Raw Deal: Seller Ordered to Pay Buyer Over Twice the Purchase Price in Post-Closing Purchase Price Adjustment Dispute
In a February 28, 2024 opinion, the Delaware Court of Chancery confirmed an arbitrator’s award resulting in a seller of a $40 million company unexpectedly having to pay a buyer over twice that amount – $87 million – in a customary post-closing purchase price adjustment. The adjustment seems to have resulted from an ambiguity in the purchase agreement involving a drafting technicality in the definition of “Closing Date Indebtedness” and seller and buyer taking a different view of the pre- and post-closing accounting treatment of indebtedness of a joint venture in which the target company held a one-third interest due to an internal reorganization conducted at buyer’s request. Despite the court’s view that the award was economically divorced from the intended goals of the purchase agreement, it awarded summary judgement for the buyer, concluding that the arbitrator acted within the scope of his authority. The case illustrates the importance of understanding the accounting implications of legal drafting in the customary purchase price adjustment sections of a purchase agreement, as well as the choice of what type of dispute resolution mechanism is selected by the parties for purchase price adjustment disputes.
Background and Decision
SM Buyer LLC (“Buyer”) and RMP Seller Holdings, LLC (“Seller”), the sole owner of grocery store chain Save Mart Supermarkets, LLC (“Save Mart”) entered into an equity purchase agreement (the “Agreement”).[1] The Agreement provided that Buyer would acquire 100% of Save Mart’s equity interests and included a standard purchase price adjustment mechanism.[2] Under the purchase price adjustment provisions, at closing, the purchase price would be payable by Buyer based on a Seller-prepared estimated pre-closing statement.[3] Within 90 days of closing, Buyer was required to prepare a proposed final closing statement, which the Seller had a right to review and agree to or dispute.[4] Under the Agreement, the purchase price could be adjusted once the final closing statement was determined per the Agreement, resulting in either additional purchase price payable by Buyer to Seller, or a refund to Buyer of a portion of the purchase price paid to Seller at the closing, depending on how the actual, final amounts in the closing statement compared to the estimated amounts set forth in the pre-closing statement (and used at the closing).[5] Importantly, Save Mart’s indebtedness would reduce the purchase price dollar for dollar in this process.
After signing, at Buyer’s request, Buyer and Seller agreed to an amendment intended to protect Buyer from potential creditor claims against a separate grocery store joint venture (the “Joint Venture”), of which Save Mart owned a one-third general partner interest (the “GP Interest”).[6] The amendment provided that at closing Seller would transfer its GP Interest in the Joint Venture to an affiliate, and that affiliate would transfer the GP Interest to one of Buyer’s affiliates for $90 million at closing.[7] As a result of these transactions, the GP Interest was held by a subsidiary of the Seller at the closing.
Seller delivered a pre-closing statement, reflecting an aggregate purchase price of approximately $40 million, to Buyer, on March 23, 2022.[8] On the pre-closing statement, Seller listed the GP Interest as an equity investment and did not separately include the debt owed by the Joint Venture as “Closing Date Indebtedness.”[9] On June 27, 2022, Buyer delivered to Seller the proposed final closing statement, which included $109 million in indebtedness of the Joint Venture.[10] Mathematically, this made the purchase price a negative number, such that Seller would have to pay Buyer for acquiring Save Mart.
This disconnect occurred because the pre-closing statement delivered by Buyer valued the GP Interest as an equity investment, net of a proportionate share of the debt of the Joint Venture.[11] The Buyer’s final closing statement included all of the debt of the Joint Venture as “Closing Date Indebtedness.”[12] However, the pre- and post-closing statements were prepared on an inconsistent basis, resulting in this outcome.
After Seller disputed the proposed final closing statement, the parties entered into a dispute resolution agreement, which appointed an arbitrator to resolve the dispute over treatment of the Joint Venture’s debt, and an accounting referee to resolve a different dispute.[13] To resolve their respective disputes, both the arbitrator and accounting referee considered the treatment of the Joint Venture’s debt. The accounting referee did not propose a purchase price adjustment based on the Joint Venture’s debt, but the arbitrator ruled in favor of Buyer, awarding it an $87 million refund to be paid by Seller, based on a strict interpretation of the Agreement’s definition of “Closing Date Indebtedness.”[14]
On September 21, 2023, Buyer filed suit with the Delaware Court of Chancery to confirm the arbitration award.
Before analyzing the arbitration award, the court acknowledged that the standard of review posed a significant challenge for Seller and other parties hoping to overturn such awards. As the Delaware Supreme Court stated in SPX v. Garda USA,[15] “review of an arbitration award is one of the narrowest standards of judicial review.”[16] Moreover, a finding of “manifest disregard for the law,” Seller’s sole argument, requires “that the arbitrator (1) knew of the relevant legal principle, (2) appreciated that this principle controlled the outcome of the disputed issue, and (3) nonetheless willfully flouted the governing law by refusing to apply it.”[17] Under this standard, Seller could prevail only if the record showed that it was implausible that the arbitrator acted within the scope of his authority.[18] The court’s decision, therefore, hinged on whether the arbitrator plausibly applied the governing law (here, contract interpretation principles under Delaware law), not whether the court agreed with his decision.
According to the court, and as admitted by Seller in the arbitration hearing, a literal reading of the definition of “Closing Date Indebtedness” plausibly justified the $87 million adjustment.[19] According to the court, the Arbitrator “analyzed the Agreement as a whole and interpreted its language consistent with recent trends in Delaware law towards a highly contractarian jurisprudence.”[20]
The court acknowledged that the arbitrator’s price adjustment was likely contrary to the economic realities of the deal because it significantly changed the purchase price despite no actual change in the value of the GP Interest, and in the court’s view, the accounting principles in the Agreement and the requirement that the Seller and Buyer provide respective closing statements on a consistent basis meant that Buyer’s closing adjustment was “contrary to the plain meaning of the Agreement.”[21] Unlike in SPX where the arbitrator’s decision was contrary to the “plain and unambiguous” text of the stock purchase agreement, treating the Joint Venture debt as “Closing Date Indebtedness” is consistent with the text of the parties’ equity purchase agreement.[22] Though the arbitration award was “economically divorced from the intended transaction,” the court denied Seller’s motion for summary judgement and granted Buyer’s motion because the arbitrator reached a plausible conclusion under a literal reading of the Agreement. The Agreement defined “Closing Date Indebtedness” to include all debt owed by Save Mart, which would logically include debt legally owed by Save Mart’s subsidiaries. Therefore, the arbitrator was within his authority to conclude that the Joint Venture fell within the definition of “Closing Date Indebtedness.”[23]
Takeaways:
- Unintended Consequences of Resolving Disputes Through Arbitration: The court did not seem to agree with the outcome but confirmed the arbitrator’s decision because there were no available legal grounds for it to overturn the decision. It seems that the court would have reached a different outcome than the arbitrator based on language in the opinion, but with such a narrow standard for reviewing arbitration awards, it is important to consider the standard of review of arbitration awards before entering into an arbitration agreement. Equally, in purchase agreements where a closing statement dispute resolution mechanism is provided for in the agreement, choosing to appoint an accounting firm to resolve the dispute as “an expert” rather than “an arbitrator” can take on substantial importance, as can the limitations on scope of any post-closing court review that are frequently included in M&A agreements.
- Consider Joint Ventures When Drafting Purchase Price Adjustments: It seems that Seller did not intend for the Joint Venture’s debt (or at least the full amount of its debt) to be within the scope of “Closing Date Indebtedness,” though such a conclusion followed logically from a literal interpretation of the definition as drafted. When drafting purchase price adjustment provisions, consideration should be given to applicable legal liabilities for debt and debt-like items (here, through a general partner interest) and to how joint ventures and subsidiaries’ assets and liabilities will be treated on the financial statements and in the purchase agreement’s defined terms. In this area, the defined terms can be technically drafted, and lawyers should understand the full scope of accounting treatment of non-wholly owned entities to ensure the intended treatment is provided for.
[1] SM Buyer LLC v. RMP Seller Holdings, LLC, C.A. No. 2023-0957-JTL, order at 1-2 (Del. Ch. Feb. 28, 2024).
[2] Id.
[3] Id.
[4] Id.
[5] Id.
[6] Id.
[7] Id at 3.
[8] Id.
[9] Id.
[10] Id.
[11] Id.
[12] See SM Buyer LLC, C.A. No. 2023-0957-JTL,at 3-4.
[13] Id at 5.
[14] Id.
[15] SPX Corp. v. Garda USA, Inc., 94 A.3d 745, 750 (Del. 2014).
[16] SM Buyer LLC, C.A. No. 2023-0957-JTL, at 5.
[17] Id.
[18] Id. at 7.
[19] Id 4.
[20] Id.
[21] Id at 9.
[22] Id.
[23] Id at 3.
