The Bottom Line

The Delaware District Court affirmed the bankruptcy court’s decision that the combination of a narrow arbitration provision and the bankruptcy court’s reservation of jurisdiction warranted denial of a motion to compel arbitration. The specific language of the arbitration provision, combined with the use of an accounting term of art, narrowed the scope of the arbitration provision sufficiently to rebut the presumption of arbitration under the Federal Arbitration Act.

What Happened?

In Halperin v. Heritage Home Group, LLC, (In re FBI Wind Down, Inc.), Civ. No. 16-834 (SLR), 2017 WL 2125757 (D. Del. May 16, 2017), the debtor sought to sell all of its assets as a going concern. Under the terms of the Asset Purchase Agreement (the “APA”), Heritage Home Group, LLC (“HHG”) agreed to purchase the debtors’ businesses for the fixed price of $280 million, plus the assumption of certain liabilities.

Because HHG was purchasing the businesses as a going concern, it was also taking control of the debtors’ cash management systems and bank accounts to ensure a seamless transition. The APA, however, excluded certain assets, namely cash and cash equivalents (the “Excluded Assets”). Both parties anticipated that millions of dollars’ worth of the Excluded Assets would be in transit at the time of closing, and that it would be impossible to quantify the amount prior to closing. Therefore, the APA included a “cash component adjustment” that would allow the parties to later reconcile the amount of Excluded Assets at closing to ensure the purchase price remained at $280 million. HHG also agreed to assume certain obligations under the APA, including the debtors’ accounts payable, subject to a cap of $9 million (the “Accounts Payable Obligations”). As these would also be in flux at closing, the APA included an adjustment mechanism to reconcile the accounts post-closing. Relevant to the dispute at issue, the APA included identical arbitration provisions with respect to both of these adjustment mechanisms. Under the arbitration provision, the parties agreed to submit “any disputed items” with respect to the post-closing adjustments to a mutually acceptable “big four” accounting firm. In the order approving the sale transaction, the bankruptcy court specifically retained jurisdiction to “interpret, implement, and enforce” the terms of the sale order and APA.

After the sale closed, the parties attempted to reconcile the Excluded Assets and the Accounts Payable Obligations under the terms of the APA. A dispute arose, however, between HHG and the Liquidating Trustee for the wind down entity (the “Trustee”). The parties could not agree on whether “Auction Clearing House Electronic Receipts and Deposits (“ACHE-R/D”) were part of the Excluded Assets and whether the debtors’ standard accounting practices or GAAP accounting principles should be applied to calculate the Accounts Payable Obligations.

The Trustee filed an adversary proceeding in the bankruptcy court to resolve the dispute. HHG responded by filing a motion to compel arbitration under the APA.

The bankruptcy court denied the motion to compel arbitration holding that the arbitration provision “was narrow in scope and applied only to the post-closing adjustments.” FBI Wind Down, 2017 WL 2125757, at *4. According to the bankruptcy court, “disputed items” was a subset of “disputes” that may arise under the post-closing adjustment procedures. Specifically, the bankruptcy court noted that “item” is a term of art in accounting that generally refers to a specific accounting entry. Thus, the scope of the arbitration provision was limited to disputes over the correct calculations and did not cover disputes over the meaning of the terms in the APA.

In addition, the bankruptcy court found that limiting the arbitration provision to disputes over specific accounting entries would render it harmonious with the sale order’s retention of jurisdiction to interpret, implement, and enforce the APA. The bankruptcy court noted that the retention provision was drafted by the parties to be included in the sale order and was not imposed by the court.

After determining the scope of the arbitration provision, the bankruptcy court analyzed the claims raised by the trustee and found that they fell outside the provision’s scope. The disputes over whether ACHE-R/D were part of the Excluded Assets and which accounting principles to use in calculating the Accounts Payable Obligations were disputes over the meaning of defined terms in the APA. The narrow scope of the arbitration provision combined with the retention of jurisdiction meant that the bankruptcy court was the proper forum for resolving these disputes.

On appeal, the district court affirmed the bankruptcy court finding that it had properly construed the scope of the arbitration provision and properly determined that the issues raised were not within the arbitration provision’s scope. The district court noted that, under Third Circuit law, “the presumption in favor of arbitrability applies only where the arbitration provision is broad or there is some ambiguity or doubt as to its scope.” FBI Wind Down, 2017 WL 2125757, at *6.

In this case, the district court agreed with the bankruptcy court that the arbitration provision was not ambiguous and was drafted narrowly in scope. The use of the phrase “any disputed items” was clearly different from broad language such as “any dispute.” The district court also agreed with the bankruptcy court’s reliance on the accounting definition of “item” and its narrowing effect on the arbitration provision.

The district court also agreed with the bankruptcy court that the disputes fell outside the scope of the arbitration provision as they were basic issues of contract interpretations and not a dispute over specific accounting entries. The bankruptcy court’s retention of jurisdiction gave it authority to interpret the APA.

Additionally, the district court found that principles of contract interpretation supported the bankruptcy court’s conclusions, including:

·Giving terms their ordinary meaning supported giving “item” its accounting definition.

·Giving meaning to all provisions of a contract supported reading the arbitration provision and the retention of jurisdiction harmoniously to cover separate issues.

·Letting specific language control general language did not change the result because that rule only applies where the language at issue applies to the same subject and presents a conflict. Here, the arbitration provision and the retention of jurisdiction did not apply to the same subject and were not in conflict.

Thus, the bankruptcy court’s decision was supported by a straightforward reading of the unambiguous language of the agreement and principles of contract interpretation.

Why This Case is Interesting

The decision addresses two basic premises that sometimes clash in bankruptcy. First, under the appropriate circumstances, arbitration provisions will be enforced in bankruptcy. However, parties (at least estate-parties) typically want the bankruptcy court to interpret disputes that can affect the assets or liabilities of the estate – especially disputes arising out of a court approved sale agreement. The resolution of that clash turned here on careful drafting. Both the bankruptcy court and the district court found the use of an accounting term of art (“item”) to be significant in interpreting a narrow scope of the arbitration provision. Parties should take care to focus on whether they want to use specific terms of art (to give a narrow scope) or avoid terms of art (for a broader scope). Second, the decision shows the importance of including the standard retention of jurisdiction language in orders. Such language is often included by default without giving thought to how it might affect the agreement being approved. Yet in this case, both the bankruptcy court and the district court found that the parties intentionally included the language as part of the APA despite an arbitration provision. That warranted giving meaning to the language according to the perceived intent of the parties, in this case removing questions of contract interpretation from arbitration. As always, drafting matters and this decision highlights an important aspect of preserving (or avoiding) bankruptcy court review of contracts entered into after the commencement of the case.