Learn about a recent M&A case where a court ruled on the nature of an Ernst & Young earnout calculation, determining it as arbitration rather than expert determination. Get insights into the legal conflict and the court’s ruling.
November 19, 2019
Introduction:
In mergers and acquisitions (M&A) deals, adjustments to the purchase price often require post-closing calculations. These calculations, such as working capital and earnout, can lead to disputes. To manage such disagreements, M&A documents usually outline a dispute resolution process in advance.
The Situation:
This particular case involved the purchase of a Indiana-based engineering and consulting business. The initial purchase price was $21 million, with an additional earnout determined by the company’s earnings before interest, taxes, depreciation, and amortization.
The Legal Conflict:
A disagreement arose when the buyer calculated no earnout for the second and final year after the closing. The seller challenged this calculation, and the matter was taken to Ernst & Young (E&Y), an independent accounting firm, as specified in the stock purchase agreement. E&Y determined a second year earnout of $3 million. The buyer contested this, leading to a trial court case in Indiana. The trial court ruled in favor of E&Y, but the buyer appealed to Indiana’s intermediate appellate court.
The Key Issue:
The dispute resolution process in the stock purchase agreement stated that E&Y would review all relevant aspects and deliver a calculation that both the buyer and seller would be bound by. The trial court treated this as an arbitration award. However, the buyer argued that the calculation should be considered an expert determination under Delaware law, allowing for legal examination.
The Court’s Ruling:
The court’s decision rested on whether the parties intended E&Y to act as an expert (deciding factual matters) or an arbitrator (deciding both factual and legal matters). The court concluded that E&Y functioned as an arbitrator. Despite the absence of the term “arbitration” in the agreement, the court emphasized the broad authority given to E&Y to resolve earnout disputes. The court rejected the buyer’s argument that the agreement implied expert determination due to a lack of limiting language to that effect.
Conclusion:
In this case, the court ruled that E&Y’s calculation of the earnout dispute was an arbitration, not an expert determination. Consequently, the buyer’s opportunity to litigate the dispute in court was denied. The court highlighted that the presence of explicit wording, such as “as an expert and not as an arbitrator,” would have changed the outcome.
Case Reference:
This case is referred to as SGS North America, Inc. v. Mullholand, No. 19A-PL-1283, Court of Appeals of Indiana (November 14, 2019)
By John McCauley: I help companies and their lawyers minimize legal risk associated with small U.S. business mergers and acquisitions (transaction value less than $50 million
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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