger agreement.

By John McCauley: I help people manage M&A legal risks.

Email:             jmccauley@mk-law.com

Profile:            http://www.martindale.com/John-B-McCauley/176725-lawyer.htm

Telephone:      714 273-6291 

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