Arbitration Required in Purchase Price Adjustment Dispute

This case involves a company that purchased an international medical products and services business from a corporation. The company paid $47 million to purchase the business. The price was set according to the terms of a “Purchase Agreement” between the company and the corporation that was executed years previously. The corporation had prepared a final balance sheet that, when compared with the reference balance sheet, would have lowered the purchase price by $7 million. The purchase agreement allowed the company to prepare its own version of the final balance sheet, that showed a purchase price reduction of $24 million—over half of the entire purchase price. The company claimed that the corporation did not apply GAAP (Generally Accepted Accounting Principles) in preparing either the reference balance sheet or the corporation’s version of the final balance sheet. Even though the purchase agreement stated that disputes regarding the final balance sheet would be submitted to an independent accounting firm for final resolution, the corporation refused to do this. The corporation claimed that the failure to comply with GAAP constituted a breach of the GAAP representation that would make the claim subject to separate legal arbitration and limited to 25% of the purchasing price.

Question(s) For Expert Witness

1. Is a dispute over the final balance sheet in a purchase agreement subject to arbitration?

Expert Witness Response

Usually, a purchase agreement will contain procedures for adjusting the purchase price based on changes in the working capital of the business process management from the time that the agreement is signed until the sale is closed. In most cases like this, a purchase agreement contains certain elements for a post-closing purchase price adjustment process. In most cases, a balance sheet is prepared during the due diligence period by the seller (the “reference balance sheet”) to establish some type of reference figure for working capital. Then, a balance sheet is usually prepared as of the closing date by the purchaser (the “final balance sheet”). The two balance sheets are compared and if there is no dispute, the purchase price will be adjusted to reflect the difference, according to the purchase agreement. Usually, the purchase agreement will require that the reference balance sheet and the final balance sheet be prepared in accordance with GAAP. Any dispute is normally referred to an agreed-upon accountant who will issue a final determination of the final balance sheet and the resulting adjustment to the purchase price. If a dispute arises over whether the balance sheets are GAAP compliant, this may be held to be outside of the scope of the arbitration process and subject instead to the sale agreement’s indemnification provisions. In this case, it is likely that the claim would have to be decided through legal arbitration instead of by an accountant arbitrator. This is because submitting the claim to legal arbitration would follow the main dispute resolution provision in the parties’ purchase agreement.