DealLawyers.com Blog

This spring, in Golden Rule Financial Corporation v. Shareholder Representative Services (Del. Ch.; 4/26), the Delaware Chancery Court resolved claims for breach of representations and warranties in a merger agreement in a post-trial decision. This Sidley Enhanced Scrutiny blog summarizes the holding as follows:

[T]he Delaware Court of Chancery held that, following a post-merger purchase-price adjustment that benefited the seller, the buyer may still receive indemnification from the seller for that adjustment payment if the adjustment was caused by a misrepresentation in the agreement or a warranty breach. The case shows that the Delaware courts recognize that contractual purchase-price adjustments and contractual indemnification processes are not mutually exclusive, but they can complement each other in a way that allows the processes to proceed according to their terms while effectuating the commercial intent of the parties.

Here are the facts as summarized by Sidley. There were a few issues and challenges leading up to this dispute, so buckle up.

The buyer acquired the seller in 2019 for a $750 million base purchase price, subject to a post-closing purchase-price adjustment based on whether certain accounting metrics at closing exceeded or fell short of agreed-upon targets.  One such metric was “tangible net worth” — which the parties agreed would be determined in accordance with GAAP’s revenue recognition standard: ASC 606.   Although the standard was new at the time, the seller represented that it had already been adopted and would have an immaterial impact on its pre-closing financials.

The merger agreement also naturally contained financial-statement representations.  Among other things, the seller represented that its financial statements were prepared in accordance with GAAP and fairly presented, in all material respects, the company’s financial condition and results of operations.  And as part of the post-closing purchase-price adjustment, the merger agreement also required that the estimated balance sheet and tangible net worth calculations be prepared in accordance with agreed accounting principles, which specifically required application of ASC 606.

After closing, it became known that the seller had misapplied ASC 606 in its pre-closing financials. Correcting that treatment produced a different tangible net worth adjustment by approximately $38.3 million, compared to what the buyer would have paid without the correct application of ASC 606.  Thus, the seller sought a purchase-price adjustment.  In response, the buyer filed a complaint in the Delaware Court of Chancery seeking a declaration and injunction to prevent the seller from asking the designated accountant to calculate the “Final Adjustment Amount” using an application of ASC 606 that was inconsistent with the pre-closing financial statements.  The court reasoned that the parties’ agreement required ASC 606 to be applied correctly and, thus, the agreement did not prohibit the seller from asking the accounting firm to calculate the Final Adjustment Amount.

Given the concededly incorrect application of ASC 606, the outcome in the purchase-price adjustment process was that the buyer was obligated to pay the extra $38.3 million to the selling shareholders. Following the accounting proceeding, the buyer filed a new lawsuit, this time for indemnification.  The buyer alleged that it overpaid the Final Adjustment Amount due to the seller’s breach of representations and warranties regarding the accuracy of its financial statements.

Ultimately, Vice Chancellor Fiorvanti held that the seller breached the merger agreement representation that its financial statements were prepared in accordance with GAAP and its estimated balance sheet obligations for the purchase-price adjustment provision. Seller tried to argue that the no-duplication provision prevented the claims. VC Fiorvanti disagreed since the no-duplication provision was intended to prevent double recovery, not bar indemnification claims generally, and that buyer proved that, if seller had applied GAAP correctly in the pre-signing and interim period, buyer would have avoided the entire $38.3 million upward adjustment. Sidley concludes:

Golden Rule teaches that while a purchase-price adjustment settles the final price, it does not decide who bears the risk that a representation was false or encroach on the purpose of indemnification.  Absent language making the adjustment the exclusive remedy, a broadly drafted indemnity paired with a no-duplication provision aimed at true double recovery can provide a buyer a path to recovery where the adjustment payment itself is traceable to a breached representation, warranty, or covenant.

– Meredith Ervine