- In Chicago Bridge & Iron Company N.V. v. Westinghouse Electric Company LLC and WSW Acquisition Co., LLC, the Delaware Chancery Court was required to interpret purchase price dispute resolution mechanisms commonly found in private company acquisition agreements.
- The decision provides clear guidance for drafting the purchase agreement so that it does not create ambiguity as to the role of dispute resolution language in the contract.
In Chicago Bridge & Iron Company N.V. v. Westinghouse Electric Company LLC and WSW Acquisition Co., LLC, C.A. No. 12585-VCL (decided Dec. 5, 2016), the Delaware Chancery Court was required to interpret purchase price dispute resolution mechanisms commonly found in private company acquisition agreements. In this case, Chicago Bridge & Iron Company N.V. (the Seller) sold its subsidiary, CB&I Stone and Webster, Inc. (the Company), to Westinghouse Electric Company LLC (the Buyer), primarily to resolve business disputes between the Buyer and the Seller regarding nuclear power plant construction services provided by the Company with respect to nuclear power plants designed by the Buyer. The purchase agreement (the PSA) was unusual in two key respects: First, the purchase price had zero firm dollars at closing, although it did have a working capital target, deferred purchase price and earn-out provisions. Second, the representations and warranties terminated at closing, which is relatively uncommon in private deals.
Under the PSA, the Seller was to deliver $1.174 billion of working capital at closing under a typical process of providing a working capital estimate for closing subject to a post-closing true-up mechanism. The calculation of working capital was required to be prepared in accordance with generally accepted accounting principles (GAAP) and a set of "Agreed Accounting Principles." At closing, the Seller submitted a working capital estimate of $1.6 billion, requiring a closing payment by the Buyer of approximately $425 million. Following closing, the Buyer prepared its own calculation of working capital, claiming that the Seller's pre-closing estimate of working capital had not been prepared in accordance with GAAP and the Agreed Accounting Principles. The Buyer asserted that correcting the accounting resulted in working capital of negative $977 million, suggesting that the Seller owed the Buyer approximately $2.15 billion (net of the $425 million closing payment).
The Seller timely objected to the Buyer's calculation, which initiated a mandatory 30-day negotiation period under the PSA. The PSA provided that if negotiations were unsuccessful, then either party could submit the dispute for resolution by an "Independent Auditor" for a "final, conclusive, binding, non-appealable and incontestable" resolution. Rather than submit the dispute to the mandatory Independent Auditor process, however, the Seller filed an action in the Delaware Chancery Court claiming that the Buyer's calculation of working capital was improper under the terms of the PSA because (i) the failure to comply with GAAP was a representation and warranty claim, the survival of which terminated at closing, and (ii) the calculation violated the implied covenant of good faith and fair dealing. In addition, the Seller argued that even if the dispute were submitted to it, the Independent Auditor did not have the authority under the PSA to determine compliance with GAAP and the Agreed Accounting Principles. In effect, the Seller was seeking to escape the exclusive Independent Auditor provision to resolve the purchase price dispute.
Vice Chancellor J. Travis Laster rejected the Seller's position and ordered the parties to resolve the dispute under the contractual Independent Auditor process. In doing so, Laster identified two Delaware precedents, in one of which, OSI Systems, Inc. v. Instrumentarioum Corp., 892 A.2d 1089 (Del. Ch. 2006), then Vice Chancellor Leo Strine, Jr. narrowly construed the contract to exclude GAAP compliance from the ambit of the Independent Auditor reviewing the working capital calculation. The OSI decision was predicated upon the fact that the dispute resolution mechanism authorized the auditor to make a "final determination ... of the appropriate amount of each of the line items ..." in the working capital calculation. Strine found that this language was not broad enough to encompass the GAAP compliance question. He also noted that representations and warranties as to GAAP compliance extended to the closing balance sheet used to calculate working capital and thus brought GAAP compliance within the scope of a breach of a representation and warranty, further supporting the narrow construction of the Independent Auditor process.
Chancellor Laster, however, applied the more recent precedent in Alliant Techsystems, Inc. v. MidOcean Bushnell Holdings, L.P., 2015 WL 1897659 (Del. Ch. Apr. 24, 2015), to reach the opposite conclusion of that argued by the Seller in Chicago Bridge. Consistent with Alliant, Laster observed that the PSA contained unambiguous language that required the working capital dispute, including the determination as to compliance with GAAP and the Agreed Accounting Principles, be submitted to the Independent Auditor. In doing so, he noted the following key aspects:
- Language that the Independent Auditor was to act as an expert and not as an arbitrator did not limit its role to pure mathematics – the parties intended that the Independent Auditor will resolve the dispute – "as accountants do" – by examining the corporate books and applying the appropriate accounting principles. In this connection, the PSA stated that the Independent Auditor was to resolve "any and all matters that remain in dispute [with respect to the working capital calculation]." Laster noted that such language was sufficiently broad to encompass GAAP compliance.
- Although the PSA had a no-survival clause as to representations and warranties, it included a carve-out for the working capital dispute mechanism, thus making clear that the working capital issue was a completely separate matter; Laster likened this carve-out to the exclusion from the exclusive remedy provision found in the Alliant indemnity provision.
- The potential size of the adjustment is not a reason to remove the issue from the Independent Auditor.
- The implied covenant of good faith would not be used to infer language that contradicts a clear exercise of a contractual right. Because the PSA addressed the resolution of the disputed calculation, there was no gap for the implied covenant to fill.
This decision provides extremely clear guidance for contract drafting. To ensure that working capital or other purchase price adjustment disputes are to be resolved by a targeted Independent Auditor process, it is critical that the agreement contain unambiguous language as to the ambit of the Independent Auditor's authority. In this respect, it is critical that the Independent Auditor have the ability to resolve all accounting matters that could affect the calculation. Language that could arguably limit the auditor's role to mere mathematics (i.e., bookkeeping rather than accounting) could result in forcing the dispute into litigation or a more general arbitration proceeding. The agreement should also contain express and unambiguous language that the Independent Auditor process is the exclusive process for resolving purchase price disputes. An example of language to this effect follows:
"If the Seller timely delivers to Buyer an objection to Buyer's calculation of Actual Net Working Capital (a "Seller's Objection") and the Seller and Buyer are unable to resolve all of their disagreements with respect to the proposed adjustments set forth in the Seller's Objection within thirty (30) days following Buyer's receipt of the Seller's Objection, then they shall, within five (5) days thereafter, jointly retain the Independent Auditor . . ., which shall determine, on the basis set forth in and in accordance with this Section X.X, and only with respect to those items in the Seller's Objection on which Buyer and the Seller have not agreed, whether and to what extent, if any, the Cash Purchase Price requires adjustment pursuant to this Section X.X. . . . In resolving any disputed item, the Independent Auditor may not assign a value to any disputed item that is greater than the greatest value claimed for the item by either party in its [initial submission] or, if applicable, its [rebuttal submission] or less than the smallest value claimed for the item by either party in its [initial submission] or, if applicable, its [rebuttal submission]. The scope of the disputes to be resolved by the Independent Auditor is limited to whether the preparation of the Closing Balance Sheet and the calculation of the Actual Net Working Capital were done in a manner consistent with GAAP [and the Agreed Accounting Principles] and otherwise in accordance with this Section X.X, and the Independent Auditor is not to make any other determination unless jointly requested in writing by the Seller and Buyer. Notwithstanding anything to the contrary in this Agreement, any disputes regarding the Closing Balance Sheet and the calculation of the Actual Net Working Capital shall be resolved solely and exclusively as set forth in this Section X.X. The findings and determinations of the Independent Auditor as set forth in its written report shall be deemed final, conclusive and binding upon the parties and shall not be subject to collateral attack for any reason. The parties shall be entitled to have a judgment entered on such written report in any court of competent jurisdiction."
The Chicago Bridge case also suggests that including the closing balance sheet in the financial statement representations and warranties could be counter-productive and potentially bring the dispute within the indemnification mechanism. In addition, exclusive remedy language in the indemnification section should expressly exclude purchase price adjustment (and earn-out calculation adjustment mechanisms, as well as tax covenants that regulate which party is responsible for pre-closing and post-closing taxes) so that it does not create ambiguity as to the role of other dispute resolution language in the contract.