M&A Disputes. Biemans A. Vincent

judges, but can still involve accountants to provide consulting services and/or educate the trier of fact on the relevant accounting issues as a retained expert.

      Disputes in the third category – adjustments based on representations, warranties, and indemnifications – are typically legal in nature. Moreover, although the related payments may be considered adjustments to the purchase price from an accounting perspective, the purchase agreements typically treat those items as payments between the parties and not explicitly as purchase price adjustments, unless for accounting or tax purposes. In our experience, it is highly uncommon for disputes in the third category to be brought before an independent accountant.

      Notwithstanding, the findings of the independent accountant in relation to a dispute in the first category can indirectly impact the outcome of disputes in the second and third categories. By means of example, the accounting arbitrator can rule on the amount that should be included on the balance sheet as of the closing date for a partially performed contract, which would fall under the first category. That starting balance and the associated accounting can then have an impact on the amount of revenue that should be recognized in the year subsequent to closing. As a result, the accountant's ruling related to balance sheet work‐in‐progress accounting can impact the amount of the earn‐out owed to the seller for performance subsequent to closing. Similarly, by means of another example, the independent accountant could rule on the appropriate amount to be included on the balance sheet as a tax accrual. If the purchase agreement also contains a clause that arranges for indemnification of prior period taxes in excess of the applicable tax accrual, the ruling of the independent accountant in the context of a category 1 adjustment could very well impact a purchase price adjustment in relation to category 3.

      As this book relates to accounting arbitrations as opposed to civil litigation, it focuses primarily on the conception, negotiation, and adjudication of the first category of post‐closing purchase price adjustments. The most prevalent adjustment mechanism in this category is for the amount of net working capital that exists on the target company's balance sheet as of the closing date. Post‐closing net working capital adjustments also form the bulk of post‐closing disputes that are brought before an accounting arbitrator.

      Given their prevalence in practice as well as the analogous applicability of many of the identified issues to other adjustment mechanisms, the majority of this book will focus on net working capital–based adjustment mechanisms and disputes. Notwithstanding, we mention other purchase price adjustment mechanisms and disputes throughout this book where appropriate. We also specifically discuss certain other adjustment mechanisms, including EBITDA‐based adjustments and earn‐outs in Chapter 22.

      ACCOUNTING ARBITRATIONS VERSUS EXPERT DETERMINATIONS

      Post‐closing purchase price adjustment disputes before an independent accountant can take the formal form of an accounting arbitration or of an expert determination. There are a variety of legal consequences that may be associated with the selection of one over the other regarding, for example, the accountant's legal powers and the enforceability of the conclusion.

      The parties may (or may not) preemptively select one formal approach over the other in the purchase agreement. The dispute resolution process before the independent accountant and the issues at play, however, are typically the same whether the parties opt for expert determination or arbitration.

      Since for purposes of this book the terms are essentially interchangeable, we will refer to both arbitrations and expert determinations as accounting arbitrations or arbitrations throughout this book. Similarly, we will refer to the independent accountant as the accounting arbitrator or arbitrator whether he or she was retained to issue an arbitration award or to render an expert determination. The same is not uncommon in various articles and other publications on the topic of M&A disputes.

      OVERVIEW OF THE BOOK

      In this book, we will cover the various aspects of the accounting arbitration process as well as selected common arguments and issues. We will use the net working capital adjustment mechanism as the basis for most of our discussion.

      First, we provide an overview of the dispute phase to briefly introduce the post‐closing dispute resolution process (Chapter 2) as well as an overview of post‐closing net working capital adjustments (Chapter 3). Those two chapters will provide the reader with foundational information to place the subsequent chapters in context.

      We then address some of the core concepts and issues at the foundation of many post‐closing purchase price adjustments and disputes, including the nature of GAAP (Chapter 4), the concept of past practices in accordance with GAAP (Chapter 5), and several other important and commonly recurring items (Chapters 6–9).

      After this, we discuss the post‐closing purchase price dispute process in more detail. We start off with opportunities for mitigation that are available to the parties prior to the dispute being brought before the accounting arbitrator (Chapter 10). We then discuss the entire dispute process from retention of the accounting arbitrator through the award (Chapters 11–14).

      After discussing the process, we discuss common sources of adjustments, including some specific financial statement accounts (Chapters 15–19). We include technical accounting guidance as well as advice on the documentation and presentation of arguments to the accounting arbitrator.

      Finally, we cover other relevant topics, including a discussion of purchase agreements and their relevant provisions (Chapter 20), the interaction of net working capital adjustments and indemnification provisions (Chapter 21), other adjustment mechanisms (Chapter 22), and selected international considerations (Chapter 23).

      Overall, this book is meant to provide in‐depth professional guidance for practitioners. It cannot, however, exhaustively cover each possible variation. There are few absolute truths in a field for which the framework is predominantly set by contractual arrangements between sellers and buyers in combination with accounting guidance. In order to keep the book readable, we have attempted to avoid inserting “typically” or “generally” into every statement even when exceptions can exist. We urge the reader to carefully evaluate the facts, circumstances, and legal context of the individual cases with which he or she comes into contact. As we cover the various topics, we have attempted to illustrate important concepts with examples. Those examples are simplified to illustrate specific concepts, are fictitious, and are not meant to capture the full nuance of real‐world matters.

CHAPTER 2

      The Post‐Closing Adjustment and Dispute Process

      The previous chapter introduced the transaction lifecycle and briefly discussed how the activities in the pre‐closing phase can impact a purchase price adjustment dispute in the post‐closing phase. We now highlight the different elements of the post‐closing purchase price adjustment process in more detail to provide a framework for the rest of the book. Although we introduce the dispute resolution process in this chapter, we cover it much more extensively later in the book.

      FROM CLOSING TO DISPUTE

      The transaction has closed and the parties are in the honeymoon period. Nothing spoils this pleasant period like an accounting arbitration. How do the parties get from a mutually agreeable closing to a formal dispute? The answer – a disagreement regarding the need for, or the appropriate amount of, an adjustment to the purchase price.

      The