Scientists have apparently concluded that ancient horses had stripe-like coats similar to zebra. But domestication and human selection of the most appealing look for a horse caused those stripes to disappear over time. Despite this similar ancestry, however, a zebra is most decidedly not a horse with stripes. And woe to anyone who assumes that a zebra can be roped and ridden like a horse. Zebra have, in fact, successfully resisted domestication. They have a ducking reflex that makes lassoing them difficult in the extreme, they are easily startled, and they can be quite vicious.
Following the lead of a New York City Bar Report, a prior post to Weil’s Global Private Equity blog used the zebra/striped horse metaphor in distinguishing an expert determination (more like a domesticated horse, stripes or not) from an arbitration (more like an uncontrollable zebra). Indeed, the common practice of appointing an accounting firm to resolve purchase price adjustment disputes can be radically different if that accounting firm is denominated as an “arbitrator” versus an “expert.” That prior post noted the difference between an arbitrator’s and an expert’s role in resolving a purchase price adjustment dispute as follows:
The powers granted to an arbitrator are “analogous to the powers of a judge.” In an arbitration, “[a]rbitrators are expected to rule on issues of law, make binding interpretations of contracts, resolve disputed issues of fact, determine liability, and award damages or other forms of relief.” And pursuant to the Federal Arbitration Act, an arbitrator’s award is enforceable by a court and there are very limited rights to appeal or review that award.
An expert determination, on the other hand, is not a quasi-judicial proceeding at all, but instead is simply an informal determination by an expert of a specific factual issue that a contract requires to be so determined by the designated expert. One must still utilize the courts to enforce that determination as part of a broader breach of contract action. But courts typically do so if the contract so provides. And, unlike an arbitration, the contract can also establish the court’s standard of review, such as “the expert’s determination shall be binding on all parties, except in the case of manifest error.”
In other words, an accountant as arbitrator may have an expansive role that includes legal decisions beyond the expertise of the designated accounting firm. An accountant as expert, on the other hand, has a limited and specific role that typically comports with the accounting firm’s area of expertise. It is critical, therefore, that acquisition agreements clearly designate accounting firms as experts, not arbitrators, unless the parties truly desire to vest judge-like powers in the hands of the accountant.
Two recent Delaware Court of Chancery decisions, decided within days of one another, illustrate the need to reiterate this lesson with additional emphasis: Agiliance, Inc. v. Resolver SOAR, LLC, C.A. No. 2018-0389-TMR, 2019 WL 343668 (Del. Ch. Jan. 25, 2019); and Ray Beyond Corp. v. Trimaran Fund Management, L.L.C., C.A. No. 2018-0497-KSJM, 2019 WL 366614 (Del. Ch. Jan. 29, 2019).
In Agiliance, the buyer and seller disagreed on the post-closing working capital adjustment. The asset purchase agreement in question did not contain an express expert-not-arbitrator provision, but rather called the dispute resolution by an accountant an “arbitration.” The court described Section 2.7(b)(ii) of the asset purchase agreement as follows:
It requires that “[if] [seller] and [buyer] do not reach … written agreement …, then such disagreement shall be submitted for arbitration by a nationally-recognized accounting firm that agrees to use its best efforts to complete such arbitration within thirty (30) days. … [buyer], on the one hand, and [seller], on the other hand, will submit a proposed” Net Working Capital calculation to the nationally-recognized accounting firm (the “Accounting Firm”). “The scope of the dispute to be resolved by the Accounting Firm shall be limited to a choice of either the [buyer proposal] or the [seller proposal], and the Accounting Firm shall not make any other determination.” Thereafter, the “accounting firm shall … arbitrate the dispute and submit a written statement of its adjudication, which statement, when delivered to [seller] and [buyer].” “The determination of the Accounting Firm shall constitute an arbitral award that is final, binding and unappealable and upon which a judgment may be entered by any court having jurisdiction thereof.” (emphasis added)
Notwithstanding the many references to “arbitration,” the buyer argued that an expert determination was actually contemplated because (i) the agreement limited the scope of review by the accountant to a determination of whether the buyer’s or the seller’s proposal was correct, (ii) the agreement did not provide any procedural rules of arbitration, and (iii) an accountant does not have legal experience to arbitrate. The court held that none of these arguments changed or invalidated the intent of the parties to arbitrate as evidenced by the unambiguous use of word “arbitration” in the agreement. Accordingly, the court ordered that the matter be resolved solely by the accounting firm as an arbitration. Given that the sole issue to be decided was whether the buyer or seller proposal was the correct one, it is not completely clear what difference it would have made even if this was determined to be an expert determination. In other words, this arbitration appears to be a rare example of a domesticated zebra. In other contexts, however, allowing the accounting firm the freedom to decide issues unrelated to its accounting expertise may unleash an uncontrollable zebra.
In Ray Beyond, on the other hand, the parties expressly provided in the merger agreement that the designated accountant would act as an expert, not an arbitrator. The merger agreement also provided that the matter of appropriate distribution of escrowed funds shall be submitted to the designated accountant. The release of the escrowed funds, however, was dependent upon the execution by third parties of a “qualifying contract” that was required to have certain criteria. When the parties disagreed as to whether a qualifying contract had in fact been executed, the buyer sought to submit that issue to the accountant. However, the court decided that the expert-not-arbitrator provision in the merger agreement clearly demonstrated the parties’ intent for expert determination, not arbitration. Thus, even though the agreement required all issues regarding the distribution of the escrow funds to be determined by the accountant, and even though the only issue in dispute regarding the distribution of the escrowed funds was whether a qualifying contract had been executed, the designation of the accounting firm as an expert, not an arbitrator, trumped any other provision seemingly to the contrary. Accordingly, it was for the court not the accounting firm to determine the legal issue of whether a qualifying contract had been executed.
Interestingly, in rejecting the buyer’s arguments to broaden the scope of review by the accountant similar to that of an arbitrator, the court mentioned that the accountant was not authorized to act as an arbitrator in Ray Beyond because (i) the accountant has a limited scope of review, (ii) no procedural rules of arbitration were provided, and (iii) the accountant lacks legal experience to act as an arbitrator. In Agiliance, of course, the court held that the accountant was designated to act as an arbitrator notwithstanding these same arguments by the buyer.
The distinction between Agiliance and Ray Beyond, then, is the existence, vel non, of a clear designation of the accounting firm as an expert, not an arbitrator, in the agreement. If you call your designated accounting firm a zebra, it will be a zebra (with potentially uncontrollable authority), and if you call your designated accounting firm a horse, even a striped one, it will be a horse (with controllable and limited authority). Say what you mean.