December 9, 2021
In a recent case examining a purchase agreement’s post-closing purchase price adjustment provision, the Delaware Supreme Court held that the agreement demanded that the provision be applied correctly when determining the final purchase price, even if that application is inconsistent with prior practice.
Golden Rule Financial Corp. v. Shareholder Representative Services, LLC addressed a dispute between a buyer and a seller regarding the ultimate purchase price of the company at issue. The parties’ purchase agreement included a mechanism that called for the purchase price to be adjusted upward or downward after closing, depending on whether certain metrics fell short of or exceeded targets that the parties established at signing. In determining whether the adjustment would result in an additional payment to the seller or a credit back to the buyer, the agreement stated in relevant part that the purchase price adjustment would reflect a specified accounting standard — ASC 606 — which was already incorporated in the target company’s financial statements. Relevant to the parties’ dispute, the purchase agreement also stated that the purchase price adjustment would be prepared using “consistently applied” accounting principles.
When calculating the post-closing purchase price adjustment, the buyer determined that the company had been consistently, but incorrectly, applying ASC 606 in its pre-closing financial statements. Using the correct application of ASC 606, the buyer calculated that the final purchase price would increase by several million dollars. Using the incorrect application the company used previously, the purchase price would decrease by several million dollars. The seller took the position that the correct application should be used. The buyer disagreed and sought relief by requesting that the Delaware Chancery Court find that the purchase agreement required a consistent, but incorrect, application of ASC 606.
The Chancery Court disagreed, and on Dec. 3, 2021, the Delaware Supreme Court affirmed. Given the plain language of the purchase agreement and the specific reference to the application of ASC 606, as opposed to the more general reference to the consistent application of accounting principles, the Supreme Court agreed with the Chancery Court’s determination that the focus on the term “consistently” ignored both the parties’ agreement to utilize ASC 606 and the fact that the agreed-upon accounting principles must also be “applied.” In affirming, the Supreme Court explained that blessing an incorrect application of ASC 606 would result in that standard “being left unapplied, despite the parties’ express agreement to apply ASC 606.” Essentially, allowing the parties to continue to incorrectly apply ASC 606, even if consistent with prior treatment, would result in its not being applied at all, contrary to the purchase agreement.
In light of the Delaware Supreme Court’s decision, parties to purchase agreements governed by Delaware law should pay close attention to clarity in drafting purchase price adjustment provisions and accurately calculating such adjustments. Buyers, in particular, should take steps to ensure during the diligence process that they understand how the target company prepares its financial statements.