A Delaware Law Alert: M&A Disputes

Two recent Delaware Superior Court opinions are essential reading for M&A practitioners drafting language with respect to how disputes related to purchase price adjustments, earnouts, and other accounting-related determinations are to be resolved. Both opinions involve questions of whether the designated accounting expert committed “manifest error” (a term not previously defined in this context under Delaware law), and they offer important guidance on the binding nature of expert determinations, as well as the scope of an expert’s authority.

Background

Pazos v. AdaptHealth LLC¹ involved a disputed working capital adjustment, and AM Buyer LLC v. Argosy Investment Partners IV, L.P.² involved a disputed earnout payment statement. In each case, the parties submitted the disputes to an independent accounting firm through an expert determination procedure, as provided in the respective purchase agreements. Under both agreements, the expert determination would be final and binding absent manifest error. The disputes were resolved against the buyers, who then claimed that the accounting firms had exceeded their authority and made manifest errors. After limited discovery and supplemental briefing, the court found no evidence of manifest error in either case.

Takeaways

• Arbitration v. Expert Determination: The plaintiff in Pazos argued that as an initial matter the dispute resolution mechanism in the purchase agreement was an arbitration provision subject to the Federal Arbitration Act.  The court rejected this argument, applying the “authority test” to conclude instead that the dispute resolution mechanism was an expert determination provision because the authority of the accounting firm was limited to a specific factual dispute within the accounting firm’s special expertise. Thus, if the intention is to draft an arbitration provision subject to specific arbitration rules, this should be clearly stated.

• Manifest Error: As an issue of first impression, the Pazos court held (and the AM Buyer court followed suit) that an expert commits manifest error only if “it made a plain and obvious error, and the record demonstrates strong reliance on that error.” Notably, the errors alleged in the opinions did not involve calculation mistakes; instead, they focused on whether and how the experts considered specific materials submitted to them by the parties. The opinions emphasize that crediting and weighing the submissions of the parties one way or another is the province of the expert and that the court will not conduct its own accountant-level review.  Therefore, to the extent a dispute resolution mechanism has a “manifest error” carve-out to the concept that the expert’s determination is “final and binding” on the parties, this carve-out should be viewed as a very high bar to clear.

• The Expert Report: In drafting the expert determination provision, parties should consider requiring the expert to prepare a detailed report explaining its findings. With such a report, the Pazos court suggested it would have been able to readily resolve issues of manifest error based on the accountant’s explanations alone. Absent such a report, a court is constrained (as it was in the Pazos case) to prolong the proceedings by ordering limited discovery and supplemental briefing.

• Expert Authority: In AM Buyer, the court held that an expert may resolve disputed points of contract interpretation and even impose evidentiary penalties on the parties. Specifically, after the expert determined that the buyer had not maintained separate books and records to calculate the earnout as required by the agreement, the expert explained in its report that it gave the sellers’ positions more weight in deciding issues affected by the lack of such separate books and records.

• Drafting: The holdings of these opinions are based largely on principles of contract interpretation. If parties desire to further limit the scope of an expert determination or to expand the scope of the court’s review, they should explicitly say so in the purchase agreement.

¹ C.A. No. N23C-02-164 PRW CCLD, ___ A.3d ___ (Del. Super. Ct. August 12, 2024, Wallace, J.).

² C.A. No. N23C-11-167 PRW CCLD (Del. Super. Ct. September 3, 2024, Wallace, J.)