IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
ALLIANT TECHSYSTEMS, INC., ) ) Plaintiff, ) ) v. ) C.A. No. 9813-CB ) MIDOCEAN BUSHNELL ) HOLDINGS, L.P., ) ) Defendant. )
MEMORANDUM OPINION
Date Submitted: February 3, 2015 Date Decided: April 24, 2015
William M. Lafferty, Kevin M. Coen, and D. McKinley Measley of MORRIS, NICHOLS, ARSHT & TUNNELL LLP, Wilmington, Delaware; Thomas G. Rafferty and Antony L. Ryan of CRAVATH, SWAINE & MOORE LLP, New York, New York; Attorneys for Plaintiff.
David E. Ross of ROSS ARONSTAM & MORITZ LLP, Wilmington, Delaware; Matthew Solum and David S. Flugman of KIRKLAND & ELLIS LLP, New York, New York; Attorneys for Defendant.
BOUCHARD, C. I. INTRODUCTION
This action requires the Court to interpret the terms of a stock purchase agreement
to determine whether a dispute over accounting methodology relating to the calculation
of net working capital must be resolved by an accountant under a purchase price
adjustment procedure or by a court as a claim for breach of a representation and warranty.
In 2013, Alliant Techsystems Inc. (“ATK”) agreed to purchase Bushnell Group
Holdings, Inc. (“Bushnell”) from MidOcean Bushnell Holdings, L.P. (“MidOcean”) for
$985 million, subject to post-closing adjustments to be made in accordance with the
terms of a stock purchase agreement (the “Agreement”). The Agreement contains two
“sole and exclusive” remedy provisions. One provision requires the parties to use an
independent accounting firm of national reputation to resolve disputes concerning
adjustments to the estimated purchase price, including disputes concerning the
calculation of net working capital. It contains a specified cap. The other provision
governs claims for indemnification. It imposes a lower cap on either party’s ability to
recover from the other for any claims concerning the transaction, including any claim for
breach of a representation or warranty, except in certain defined circumstances. One
exception is for matters falling within the purchase price adjustment procedure.
After the transaction closed, ATK challenged a number of items underlying
MidOcean’s estimate of net working capital on the ground that the accounting treatment
for such items did not comply with United States generally accepted accounting
principles (“GAAP”). MidOcean objected, asserting that disputes over accounting
methodology cannot be raised as part of the purchase price adjustment procedure. The
1 filing of this lawsuit followed. ATK seeks an order of specific performance requiring
MidOcean to submit the current dispute to an accounting firm under the purchase price
adjustment procedure. MidOcean seeks a declaration that claims asserting purported
violations of GAAP must be resolved by a court in accordance with the provisions
governing claims for indemnification. The net amount of the parties’ dispute stands at
approximately $22 million, or a little over two percent of the estimated purchase price.
This Court and courts in other jurisdictions have reached different results in
determining whether a dispute over accounting methodology may be resolved as part of a
purchase price adjustment process. 1 This is not surprising. Claims of this nature are
creatures of contract and counterparties to a transaction are free to contractually order
their affairs as they wish. The critical issue for the Court to decide here is what the
shared intentions of the contracting parties were when they entered the Agreement.
For the reasons discussed below, I conclude based on the plain terms of the
Agreement that the present dispute over the calculation of net working capital fairly may
be raised under the purchase price adjustment procedure even though that dispute
implicates issues of accounting methodology that also could form the basis of an
1 Compare Matria Healthcare, Inc. v. Coral SR LLC, 2007 WL 763303, at *7 (Del. Ch. Mar. 1, 2007) (finding that the dispute over accounting methodology that could fit within both the AAA arbitration process for claims and the purchase price adjustment process before a settlement accountant must be resolved by the settlement accountant), with OSI Sys., Inc. v. Instrumentarium Corp., 892 A.2d 1086, 1095 (Del. Ch. 2006) (finding that a dispute over accounting methodology raised during the purchase price adjustment procedure that would have resulted in a 54% reduction of the purchase price constituted a disguised indemnity claim that must be resolved in legal arbitration and not by an accountant).
2 indemnification claim for breach of a representation and warranty. I further conclude that
where a dispute could be brought either as part of the purchase price adjustment
procedure or as an indemnification claim, the Agreement specifically provides that the
exclusive remedy provision in the purchase price adjustment procedure trumps the
exclusive remedy provision for indemnification claims. Accordingly, judgment is
entered in ATK’s favor granting its request for specific performance and denying
MidOcean’s motion for summary judgment.
II. BACKGROUND 2
A. The Parties
Plaintiff Alliant Techsystems Inc. is a Delaware corporation with its principal
place of business in Arlington, Virginia. ATK is a developer and manufacturer of
aerospace, defense, and sporting products.
Non-party Bushnell Group Holdings, Inc. is a Delaware corporation that sells
branded sports optics, outdoor accessories, and performance eyewear.
Together with its subsidiaries, Bushnell is referred to at times as the “Company.”
Defendant MidOcean Bushnell Holdings, L.P. is a Delaware limited partnership.
2 Unless noted otherwise, the facts recited in this opinion are based on the well-pled facts admitted to be true in MidOcean’s Verified Answer (the “Answer”). See Warner Commc’ns Inc. v. Chris–craft Indus., Inc., 583 A.2d 962, 965 (Del. Ch. 1989), aff’d, 567 A.2d 419 (Del. 1989) (TABLE). I also consider the unambiguous terms of the stock purchase agreement, which was attached to the complaint. See OSI Sys., Inc., 892 A.2d at 1089, 1095 (“The court also may consider the unambiguous terms of exhibits attached to the pleadings . . . .”) (granting judgment on the pleadings).
3 B. The Purchase Agreement
On September 4, 2013, ATK agreed to acquire Bushnell for $985 million
(including debt), subject to certain post-closing adjustments. The final Purchase Price
was to be determined through a process (the “Purchase Price Adjustment Procedure”) that
would take into account, among other things, whether any adjustment should be made for
changes in Net Working Capital between the date of the Agreement and the Closing of
the transaction. 3
Net Working Capital is defined as the sum of all current assets minus the sum of
all current liabilities “calculated in accordance with GAAP and otherwise in a manner
consistent with the practice and methodologies used in the preparation of” certain
financial statements of the Company. 4 The assumed amount of Net Working Capital in
the Agreement is $188.1 million. 5 The Net Working Capital Adjustment is the amount
by which Net Working Capital at Closing is greater or less than $188.1 million.
1. Section 2.4 of the Agreement
As is common in stock purchase agreements, the Agreement contains a multi-step
process to determine the final Purchase Price. That process is spelled out in Section 2.4.
3 Unless otherwise defined herein, all capitalized terms have the meaning given to them in the Purchase Agreement. 4 Compl. Ex. A § 1.1 (the “Purchase Agreement”) (definition of “Net Working Capital”). The relevant financial statements are the Company’s audited consolidated balance sheets as of December 31, 2010, December 31, 2011, and December 31, 2012, and the related audited consolidated statements of income, cash flows and stockholders’ equity for each fiscal year of the Company then ended. See Purchase Agreement § 3.4(a)(i). 5 Purchase Agreement § 1.1 (definition of “Net Working Capital Adjustment”).
4 First, no later than three business days before the Closing, MidOcean was required
to deliver to ATK a statement setting forth reasonably detailed calculations of certain
amounts from which an estimated Purchase Price would be computed. 6 Relevant here,
MidOcean was required to provide its good faith estimate as of the Closing of the Net
Working Capital of the Company and the related Net Working Capital Adjustment from
the $188.1 million of Net Working Capital assumed in the Agreement.
Second, no later than 60 days after the Closing, ATK (as the buyer now in
possession of the business) was required to deliver to MidOcean reasonably detailed
calculations of certain amounts (the “Proposed Closing Date Calculations”), including the
Net Working Capital of the Company as of the Closing and the related Net Working
Capital Adjustment. 7
Third, after receiving the Proposed Closing Date Calculations from ATK,
MidOcean had 45 days to review them and to deliver to ATK a written notice of dispute
(the “Purchase Price Dispute Notice”) specifying “in reasonable detail those items or
amounts in [ATK’s] calculation of the Proposed Closing Date Calculations as to which
[MidOcean] disagrees (the ‘Disputed Items’) and the basis for such disagreement.” 8
If MidOcean delivered to ATK a Purchase Price Dispute Notice, the parties were
then required to “use their respective commercially reasonable efforts to reach agreement
6 Id. § 2.4(a). 7 Id. § 2.4(b)(i). 8 Id. § 2.4(b)(ii).
5 on the Disputed Items set forth in the Purchase Price Dispute Notice in good faith during
the 30-day period commencing on the date Buyer receives the applicable Purchase Price
Dispute Notice from the Seller.” 9 If ATK and MidOcean were unable to agree upon a
final resolution of the Disputed Items, they were required to submit the remaining
Disputed Items immediately “to an independent accounting firm of national reputation
mutually acceptable” to them (the “Accounting Firm”). 10
Under the Agreement, the Accounting Firm must act “as an expert, and not as an
arbitrator” and may only issue determinations with respect to Disputed Items based “on
the definitions and other applicable provisions of [the] Agreement.” 11 The Agreement
limits the recovery for a Purchase Price adjustment to the amounts held in two escrow
accounts that were established at the Closing: the Adjustment Escrow Account ($5
million) and the Indemnity Escrow Account ($7,387,500). 12
The Agreement expressly states that the Purchase Price Adjustment Procedure is
the sole and exclusive method for resolving the Disputed Items: “[T]he procedures set
forth in this Section 2.4 for resolving disputes with respect to the Proposed Closing Date
Calculations shall be the sole and exclusive method for resolving any Disputed Items.” 13
9 Id. 10 Id. 11 Id. 12 See Id. §§ 2.4(a)(i)-(ii), c(ii). 13 Id. §2.4(b)(iv).
6 2. Article IX of the Agreement
Article IX of the Agreement sets forth the parties’ indemnification rights. In
Section 9.1, MidOcean agreed to indemnify and hold harmless ATK for, among other
things, “any breach or default in performance by the Company or the Seller of any
covenant or obligation of the Company or the Seller . . . [and] any breach of, or
inaccuracy in, any representation or warranty of the Company or the Seller contained in
this Agreement.” 14 Among other things, the Company represented and warranted to
ATK that its year-end 2010, 2011, and 2012 audited financial statements and its April 30,
2013, unaudited financial statements were “prepared in accordance with GAAP applied
on a consistent basis throughout the periods covered thereby.” 15
Section 9.3 of the Agreement imposes certain limitations on the parties’
indemnification rights. Specifically, Section 9.3(b)(ii) provides that MidOcean will not
be required to indemnify ATK unless the aggregate of all claims “exceeds the Indemnity
Threshold, and then only to the extent such Losses exceed the Indemnity Threshold,” 16
which could be as high as $4,925,000. 17 The parties also agreed to limit their respective
liability for indemnity claims to the amount in the Indemnity Escrow Account. 18
14 Id. § 9.1(a)(i)-(ii). 15 Id. § 3.4(a). 16 Id. § 9.3(b)(ii). 17 More precisely, the Indemnity Threshold is defined as “the greater of (i) zero and (ii) (a) $4,925,000 less (b) the Interim Loss Estimate Amount.” Id. § 1.1. 18 Id. § 9.3(c)(i) (“Seller shall not be required to indemnify any Buyer Indemnified Party and shall not have any liability under Section 9.1 for amounts in the aggregate in excess 7 Section 9.5 of the Agreement provides that the “sole and exclusive remedy” for
any claim relating to the transaction shall be governed and limited by the indemnification
provisions in Article IX, with certain exceptions:
Except as otherwise expressly provided in any Ancillary Document and, in the case of the Buyer Indemnified Parties as provided in the Representation and Warranty Insurance Policy, from and after the Closing, the sole and exclusive remedy of each Buyer Indemnified Party and Seller Indemnified Party as against any Indemnifying Party, with respect to all claims of any nature whatsoever relating to the Transactions, including any breach of any representation, warranty, covenant or agreement contained in this Agreement, shall be pursuant to and limited by the indemnification provisions set forth in this Article IX, it being understood that (x) the foregoing limitations shall not apply in respect of a claim of fraud or for the remedies of injunctive relief or specific performance set forth herein and (y) nothing in this sentence shall operate to interfere with or impede the operation of the provisions of Section 2.4 or 6.2(e). 19 Notwithstanding anything to the contrary set forth herein, but except as otherwise expressly provided in any Ancillary Document, (A) any amount to which any Buyer Indemnified Party is entitled pursuant to this Article IX (other than with respect to Interim Losses) shall be limited to, and solely satisfied from, the funds that remain in the Indemnity Escrow Account at the time . . . . 20
The language in proviso (y) of the first sentence emphasized above (“Proviso (y)”) is an
exception to the sole and exclusive remedy limitation in Section 9.5 that carves out
disputes falling within the operation of the Purchase Price Adjustment Procedure in
Section 2.4.
of the Indemnity Escrow Amount (other than with respect to Interim Losses) and Seller shall not be required to indemnify any Buyer Indemnified Party and shall not have any liability under Section 9.1 other than out of the Indemnity Escrow Account (other than with respect to Interim Losses).”). 19 Id. § 9.5 (emphasis added).
8 To prevent double recoveries, the Agreement provides that the “amount of any
Loss for which indemnification is provided” would be net of, among other things, “any
actual cash payments, setoffs or cash recoupment of any payments . . . in each case
actually received, realized or retained by the indemnified party as a result of any event
giving rise to a claim for such indemnification.” 21
3. Section 2.4 vs. Section 9.5
There are two significant differences between the exclusive remedy provisions in
Sections 2.4 and 9.5 of the Agreement that bear on the parties’ dispute in this case. First,
Purchase Price disputes under Section 2.4 are to be resolved by an Accounting Firm on a
compressed schedule 22 while indemnification claims under Section 9.5 are to be resolved
in a judicial proceeding. Second, for a Purchase Price dispute, ATK can recover from
MidOcean beginning with its first dollar of loss against the funds available in both the
Adjustment Escrow and Indemnity Escrow Accounts, i.e., up to $12,387,500. 23 For an
indemnification claim, with certain exceptions not relevant here, ATK may only recover
from MidOcean if its claim exceeds the Indemnity Threshold (up to $4,925,000) and any
recovery from MidOcean is limited to the funds available in the Indemnity Escrow
21 Id. § 9.3(d). 22 Id. § 2.4(b)(ii) (“The Accounting Firm shall be requested to render a written determination of the Disputed Items . . . within 45 days after referral of the matter to such Accounting Firm . . . .”). 23 Id. §§ 2.4(a)(i)-(ii), (c)(ii).
9 Account, i.e., up to $7,387,500. 24 As reflected in the Agreement, an insurance policy
provides ATK an additional potential source of recovery for certain indemnification
claims. 25
C. Events Leading to the Present Dispute
On or about October 31, 2013, MidOcean delivered to ATK a statement of the
estimated Purchase Price and its components, including its good faith estimate of Net
Working Capital and the related Net Working Capital Adjustment. 26 MidOcean’s
estimate of Net Working Capital was $192,407,000. Because this estimate exceeded the
assumed amount of $188.1 million in the Agreement, an upward adjustment to the
Purchase Price was made in MidOcean’s favor relating to Net Working Capital in the
amount of $4,307,000. 27 At the Closing, which occurred on or about November 1,
2013, ATK paid the adjusted Purchase Price to MidOcean, less certain amounts that ATK
paid into specified escrow accounts. 28
On December 30, 2013, ATK delivered to MidOcean its Proposed Closing Date
Calculations. ATK calculated that Net Working Capital as of Closing was $166,447,000.
Based on this calculation, ATK asserted that MidOcean owed it a net amount of
24 Id. §§ 1.1 (definition of “Indemnity Threshold”), 9.3(b)(ii), 9.3(c), 9.5. 25 See id. § 9.9 (“Seller and the Company acknowledge that Buyer is entering into the Representation and Warranty Insurance Policy . . . .”). 26 Answer ¶ 28. 27 Compl. ¶ 28. The complaint states that the estimated Net Working Capital Adjustment was $4,317,800. I believe this is a typographical error, but the difference is immaterial. 28 Answer ¶ 29.
10 $25,960,000 relating to Net Working Capital. 29 In its cover letter, ATK expressly
reserved its right to pursue claims under the indemnification provisions of the
Agreement. 30
On March 14, 2014, MidOcean gave a Purchase Price Dispute Notice to ATK in
which it disputed, among other things, the accuracy of ATK’s calculation of Net Working
Capital. 31 According to MidOcean, its calculation deviated from ATK’s calculation
because, among other reasons, ATK “ignored the requirement that the Proposed Closing
Date Calculations are determined based on the practices and methodologies used by the
Company in the preparation of the Financial Statements referenced in Section 3.4(a)(i) of
the Agreement.” 32
Delivery of the Purchase Price Dispute Notice initiated the thirty-day period
during which the parties were to use commercially reasonable efforts to resolve the
Disputed Items. 33 During this process, the parties resolved their disagreements over
certain Disputed Items worth over $3.6 million, 34 but approximately $22 million remains
in dispute, all of which relates to the calculation of Net Working Capital.
29 In its Proposed Closing Date Calculations, ATK also disagreed with MidOcean’s estimate of Cash and Cash Equivalents. That dispute has been resolved. 30 Answer Ex. C. 31 Answer Ex. D at 1. 32 Id. at 2. 33 See Purchase Agreement § 2.4(b)(ii). 34 Answer ¶ 39.
11 On May 15, 2014, MidOcean sent a letter to ATK advising that it would not
submit the remaining Disputed Items to an Accounting Firm for final resolution. 35
MidOcean stated “that the discrepancy in the parties’ position is based largely, if not
entirely,” on whether certain items “were accounted for in accordance with generally
accepted accounting principles (see Agreement § 3.4) and in accordance with the
inventory representation in the Agreement (see Agreement § 3.22).” 36 MidOcean thus
asserted that the dispute “cannot be resolved through the working capital arbitration
process or by an accounting firm pursuant to Section 2.4(b)(ii) of the Agreement,” but
instead had to be resolved in accordance with Article IX of the Agreement. 37
On May 23, 2014, ATK sent a letter to MidOcean disagreeing with its position.
ATK openly acknowledged that the parties’ dispute involved whether ATK’s “Proposed
Closing Date Calculations . . . were prepared in accordance with GAAP” 38 and asserted
that the dispute nonetheless should be resolved by an Accounting Firm under the
Purchase Price Adjustment Procedure in Section 2.4 of the Agreement. 39 ATK proposed
three accounting firms and asked MidOcean to identify which of those firms were
35 Answer Ex. B. 36 Id. at 1. 37 Id. at 2. 38 Answer Ex. E at 3. 39 Id. at 1-2. 12 acceptable to it or to propose an alternative independent accounting firm of national
reputation. 40
On May 30, 2014, MidOcean reiterated its position that ATK was alleging a
breach of a representation and that “any claim for an alleged breach of a representation
was limited to the indemnity process.” 41 On June 24, 2014, ATK filed this lawsuit.
D. Procedural History
ATK’s complaint contains one count for specific performance seeking to direct
MidOcean to submit the remaining Disputed Items immediately to an Accounting Firm
under Section 2.4(b)(ii) of the Agreement. 42
On July 28, 2014, MidOcean filed its answer and a counterclaim. The
counterclaim seeks a declaration that ATK’s claims asserting purported violations of
GAAP must be resolved through the indemnity procedure set forth in Article IX. 43
On November 7, 2014, ATK filed a motion for judgment on the pleadings. On
December 5, 2014, MidOcean filed a cross-motion for summary judgment. On February
3, 2015, I heard oral argument on both motions.
40 Id. at 3. 41 Answer Ex. F at 2. 42 Compl. ¶ 50. 43 Answer ¶ 41.
13 III. LEGAL ANALYSIS
A. The Legal Standard
Under Court of Chancery Rule 12(c), ATK’s motion for judgment on the
pleadings must be denied unless, accepting as true all well-pled facts admitted in the
answer and drawing all reasonable inferences from those facts in MidOcean’s favor, 44
“no material issue of fact exists and the movant is entitled to judgment as a matter of
law.” 45 Similarly, MidOcean’s motion for summary judgment will be granted only if it is
able to demonstrate that there are no material facts in dispute and that it is entitled to
judgment as a matter of law. 46
Under Delaware law, which governs the Agreement, 47 the “proper interpretation
of language in a contract, while analytically a question of fact, is treated as a question of
law both in the trial court and on appeal,” 48 and “judgment on the pleadings . . . is a
44 See Warner Commc’ns Inc. v. Chris-Craft Indus., Inc., 583 A.2d 962, 965 (Del. Ch. 1989), aff’d, 567 A.2d 419 (Del. 1989). 45 Desert Equities, Inc. v. Morgan Stanley Leveraged Equity Fund, II, L.P., 624 A.2d 1199, 1205 (Del. 1993) (“In determining a motion under Court of Chancery Rule 12(c) for judgment on the pleadings, a trial court is required to view the facts pleaded and the inferences to be drawn from such facts in a light most favorable to the non-moving party.”). 46 Ct. Ch. R. 56(c). 47 Purchase Agreement § 10.5. 48 Pellaton v. Bank of New York, 592 A.2d 473, 478 (Del. 1991) (quoting Klair v. Reese, 531 A.2d 219, 222 (Del. 1987)).
14 proper framework for enforcing unambiguous contracts.” 49 That the parties dispute how
to interpret the Agreement does not render it ambiguous. Rather, under Delaware law, “a
contract is ambiguous only when the provisions in controversy are reasonably or fairly
susceptible of different interpretations or may have two or more different meanings.” 50
In my view, the present dispute can be resolved based on unambiguous provisions of the
Agreement.
B. The Parties’ Contentions
As discussed above, Section 2.4 of the Agreement sets forth the sole and exclusive
remedy for resolving disputes over adjustments to the Purchase Price and Section 9.5 of
the Agreement sets forth the sole and exclusive remedy for resolving indemnification
claims. The fundamental issue to be decided in this case is which of these two exclusive
remedy provisions governs the parties’ dispute over the calculation of Net Working
Capital given that this dispute, as ATK admits, also could form the basis for an
indemnification claim under Section 9.5 for breach of a representation or warranty in the
Agreement. 51
49 NBC Universal, Inc. v. Paxson Comm. Corp., 2005 WL 1038997, at *5 (Del. Ch. Apr. 29, 2005). 50 Rhone-Poulenc Basic Chems. Co. v. Am. Motorists Ins. Co., 616 A.2d 1192, 1196 (Del. 1992). 51 As noted above, the Company represented and warranted to ATK that its year-end 2010, 2011, and 2012 audited financial statements and its April 30, 2013 unaudited financial statements were “prepared in accordance with GAAP applied on a consistent basis throughout the periods covered thereby.” Purchase Agreement § 3.4(a). It is reasonably inferable that the amount of Net Working Capital assumed in the Purchase Agreement ($188.1 million) was derived from these financial statements. See Oral Arg. 15 MidOcean argues that Sections 2.4 and 9.5 of the Agreement were intended to
address different types of disputes. According to MidOcean, the “Accounting Firm
dispute resolution process in [Section 2.4 of] the Agreement is limited deliberately to the
‘items or amounts in Buyer’s calculation of the Proposed Closing Date Calculations as to
which the Seller disagrees’ ” and was never intended to “resolve questions over the
proper interpretation of GAAP.” 52 MidOcean further contends that, to the extent the
provisions overlap, Section 9.5 provides the exclusive remedy for resolving disputes over
GAAP. 53
ATK argues based on the definition of Net Working Capital in the Agreement that
certain (but not all) disagreements over compliance with GAAP relating to the calculation
of Net Working Capital – including the ones at issue here – fall within the scope of
matters that the Accounting Firm may resolve as part of the Purchase Price Adjustment
Procedure in Section 2.4. ATK further argues that the Agreement contains a hierarchy
requiring that such disputes, even though they also could form the basis of an
indemnification claim under Section 9.5, be resolved by the Accounting Firm. In other
words, MidOcean argues that the exclusive remedy provision in Section 2.4 trumps the
exclusive remedy provision in Section 9.5 when the provisions overlap.
Tr. 10 (Feb. 3, 2015). MidOcean’s estimate of Net Working Capital presumably was based on the same accounting methodology used in these financial statements, which ATK challenges in various respects as not being calculated in accordance with GAAP. 52 MidOcean Op. Br. 21 (quoting Purchase Agreement § 2.4(b)(ii)). 53 MidOcean Reply Br. 16-18.
16 For the reasons discussed below, I agree with ATK’s interpretation.
C. The Present Dispute over Compliance with GAAP must be Resolved Under the Purchase Price Adjustment Procedure
In my opinion, the plain terms of the Agreement compel the conclusion that the
parties’ disagreement over the calculation of Net Working Capital falls within the scope
of the Purchase Price Adjustment Procedure in Section 2.4 of the Agreement even though
that disagreement implicates issues concerning compliance with GAAP that could form
the basis for an indemnification claim under Section 9.5.
To begin, Section 2.4 provides a procedure to resolve disputes over “Disputed
Items,” which consists of “those items or amounts in Buyer’s calculation of the Proposed
Closing Date Calculations as to which the Seller disagrees.” 54 Net Working Capital is
one of the Proposed Closing Date Calculations to which MidOcean has disagreed.
Net Working Capital is defined in the Agreement, in relevant part, as follows:
the sum of all current assets . . . of the Group Companies less the sum of all current liabilities . . . of the Group Companies, in each case determined on a consolidated basis without duplication as of 12:01 a.m. New York time on the Closing Date and calculated in accordance with GAAP and otherwise in a manner consistent with the practices and methodologies used in the preparation of the Financial Statements referenced in Section 3.4(a)(i) . . . . 55
Importantly, the Agreement requires that MidOcean prepare its estimated Purchase Price,
which includes its good faith estimate of Net Working Capital, in accordance with the
54 Purchase Agreement § 2.4(b)(ii). 55 Id. § 1.1 (definition of “Net Working Capital”) (emphasis added).
17 definitions in the Agreement. 56 It similarly requires that ATK prepare its Proposed
Closing Date Calculations, including its calculation of Net Working Capital, in
accordance with those same definitions, 57 and that the Accounting Firm’s determination
ultimately be based on those same definitions. 58
To be faithful to the definition of Net Working Capital in the Agreement quoted
above, Net Working Capital had to be: “[i] calculated in accordance with GAAP and [ii]
otherwise in a manner consistent with the practices and methodologies used in the
preparation of the Financial Statements referenced in Section 3.4(a)(i).” 59 GAAP is not a
set of prescriptive rules. Instead, GAAP “tolerate[s] a range of ‘reasonable’ treatments,
leaving the choice among alternatives to management.” 60
Thus, applying the two parts built into the definition of Net Working Capital, if
MidOcean was following GAAP when it submitted its good faith estimate of Net
Working Capital, ATK could not seek to adjust Net Working Capital when it prepared its
Proposed Closing Date Calculations by selecting another GAAP-compliant accounting
56 Id. § 2.4(a) (requiring that the components of MidOcean’s estimated Purchase Price be “calculated in accordance with the terms of this Agreement (including the applicable definitions set forth herein)”). 57 Id. § 2.4(b)(i) (requiring that ATK prepare a reasonably detailed calculation of Net Working Capital “in a manner consistent with the definitions thereof and otherwise in accordance with the terms of [the] Agreement.”). 58 Id. 2.4(b)(ii) (Accounting Firm’s determination “must be based solely on definitions and other applicable provisions of [the] Agreement”). 59 Id. § 1.1 (definition of “Net Working Capital”). 60 Thor Power Tool Co. v. Comm’r, 439 U.S. 522, 544 (1979).
18 treatment different from Bushnell’s historical accounting practices and methodologies.
ATK concedes as much. 61 On the other hand, if MidOcean was not following GAAP
when it submitted its good faith estimate of Net Working Capital, then in my view
Section 2.4 of the Agreement permitted ATK to put forward a calculation of Net
Working Capital it believes complies with GAAP when it prepared its Proposed Closing
Date Calculations.
To construe Section 2.4 otherwise and require ATK to calculate Net Working
Capital in the same manner Bushnell had done historically, even if that methodology did
not comply with GAAP, would be to read the words “calculated in accordance with
GAAP” out of the definition of Net Working Capital and to ignore the multiple
requirements in Section 2.4 to adhere to the definitions in the Agreement in connection
with the Purchase Price Adjustment Procedure. Such an interpretation would contravene
basic principles of contract construction requiring that contracts be read as a whole and
that meaning be given to all the provisions of the contract whenever possible. 62
Had the parties intended to proscribe ATK from challenging whether MidOcean’s
estimate of Net Working Capital was based on calculations compliant with GAAP as part
of the Purchase Price Adjustment Procedure, they logically would have defined the
61 See ATK Op. Br. 20. 62 See, e.g., Osborn ex rel. Osborn v. Kemp, 991 A.2d 1153, 1159 (Del. 2010) (“We will not read a contract to render a provision or term ‘meaningless or illusory.’ ”) (citation omitted); Northwestern Nat.’l Ins. Co. v. Esmark, Inc., 672 A.2d 41, 43 (Del. 1996) (“Contracts must be construed as a whole, to give effect to the intention of the parties.”) (citing E.I. DuPont de Nemours and Co., Inc. v. Shell Oil Co., 498 A.2d 1108, 1113 (Del. 1985)).
19 method of calculating Net Working Capital for purposes of Section 2.4 to require the
application of the same accounting methodologies Bushnell had used historically in
preparing its financial statements – period – without additionally requiring that those
calculations be made in accordance with GAAP. 63 They did not do so and thus left open
the possibility that ATK could challenge MidOcean’s proposed Net Working Capital
Adjustment based on a failure to comply with GAAP.
MidOcean has not advanced a textual interpretation of the term Net Working
Capital that compels a different conclusion. To the contrary, MidOcean readily
acknowledges that it “was required by Section 2.4 to provide to ATK its ‘good faith
estimate of Net Working Capital,’ which, by definition had to be ‘calculated in
accordance with GAAP.’ ” 64
MidOcean asserts as a general proposition that “it is not unusual for an accounting
firm’s role in dispute resolution to be limited to determining whether calculations are
correct based only on the accounting principles implemented by a seller in preparing
financial statements” because the “ ‘purpose of a post-closing purchase price adjustment
63 In resolving a similar purchase price adjustment dispute, this Court entered an order explicitly limiting the authority of an independent accounting firm in this manner based on the terms of the contract at dispute in that case. See Gen. Dynamics Corp. v. Orbital Scis. Corp., 2011 WL 552342 (Del. Ch. Feb. 15, 2011) (ORDER) (“The authority of the Independent Accounting Firm shall be limited strictly . . . [to determining certain amounts] based on the application of the same accounting principles” that were used in the preparation of financial statements and net working capital exhibits set forth in the purchase agreement). 64 MidOcean Reply Br. 13 (quoting Purchase Agreement §§ 2.4(a), 1.1 (definition of “Net Working Capital”)).
20 is to account for changes in the Seller’s financial position between the pre-closing
balance sheet date and the closing date balance.’ ” 65 That would be a commercially
sensible and logical way for a buyer and seller to structure a stock purchase transaction.
The difficulty for MidOcean, however, is that is not what the parties here agreed to do.
Rather, as discussed above, the definition of Net Working Capital they chose leaves open
the possibility that ATK may challenge MidOcean’s estimate of Net Working Capital as
not being compliant with GAAP, and the Agreement explicitly requires that the Purchase
Price Adjustment Procedure adhere to this and the other definitions in the Agreement.
The parties also explicitly agreed that recourse to the Accounting Firm would be
the “sole and exclusive method for resolving any Disputed Items” 66 and that this remedy
would trump in the event of a conflict with the exclusive remedy provision in Section 9.5.
The trumping provision is found in Proviso (y) in Section 9.5, quoted below:
[T]he sole and exclusive remedy of each Buyer Indemnified Party and Seller Indemnified Party as against any Indemnifying Party, with respect to all claims of any nature whatsoever relating to the Transactions, including any breach of any representation, warranty, covenant or agreement contained in this Agreement, shall be pursuant to and limited by the indemnification provisions set forth in this Article IX, it being understood that . . . (y) nothing in this sentence shall operate to interfere with or impede the operation of the provisions of Section 2.4 or 6.2(e). 67
65 MidOcean Reply Br. 22, 22 n.12 (quoting Basil Imburgia and Brian Ong, Accounting & Financial Due Diligence—Post M&A Disputes, Practicing Law Institute Corporate Law and Practice Course Handbook Series, June 2009, at 6). 66 Purchase Agreement § 2.4(b)(iv). 67 Id. § 9.5 (emphasis added).
21 The inclusion of Proviso (y) confirms that the parties contemplated that there could be
circumstances in which a claim covered by the indemnification provisions in Article IX
also could be the subject of a dispute under the Purchase Price Adjustment Procedure
governed by Section 2.4. If that were not the case, there would have been no reason to
include Proviso (y) in Section 9.5.
Read in that context, Section 9.5 establishes a hierarchy for resolving disputes in
the event of an overlap between the Purchase Price Adjustment Procedure in Section 2.4
and the indemnification provisions in Section 9.5. In such event, the Agreement requires
that disputes falling within the ambit of the Purchase Price Adjustment Procedure in
Section 2.4 must be resolved by the Accounting Firm. 68 Thus, because the present
dispute over Net Working Capital is encompassed by Section 2.4 for the reasons
discussed above, that dispute must be resolved by the Accounting Firm.
D. MidOcean’s Interpretation of the Agreement is Without Merit
Apart from making the general observation that it is not unusual for parties to limit
an accounting firm’s role to applying the same accounting principles used by a seller,
which I find did not occur here for the reasons discussed above, MidOcean advances two
textual arguments that the parties never intended to have the Accounting Firm resolve
disputes over compliance with GAAP. I address each in turn.
68 In this sense, the Purchase Agreement operates similarly to the one at issue in Matria Healthcare, 2007 WL 763303, at *2, where the Court held that the parties had agreed to a hierarchy for resolving disputes that “could . . . fit within both the arbitration provision [for resolving misrepresentation claims] and the arbitration provision for adjustments to be made by the Settlement Accountant.”
22 First, MidOcean contends that the intent of the Agreement was to limit the
Accounting Firm to considering questions of “pure mathematics.” 69 It bases this
argument on the fact that the definition of Disputed Items in Section 2.4(b)(ii) refers to
“items or amounts” and that Section 2.4 requires the Accounting Firm to act “as an expert
and not as an arbitrator.” 70 In my opinion, the use of those terms in Section 2.4 does not
support such a restrictive view of the role of the Accounting Firm.
According to commonly used dictionaries, 71 the word “item” means “[a] single
article or unit in a collection” or “[a]n entry in an account” 72 and the word “amount”
means “[t]he total of two or more quantities” or “[a] number; a sum.” 73 Thus, the phrase
“items or amounts” as used in Section 2.4 is sufficiently broad in my view to encompass
accounting methodology, i.e., that the Accounting Firm may make an expert
determination of each component of Net Working Capital (“items”) as well as the
quantity, or dollar value, of those entries (“amounts”). To that end, this and other courts
69 MidOcean Op. Br. 6. 70 MidOcean Op. Br. 6-7, 21-23; MidOcean Reply Br. 21-22, 25. 71 See Lorillard Tobacco Co. v. Am. Legacy Found., 903 A.2d 728, 738 (Del. 2006) (“Delaware courts look to dictionaries for assistance in determining the plain meaning of terms which are not defined in a contract.”); see also Nationwide Emerging Managers, LLC v. NorthPointe Hldgs., LLC, — A.3d —, 2015 WL 1317705, at *11 (Del. Mar. 18, 2015, revised Mar. 27, 2015) (citing Lorillard, 903 A.2d at 738). 72 American Heritage Dictionary of the English Language 932 (5th ed. 2011). 73 Id. 60. 23 have construed similar language to permit accounting firms to settle disputes over
accounting methodology when resolving purchase price adjustment disputes. 74
Limiting the Accounting Firm to resolving purely math questions would be
inconsistent in my view with the directive in the Agreement that the Accounting Firm
serve as an “expert” since little, if any, accounting expertise would be required simply to
perform mathematical calculations. Although the Agreement specifically provides that
the function of the Accounting Firm is not to serve as an “arbitrator,” that does not rule
out that it fairly may be called upon to apply normal accounting principles (i.e., GAAP)
when serving the function of an expert. One of primary cases upon which MidOcean
relies, the Seventh Circuit’s decision in Omni Tech Corp. v. MPC Solutions Sales, LLC,75
supports this conclusion. There, the court found that the phrase “act as an expert and not
as an arbitrator means that [the accounting firm] will resolve the dispute as accountants
do—by examining the corporate books and applying normal accounting principles plus
any special definitions the parties have adopted—rather than by entertaining arguments
from lawyers and listening to testimony.” 76
74 See Matria Healthcare, 2007 WL 763303, at *2, *6-8 (finding that settlement accountant could consider accounting methodology in resolving adjustments or disputes over “amounts or items”); see also HBC Solutions Inc. v. Harris Corp., 2014 WL 6982921, at *2-3, *7-9 (S.D.N.Y. Dec. 10, 2014) (finding use of purchase price adjustment before an accountant to be proper where dispute notice set forth “each disputed item or amount”); Severstal U.S. Hldgs., LLC v. RG Steel, LLC 865 F.Supp.2d 430, 434-36, 444 (S.D.N.Y. 2012) (allowing settlement accountant to consider accounting methodology to resolve disputes over “any items” in protest notice). 75 432 F.3d 797 (7th Cir. 2005). 76 Id. at 799 (emphasis added).
24 To be sure, in taking on this role, the Accounting Firm may be confronted by some
level of argumentation akin to the type of adversarial process of an arbitration or judicial
proceeding. But, in my view, the parties would not have selected an “independent
accounting firm of national reputation” to serve as an “expert” if all they wanted that firm
to do was to engage in a bean-counting exercise. Instead, such a selection supports the
notion that they intended the expert to consider each side’s position 77 and to apply
genuine expertise to resolve purchase price adjustment disputes promptly. When it
comes to deciding questions of GAAP in that context, accounting firms are particularly
well-positioned to do so.
Second, MidOcean argues that “any claim that could be brought as an
indemnification claim must be brought as an indemnification claim” 78 on the theory that
the second sentence of Section 9.5 operates, in effect, as the ultimate trumping provision
in the Agreement because it states, in relevant part, that “[n]otwithstanding anything to
the contrary set forth herein … any amount to which any Buyer Indemnified Party is
entitled pursuant to this Article IX . . . shall be limited to, and solely satisfied from, the
funds that remain in the Indemnity Escrow Account at the time.” 79 MidOcean similarly
asserts that any failure on its part to comply with the requirement in Section 2.4 to
77 The Purchase Agreement contemplates two rounds of written submissions for this purpose – an opening presentation and a response from each side. Purchase Agreement § 2.4(b)(ii). 78 MidOcean Op. Br. 19. 79 Purchase Agreement § 9.5 (emphasis added).
25 calculate its good faith estimate of Net Working Capital in accordance with GAAP
should be asserted as a claim for breach of a covenant, recovery for which also would be
limited to the funds available in the Indemnity Escrow Account. 80
The flaw in MidOcean’s argument is that the second sentence of Section 9.5
simply provides that if a claim is properly brought as indemnification claim, then the
funds available as a remedy for such a claim are limited to the funds in the Indemnity
Escrow Account. This sentence does not address whether a claim that could fall within
either Section 2.4 or Section 9.5 must be resolved under one provision or the other. That
question is resolved by Proviso (y) in the first sentence of Section 9.5 which, as discussed
above, provides that the sole and exclusive remedy in Section 2.4 for resolving Disputed
Items in the Purchase Price Adjustment Procedure trumps the indemnification provision
in Section 9.5 when the two provisions overlap. Reading the two sentences of Section
9.5 together in this manner gives complete meaning to both sentences, whereas
MidOcean’s interpretation would render meaningless the inclusion of Proviso (y) in the
first sentence of Section 9.5.
Finally, in arguing for a different result, MidOcean relies primarily on two cases in
which courts have held that disputes over accounting methods must be resolved under an
indemnity provision rather than a purchase price adjustment provision: then-Vice
Chancellor Strine’s decision in OSI Systems, Inc. v. Instrumentarium Corp., 81 and the
80 MidOcean Reply Br. 13. 81 892 A.2d 1086 (Del. Ch. 2006).
26 New York Court of Appeals’ decision in Westmoreland Coal Co. v. Entech, Inc. 82 Both
cases are distinguishable for the simple reason that the purchase agreements in those
cases operated differently than the Agreement here.
In particular, in both OSI Systems and Westmoreland, the court found that the
buyer was required to apply the same accounting principles during the purchase price
adjustment process that the seller had used historically. 83 By contrast, as discussed
above, I interpret Section 2.4 of the Agreement here to operate differently to permit ATK
to challenge MidOcean’s estimate of Net Working Capital as failing to comply with
GAAP in connection with the Purchase Price Adjustment Procedure.
OSI Systems also is distinguishable because the purchase agreement in that case
did not contain a remedy hierarchy similar to the one in the Agreement here, which
expressly provides that the Purchase Price Adjustment Procedure shall be the “sole and
exclusive remedy” for disputes falling within its ambit and shall trump the “sole and
exclusive remedy” provision for indemnification claims. Although the agreement in
Westmoreland provided that “the remedies set forth in the indemnification provisions
were the parties’ ‘exclusive remedies’ for misrepresentation or breach of any warranty
82 794 N.E.2d 667 (N.Y. 2003). 83 OSI Sys., Inc., 892 A.2d at 1091 (finding that purchase price adjustment procedure “appears on its face to simply contemplate the use of an Independent Accounting Firm if there are differences of opinion about the amount of Modified Working Capital as of the Closing Date when applying the same Transaction Accounting Principles used in the Reference Statement in a consistent manner”) (emphasis added); Westmoreland Coal Co., 794 N.E.2d at 670 (“The purchase price adjustment provisions [required the seller] to prepare the closing date certificate ‘on a basis consistent with the preparation of the Interim Financial Statements.’ ”). 27 contained in the Agreement,” 84 that agreement did not contain an exception like Proviso
(y) in this case. Other courts also have distinguished Westmoreland on this basis. 85
* * *
Nothing in this opinion should be read to suggest that I have reached any
conclusion that ATK or MidOcean failed to comply with GAAP in calculating Net
Working Capital. Rather, this opinion simply concludes that, under the terms of the
Agreement, the parties’ present dispute is to be resolved by an Accounting Firm.
IV. CONCLUSION
For the foregoing reasons, ATK’s motion for judgment on the pleadings under
Court of Chancery Rule 12(c) is GRANTED and MidOcean’s motion for summary
judgment is DENIED. MidOcean is ordered to immediately submit all of the remaining
Disputed Items to an Accounting Firm for resolution in accordance with Section
2.4(b)(ii) of the Agreement. An implementing Order of Final Judgment accompanies this
Memorandum Opinion.
84 Id. at 669. 85 See HBC Solutions Inc. v. Harris Corp., 2014 WL 6982921, at *7 (S.D.N.Y. Dec. 10, 2014) (distinguishing Westmoreland where the agreement at issue “explicitly carves out” purchase price adjustment disputes from the “sole and exclusive remedy” provision); Violin Entm’t Acquisition Co. v. Virgin Entm’t Hldgs., Inc., 871 N.Y.S.2d 613, 613-14 (N.Y. App. Div. 2009) (distinguishing Westmoreland where the indemnification provision “can only be interpreted, consistent with the accounting arbitration provision, to exclude financial misrepresentations or deviations from GAAP that are contained in the final Net Working Capital schedule, that affect that schedule, and that can be resolved by a purchase price adjustment”).