Acquisition agreements in M&A transactions frequently include provision for payment to be made at closing based on estimates of certain financial metrics that are later subject to a purchase price adjustment based on a final determination (referred to as a “true-up”) within a few months following closing. These metrics may include a target’s cash, debt, unpaid transaction expenses and working capital (excluding cash), and sometimes others. The definitions that correspond to these items, and what particular items are included or excluded from each, are often the product of significant negotiation, as the final purchase price can move materially up or down based on their final determination. The process of finally determining the adjustment amount following the closing can also reveal differences in the buyer’s and seller’s interpretation of accounting principles applicable to the purchase price adjustment calculation, or how those principles apply to the target’s financial statements. These differences can become a source of post-closing conflict between buyer and seller, at a time when the parties are working through transitional issues, and when the sellers may have ongoing involvement in the business. Parties will want to resolve these disputes quickly and in a cost-effective manner. To accomplish these objectives, often the purchase agreement will require that the parties submit unresolved issues to an independent accountant for final resolution. A key consideration in such referral will be the role that the accountant will play in resolving the dispute. Will the accountant act as an arbitrator or as an expert? This is an important distinction that deserves careful consideration by both sides. By engaging an accountant to act as an expert and not an arbitrator, the parties limit the scope of the accountant’s review and avoid the formalities of an arbitration.

1. Expert Determination or Arbitration?

Courts across the United States have long recognized a distinction between expert determinations and arbitrations.[1] However, following the passage of the Federal Arbitration Act (FAA) in 1925 and the adoption of similar acts at the state level, many states began interpreting arbitration as being inclusive of expert determinations or appraisals, such that arbitration principles would apply regardless of an election in the purchase agreement.[2] However, in Delaware and several other states, courts have been clear that expert determination is a third-party dispute resolution mechanism that is separate and distinct from arbitration. As Vice Chancellor McCormick explained in Ray Beyond Corp. v. Trimaran Fund Mgmt., L.L.C., “expert determination provisions are fundamentally different from arbitration provisions. The former limit the scope of the third-party decision maker’s authority to factual disputes within the decision maker’s expertise. The latter typically confers upon the third-party decision maker broad authority similar to that of judicial officers.”[3] By engaging an accountant to act as an expert and not an arbitrator, the parties limit the scope of the accountant’s review and ensure that the accountant is not given the authority to interpret the contract or make legal determinations.

2. Implications of the Expert vs. Arbitrator Election

The characterization of the accountant’s role as expert or arbitrator has additional consequences for the conduct and effect of the dispute resolution process. The FAA applies only to arbitrations. In jurisdictions that recognize an expert determination as distinct from arbitration, the FAA will not apply to an expert determination. This is important because the FAA provides a mechanism by which the parties can compel arbitration and enforce arbitral awards. Some states have addressed this issue legislatively. New York’s Civil Practice Law and Rules § 7601 confers broad powers on the New York courts to enforce “an agreement that a question or valuation, appraisal or other issue or controversy be determined by a person named or to be selected.” Parties should be cognizant of the law governing the purchase agreement, and the corresponding laws governing arbitrations and expert determinations, in electing a dispute resolution mechanism.

Further, by invoking language calling for an expert determination in the purchase agreement, the parties narrow the third-party decision-maker’s scope of authority to factual disputes within an independent accountant’s expertise.[4] Experts will not usually be granted the power to interpret the contract or make binding decisions on issues of law.[5] As a result, any legal determination or issue of contractual interpretation that forms part of an expert determination will be subject to plenary review.[6] The review of arbitration awards is governed by the FAA which requires that courts provide significant deference to the arbitrator’s decision.[7] Generally, courts are not as limited in their review of expert determinations.[8]

Finally, the process and procedures of arbitration are more formal and similar to a judicial process, with rules for the submission of evidence and the opportunity for the parties to make arguments.[9] In contrast, expert determinations are “attended by a larger measure of informality and [experts] are not bound to the strict judicial investigation of an arbitration.”[10]

3. Specifying in the Purchase Agreement

How do parties ensure that their intent to adopt an arbitration or an expert determination is clear? Delaware courts have consistently held that specifying in the purchase agreement that the independent accountant will act as “an expert and not as an arbitrator” is a key indicator of the parties’ intent to obtain an expert determination.[11] The Court in Penton Bus. Media Holdings, LLC v. Informa PLC acknowledged that it is possible to envision a situation where the parties include the “expert not arbitrator” language but then construct a dispute resolution provision more akin to arbitration.[12] However, where the parties have included the “expert not arbitrator” language, and have not otherwise incorporated language associated with arbitration, the courts will defer to the clear intent of the parties and find in favor of an expert determination. 

Where the parties have not been explicit in their intent to employ an expert determination (i.e., by failing to include the “expert not arbitrator” language), Delaware courts will examine other aspects of the purchase agreement to determine the parties’ intent, including the scope of authority granted to the accountant, the dispute resolution procedures, and whether the procedures will finally settle the dispute.[13] In Ray Beyond the Court of Chancery held that arbitration provisions “typically include procedural rules affording each party the opportunity to present its case” and provide for the resolution of the “entire legal and factual dispute between the parties.”[14] In July 2023, in the case of Sapp v. Indus. Action Servs., LLC, the Court looked to other aspects of the purchase agreement including (i) the narrow scope of authority granted to the accounting firm, (ii) the short (30 day) time period to review and render a decision, and (iii) the failure to include arbitration-like procedural rules, and held that in the absence of an election of a dispute resolution procedure, such provisions evidenced the parties’ intent to engage the accounting firm to act as expert not arbitrator.[15] 

In summary, if arbitration is desired, the purchase agreement should (1) clearly state that the parties intend that the accountant act as arbitrator, and (2) specifically refer to a set of procedural rules to govern the arbitration. Alternatively, if the parties intend to engage the accountant as an expert only, the purchase agreement should clearly provide that the accountant will be acting “as an expert not as an arbitrator”.

4. Key Takeaways

In many states, including Delaware, expert determination is a dispute resolution mechanism that is separate and distinct from arbitration. Buyers and sellers should be cognizant of whether the governing law of their purchase agreement recognizes expert determination. In states that recognize an expert determination (including Delaware and New York), parties should carefully consider which dispute resolution procedure will best serve their needs. Above all, to minimize time-consuming and costly disputes about the applicable dispute resolution mechanism, the purchase agreement should specify whether the accountant is acting as an expert or arbitrator and should clearly define the scope of the accountant’s review.

FOOTNOTES

[1] Penton Bus. Media Holdings, PLC v. Informa Pub. Ltd. Co., 252 A.3d 445, 453-66 (Del. Ch. 2018). See also Omaha v. Omaha Water Co., 218 U.S. 180 (1910).

[2] Penton Bus. Media Holdings, 252 A.3d at 454. See, e.g., Cal. Code Civ. Proc. §§ 1280-1294.4 (providing that an arbitration agreement includes “agreements providing for valuations, appraisals and similar proceedings”).

[3] Ray Beyond Corp. v. Trimaran Fund Mgmt., L.L.C., C.A. No. 2018-0497-KSJM, 2019 WL 366614, at *1 (Del. Ch. Jan. 29, 2019).

[4] Id. at *14.

[5] Penton Bus. Media Holdings, 252 A.3d at 466 (citing N.Y.C. Bar Comm. on Int’l Commercial Arbitration, Purchase Price Adjustment Clauses and Expert Determinations: Legal Issues, Practical Problems and Suggested Improvements (2013) [hereinafter New York Bar]).

[6] See New York Bar at 22.

[7] 9 U.S.C. § 10(a).

[8] Morris, Nichols, Arsht & Tunnell v. R-H Int’l, Ltd., 1987 WL 33980, at *4 (Del. Ch. Dec. 29, 1987).

[9] Ray Beyond Corp.,2019 WL 366614, at *7.

[10] Penton Bus. Media Holdings,252 A.3d at 463.

[11] Ray Beyond Corp., 2019 WL 366614, at *14 (citing Chi. Bridge & Iron Co. N.V. v. Westinghouse Elec. Co. LLC, 166 A.3d 912 (Del. 2017), and Penton Bus. Media Holdings).

[12] Penton Bus. Media Holdings, 252 A.3d at 462.

[13] Id.

[14] Ray Beyond Corp., 2019 WL 366614, at *7-8.

[15] Sapp v. Indus. Action Servs., LLC, 75 F.4th 205, 209 (3d Cir. 2023).