A recent Delaware Supreme Court decision dismissed a claim for post-closing adjustments to the purchase price for the sale of a company. Anecdotally, almost every merger or acquisition agreement that includes a purchase price that provides for an adjustment after closing for such things as net working capital or an earnout will generate a dispute.  The case of Chicago Bridge & Iron Company N.V. v. Westinghouse Electric Company LLC, No. 573, 2016 (Supr. Ct., June 27, 2017)(as corrected on June 28, 2017), is no exception and the Court’s 48-page opinion provides helpful insights into how the Delaware courts deal with the complex contractual issues involved in such disputes.

Basic Background Facts: This case involved the purchase by Westinghouse Electric Company of a subsidiary of the Chicago Bridge & Iron Company.  Westinghouse designs nuclear power plants and Chicago Bridge builds them.  They had done business together for many years prior to the closing on the purchase of Chicago Bridge’s subsidiary by Westinghouse.  One of the reasons for the purchase was that two nuclear plants that Chicago Bridge had been building were beset by cost overruns and delays, and Chicago Bridge wanted to limit its future exposure.  The deal terms included some unusual provisions such as a bar to post-closing liability for certain representations by Chicago Bridge.  The intent of the deal was to transfer future liabilities on the construction of the two nuclear power plants to Westinghouse.

The deal terms provided for post-closing adjustments to determine net working capital, as well as  earnout provisions. Any disputes regarding net working capital were to be presented to an independent auditor for a binding and non-appealable decision.

As the court explains, the net working capital adjustment was intended to address changes from the date of the signing of the agreement until the date of closing. However, the claims by Westinghouse that it sought to have the independent auditor decide, involved time periods and claims that exceeded that limited scope. Chicago Bridge sought an injunction to prevent Westinghouse from presenting those issues to the independent auditor.  The Court of Chancery ruled in favor of Westinghouse.  The Supreme Court in this decision reversed the opinion of the Court of Chancery and ruled in favor of Chicago Bridge.

Key Legal Principles: The court provides a useful recitation of various aspects of Delaware law on contract interpretation that is especially applicable to complex agreements.  The court observed that as often happens in disputes over complex agreements, both parties asserted that their views of the disputed language were supported by the unambiguous terms of the agreement, but they reached opposite conclusions.  The court explained that an agreement is not ambiguous even though the parties reached contrary conclusions about its meaning. Rather, unless the court determines that its meaning it not susceptible to different reasonable interpretations, it will not be considered ambiguous.

The court engaged in some public policy and doctrinal pronouncements in addition to reciting multiple contract interpretation principles. For example, the court explained that the “basic business relationship between the parties must be understood to give sensible life to any contract.”  The essence of this contract was that the seller would be relieved of any future liabilities for the construction of the plants after closing.  Nonetheless, despite the limitations of post-closing adjustments focusing on net working capital, Westinghouse presented a claim for approximately $2 billion. (A harbinger of the conclusion in this opinion was the Court’s use of an exclamation point in the introductory background facts after the sentence which described the amount of the claim.)

Citing to American Bar Association publications on model stock purchase agreements, as well as treatises commenting on such agreements, the court observed that “purchase price adjustments in merger agreements account for changes in a target’s business between the signing and the closing of the merger.” See footnotes 64 to 68.  The court continued by noting that the definition of “net working capital” in this case, read in conjunction with the entire agreement, required the use of the seller’s past accounting practices rather than a new assessment of those practices’ compliance with GAAP.

The focus of any post-closing adjustment in this matter was required to be based on the application of the past practices used by the seller in accordance with GAAP—but the Court recognized that “GAAP allows for a variety of treatments and different accountants may come to differing views on what constitutes acceptable GAAP treatment . . ..” The court found that it would be unreasonable to interpret the definition of working capital as allowing for a different accounting approach from that used by the seller in their financial statements.

The court reasoned that this approach was a practical one because it would be difficult to account for the changes in the seller’s business between signing and closing if one accounting approach is used to complete the financial statements prior to the signing and another accounting approach was used to make the adjustments for the period between the signing and the closing.

The court also explained that the independent auditor had a very limited role and was not authorized to address any potential issue that might be raised in connection with the purchase agreement. The court cited to other Delaware cases in which an independent auditor, pursuant to the agreement, was authorized to address limited issues but was not given broad authority as an arbitrator. See, e.g., footnote 83.  For example, the independent auditor in this case was not empowered to address claims regarding breach of representations in the agreement.  This is especially so based on the unusual provisions of the relevant agreement that limited any post-closing liability of the seller.

The court also observed, citing treatises on agreements involving mergers and acquisitions, that the financial statement representations are the most important representations in such an agreement. See footnote 87.  The limitation on post-closing liability in the agreement, according to the plain English meaning of the relevant terms, prevented liability for representations regarding those financial statements.

The court discussed several Delaware and New York decisions addressing similar provisions in agreements, and distinguished some and relied on others to support its decision. Citing to prior Delaware decisions, the Supreme Court held that “where the contract expressly provides that the representations and warranties terminate upon closing . . . the parties have made clear their intent that they can provide no basis for a post-closing suit seeking a remedy for an alleged misrepresentation. That is, when the representations and warranties terminate, so does any right to sue on them.” See footnote 88.

See generally, Morris v. Spectra Energy Partners (DE) GP, LP, C.A. No. 12110-VCG (Del. Ch. June 27, 2017)(lengthy opinion issued the same day that interpreted undefined terms in a complex agreement involving an alternative entity. That opinion also provided important insights into the application of Delaware contract interpretation principles.)