In this memorandum opinion, the Court of Chancery granted a stockholders’ representative’s motion for summary judgment to enforce an arbitrator’s decision under the Federal Arbitration Act (“FAA”), thereby confirming the arbitrator’s calculation of the amount of an earn-out payment under the terms of a merger agreement. In reaching its decision, the Court held that whether an argument has been properly presented to an arbitrator is a question of procedural, and not substantive, arbitrability and, consequently, properly decided by the arbitrator. Although recognizing that Court of Chancery precedent was split on the issue, the Court reasoned that an alternative holding would undercut the United States Supreme Court’s definition of substantive arbitrability and would be at variance with Delaware’s policy favoring arbitration.
Plaintiff, Viacom International, Inc., brought this action challenging the calculation of certain earn-out payments, which arose from Viacom’s acquisition, through merger, of Harmonix Music Systems, Inc., maker of the Guitar Hero and Rock Band videogames. The merger agreement provided that Plaintiff would pay former Harmonix stockholders earn-out payments after the merger for the years 2007 and 2008 and named Defendant, Walter A. Winshall, as the stockholders’ representative. The earn-out payments were calculated according to a formula set forth in the merger agreement, which involved a calculation of the net revenues from the sales of Harmonix products minus production expenses and certain other amounts. The merger agreement provided an alternative dispute resolution process whereby the parties, to the extent they could not reach agreement on the earn-out payments, could submit a dispute to third-party accountants, the Resolution Accountants, who would calculate the amount of the earn-out payments.
In 2008, Plaintiff submitted to Defendant a calculation of the earn-out payments for 2007, which deducted from the net revenues only the costs attributable to the Harmonix products that were sold in 2007 and not the costs for unsold Harmonix products at year-end 2007. There was no dispute with respect to Plaintiff’s calculation of the earn-out payment and it was subsequently paid to the former Harmonix shareholders. Later in 2008, however, the parties’ relationship began to fracture when Plaintiff submitted several preliminary calculations of the earn-out payments for 2008 that included a write-down for Harmonix products that remained unsold at year’s end. Despite those preliminary calculations, Plaintiff’s final earn-out statement did not include the inventory write-downs. Instead, Plaintiff’s final earn-out statement took the position that the cost of manufacturing the unsold Harmonix products should be included in the calculation of the earn-out payments. In accordance with the terms of the merger agreement, Defendant issued a statement of disagreement, which objected to the inclusion of manufacturing costs for unsold products but which did not address the inventory write-downs as a means of valuing the unsold merchandise. The parties were unable to reconcile and engaged BDO USA, LLP as the Resolution Accountants.
Pursuant to the merger agreement and their engagement letter with the parties, the Resolution Accountants were to determine all disagreements arising from either Plaintiff’s final earn-out statement or Defendant’s statement of disagreement. Both parties submitted simultaneous submissions to the Resolution Accountants and subsequent reply submissions. As it had in its final earn-out statement, Plaintiff, in its initial submission, failed to raise the write-downs as an alternative method to value the unsold inventory, but it relied heavily upon this position in its reply submission. Given the fact that both parties had identified issues that were not in the final earn-out statement or the statement of disagreement, the Resolution Accountants contacted the parties to determine whether there was an agreement to expand the scope of their engagement. When both responded in the negative, the Resolution Accountants issued their calculation of the earn-out payments, which explained that they had not considered Plaintiff’s alternative method of valuing the unsold 2008 inventory through write-downs because that argument had not been included in either Plaintiff’s final earn-out statement or Defendant’s statement of disagreement and was, therefore, improperly submitted.
Plaintiff commenced an action in the Court of Chancery, seeking to vacate the Resolution Accountants’ determination because, among other things, the Resolution Accountants failed to consider the inventory write-downs. Plaintiff argued that the determination of whether its position regarding the write-downs had been properly submitted was a question of substantive, and not procedural, arbitrability and, therefore, a question for the Court. Plaintiff also argued that, even if properly a question for the Resolution Accountants, the decision not to consider the write-downs violated Sections 10(a)(3) and (4) of the FAA. Plaintiff moved for summary judgment on these issues, and Defendant cross-claimed for the same, seeking enforcement of the Resolution Accountants’ calculation of the earn-out payments.
The Court first addressed Plaintiff’s argument that the determination of whether an argument has been properly submitted to an arbitrator is one of substantive arbitrability and the Resolution Accountants, therefore, improperly declined to consider Plaintiff’s argument regarding the write-downs. The Court candidly admitted that it was unable to reconcile conflicting Court of Chancery precedent on the issue but ultimately held the question was one of procedural arbitrability and, therefore, properly decided by the Resolution Accountants. The Court explained that to hold otherwise would undercut the United States Supreme Court directive that questions of substantive arbitrability are those the parties anticipated the court would decide in the first instance and not those “that grow out of the dispute and bear on its final disposition,” which are properly decided by the arbitrators. Moreover, the Court noted this decision was supported by the Delaware policy favoring arbitration and stated that the practical effect of Plaintiff’s position would amount to “arbitrator-judicial badminton” of issues. The Court concluded by observing that, even if the question were one properly decided by the Court, it would agree with the Resolution Accountants that Plaintiff’s argument had been improperly presented.
The Court next addressed Plaintiff’s position that the Resolution Accountants’ calculation should be vacated pursuant to either Section 10(a)(3) or (4) of the FAA. Regarding the former, which the Court explained permits vacatur where the arbitrator’s misconduct prejudices a party’s rights, the Court rejected the Plaintiff’s position and explained that no misconduct had taken place and Plaintiff’s rights had not been prejudiced because Plaintiff could have but chose not to raise the write-downs in its final earn-out statement. Regarding Section 10(a)(4), which permits vacatur where an arbitrator exceeds its authority or fails to issue a final award, the Court explained that the Resolution Accountants had not exceeded their authority in determining that the Plaintiff’s write-down argument had been improperly presented because it was a question of procedural arbitrability and, therefore, properly decided by the Resolution Accountants. The Court also explained that the Resolution Accountants’ overture to the parties to consider the write-downs, if the parties mutually agreed to expand the engagement, had not resulted in a non-final award, as the award itself clearly indicated its finality and the offer to consider additional issues did not detract from that finality.
The Court therefore granted the Defendant’s motion for summary judgment and confirmed the Resolution Accountants’ determination of the 2008 earn-out payment.
The full opinion is available here.