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San Diego Mergers and Acquisitions: “Arbitration” Versus “Expert Determination”

Contract law truly has infinite flexibility and complexity. Indeed, these are two of the greatest attributes of contract law. Since contracts are creatures of intent, the only limits are the creativity and desires of the parties. One example is the flexibility of how disputes can be resolved. Often it seems as though litigation and arbitration are the only two options, but there are many other forms of dispute resolution. One option is mediation, which we have discussed in other articles on this website. Another option is what is called “expert determination.” Expert determination is probably most useful for discrete and limited disputes and where the issue is technical, financial, or scientific. Expert determination is increasingly being used for mergers and acquisitions with respect to post-closing accounting adjustments. A trusted San Diego corporate attorney with experience in mergers and acquisitions can help draft expert determination clauses.

The key with establishing expert determination as your dispute resolution mechanism is to specify the method of choosing the expert, the exact dispute to be resolved, and to explicitly state that the expert is acting as an expert and not as an arbitrator.

Two recent mergers and acquisitions cases out of Delaware provide examples. Sometimes, important legal lessons can be gleaned from cases in our sister States. The first case from the summer of 2018 is Penton Business Media Holdings, LLC v. Informa PLC., C.A. No. 2017-0847-JTL (Del: Court of Chancery 2018). That case involved the acquisition of Penton by Informa. The parties entered into a merger agreement that provided for post-closing allocation of the value of certain tax benefits related to the merger. The parties agreed that an expert determination would be used if there was a dispute about how to allocate the tax benefits. The relevant provision in the Merger Agreement identified an accounting firm and stated that the accountant “shall be acting as an accounting expert only and not as an arbitrator and shall not import or take into account usage, custom or other extrinsic factors.” In the months following the closing, disputes arose about the tax allocations and then disputes arose about what information the accountant was supposed to use in making the expert determination. The Seller, Penton, wanted the accountant to rely solely on the business expenditures and standard accounting practices. The buyer, Informa, wanted the accountant to consider those factors and extrinsic information like the Merger Agreement, the merger Term Sheet, and other documents related to the deal. Eventually, the matter ended up in court.

In resolving the case, the Delaware court held that a distinction still existed in the law between arbitration and expert determination. Normally, arbitrators are given the power to examine what evidence they deem as relevant and to make interpretations. This is the position argued by the buyer. The buyer argued that the accountant was acting in the manner of an arbitrator and should consider all the information. The Delaware court disagreed. Since the parties clearly delineated the accountant as “an account expert only and not as an arbitrator,” then the expert was not given the typical powers afforded to an arbitrator. Thus, the second part of the clause quoted above was properly limiting. The accountant was not to consider “account usage, custom or other extrinsic factors.” Ruling was made in favor of the Seller, Penton.

The Penton case highlights the need to specify that an expert is acting as an expert and not as an arbitrator.

Another recent case highlights the importance of carefully defining what the expert determination is to determine. See Ray Beyond Corp. v. Trimaran Fund Management, LLC, C.A. No. 2018-0497-KSJM (Del. Chan. January 29, 2019). As with the Penton case, the litigation arose following a merger that occurred in April 2018. The Merger Agreement specified that certain funds from the proceeds would be escrowed and that if disputes arose with respect to releasing the escrowed funds, the dispute(s) would be delegated to an accounting expert for resolution. Some of the escrowed funds could not be released unless the buyer entered into certain qualifying contracts with third parties. A dispute arose as to whether contracts entered into by the buyer were qualifying contracts under the Merger Agreement and the escrow conditions. The buyer sought to have the accounting expert resolve the question of whether those agreements allowed for release of the escrowed funds. The Seller disagreed, and the dispute ended up in court.

The Delaware Chancery Court began its analysis by agreeing that “[e]xpert determination provisions are fundamentally different from arbitration provisions.” The power of an arbitrator is generally broad. By contrast, the power of an expert is generally narrow and limited by the contract at issue. The Court then looked to the Merger Agreement for the definition of what the expert was empowered to determine. The court held that the dispute over how to interpret the escrow conditions and whether contracts that had been entered into were “qualifying” was beyond the scope of the powers given to the accounting expert. The expert was limited by the Merger Agreement to disputes involving accounting skills and expertise, not the legal skills necessary to interpret contracts and escrow conditions. The court refused to send the dispute to the accounting expert.

Contact San Diego Corporate Law

If you are considering a business merger or acquisition, contact attorney Michael Leonard of San Diego Corporate Law. Mr. Leonard has many years of experience handling all aspects of the sale or purchase of businesses in California. Mr. Leonard’s law practice is focused on business, transactional, and corporate matters. To schedule a consultation, contact Mr. Leonard via email or call at (858) 483-9200. San Diego Corporate Law proudly provides legal services to business owners in San Diego and the surrounding communities. Like us on Facebook.

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