Expert Or Arbitrator? Resolving Purchase Price Adjustment Disputes

• Published date: 23 August 2023
• Subject Matter: Litigation, Mediation & Arbitration, Arbitration & Dispute Resolution
• Law Firm: Sheppard Mullin Richter & Hampton
• Author: Mr Stephen R. LaSala and Lauren J. Ash

Acquisition agreements in M&A transactions frequently include provision for payment to be made at closing based on estimates of certain financial metrics that are later subject to a purchase price adjustment based on a final determination (referred to as a "true-up") within a few months following closing. These metrics may include a target's cash, debt, unpaid transaction expenses and working capital (excluding cash), and sometimes others. The definitions that correspond to these items, and what particular items are included or excluded from each, are often the product of significant negotiation, as the final purchase price can move materially up or down based on their final determination. The process of finally determining the adjustment amount following the closing can also reveal differences in the buyer's and seller's interpretation of accounting principles applicable to the purchase price adjustment calculation, or how those principles apply to the target's financial statements. These differences can become a source of post-closing conflict between buyer and seller, at a time when the parties are working through transitional issues, and when the sellers may have ongoing involvement in the business. Parties will want to resolve these disputes quickly and in a cost-effective manner. To accomplish these objectives, often the purchase agreement will require that the parties submit unresolved issues to an independent accountant for final resolution. A key consideration in such referral will be the role that the accountant will play in resolving the dispute. Will the accountant act as an arbitrator or as an expert? This is an important distinction that deserves careful consideration by both sides. By engaging an accountant to act as an expert and not an arbitrator, the parties limit the scope of the accountant's review and avoid the formalities of an arbitration.

1. Expert Determination or Arbitration?

Courts across the United States have long recognized a distinction between expert determinations and arbitrations.¹ However, following the passage of the Federal Arbitration Act (FAA) in 1925 and the adoption of similar acts at the state level, many states began interpreting arbitration as being inclusive of expert determinations or appraisals, such that arbitration principles would apply regardless of an election in the purchase agreement.² However, in Delaware and several other states, courts have been clear that expert determination is a third-party...