Introduction
Approximately one-half of the states within the United States of America, including Delaware, “recognize a distinction between experts and arbitrators…. At the federal level, the United States Courts of Appeals have split on whether an expert determination constitutes an arbitration under the FAA.” For decades, Delaware courts applying Delaware law have maintained the distinction between an arbitration and an expert determination. Recent Delaware state court decisions – including Agiliance, Ray Beyond, Penton, and, most recently, Stone – demonstrate that the distinction between an arbitration and expert determination is well established under Delaware law. The Court of Chancery’s decision in Stone provides substantial guidance to commercial parties and practitioners.
Case background
In Stone, the plaintiff, as sellers’ representative, filed suit to compel a buyer under a purchase agreement to submit the parties’ price-adjustment dispute to an accountant, as allegedly required under the governing purchase agreement. The purchase agreement contained a set of “closing payment provisions” governing price calculation, under which the “closing payment amount” would be calculated based on the “closing date members’ equity.” “Closing date members’ equity” was defined under the purchase agreement as “the members’ equity of the Company as of immediately prior to the Closing determined in accordance with the accounting practices, policies[,] and methodologies [set forth in an ‘Accounting Principles’ exhibit to the Agreement.]” Five days before closing, the company was to deliver a “closing statement” to the buyer, setting forth its estimated closing payment amount, with supporting calculations (the “estimated closing payment amount”). The buyer was required to pay the estimated closing payment amount at closing, and then to deliver an adjustment statement within 60 days, setting forth its own calculation of the closing payment amount.
The purchase agreement contained a set of dispute-resolution provisions to govern price disagreements. In the event that the sellers “disagree with any item set forth in the adjustment statement,” they were to deliver a notice of adjustment disagreement, which was to “set forth in reasonable detail, on a line item by line item basis,...the disputed items…and the basis of any disagreement asserted.” Section 2.3(d) of the purchase agreement stated that after 30 days of negotiation, any unresolved disputed items “shall be referred to and resolved by Richey May & Co. LLP (the ‘Independent Accountant’); provided that in the event that Richey May & Co. LLP refuses or is otherwise unable to act as the Independent Accountant, the Sellers’ Representative and [Nationstar] shall cooperate in good faith to appoint an independent registered public accounting firm….” The purchase agreement provided that the independent accountant would make a “final written determination” as to the “Final Closing Payment Amount,” to be “based on the relevant definitions and other applicable provisions” of the purchase agreement, and to be binding “as if a final, non-appealable arbitral decision or award.”
The company submitted its closing statement five days before closing; however, just before the closing, the buyer asserted that the estimated closing date members’ equity had not been prepared in good faith and was not determined in accordance with the agreement’s accounting principles. The buyer then submitted a purported “revised Closing Statement” with its own estimated closing payment amount, which sellers agreed to accept pending resolution of the dispute, with the disputed amount to be held in escrow.
The buyer delivered its adjustment statement in April 2019 with its closing payment amount calculation. The sellers then delivered their notice of adjustment disagreement in May, asserting that the buyer’s calculations resulted from (1) the use of incorrect closing and reference dates, (2) the use of methods inconsistent with the agreement and the accounting principles, and (3) erroneous exclusion of transaction expenses. The buyer initially acknowledged that the disagreements were “required to be resolved by the Independent Accountant,” but later objected to Richey May & Co. serving as the independent accountant on the ground that the firm did not meet the purchase agreement’s independence requirement.
The sellers’ representative filed suit in the Delaware Court of Chancery in November 2019, seeking in part a declaration that “Richey May is the appropriate arbitrator for the parties’ accounting dispute” and seeking specific performance of the agreement’s dispute-resolution provisions. The buyer counterclaimed, alleging that the sellers miscalculated the closing payment amount and seeking an order requiring (1) the sellers to submit new conforming calculations, (2) a declaration that Richey May could not serve as independent accountant, and (3) the sellers to cooperate in finding a replacement. The buyer also sought a declaration that the Court of Chancery “is the exclusive forum for adjudicating [the buyer’s] specific performance claims and all other claims requiring a construction of the Purchase Agreement.” The parties cross-moved for partial judgment on the pleadings.
The court’s ruling
The Court of Chancery denied the buyer’s motion and granted in part and denied in part the plaintiff’s motion. The court held: (1) the parties’ accounting disputes were to be referred to an independent accountant; (2) the accountant’s role under the purchase agreement was properly understood as that of an expert and not an arbitrator; and (3) the independence requirements under the purchase agreement were ambiguous, such that Richey May’s qualification as independent accountant could not be resolved on the pleadings.
The court relied on its previous decisions in Agiliance, Inc. v. Resolver SOAR, LLC and Ray Beyond Corp. v. Trimaran Fund Management, LLC in support of its holding that the parties had agreed under the purchase agreement that the independent accountant would act as an expert, not an arbitrator. The dispute-resolution provisions in Agiliance and Ray Beyond shared many similarities: (1) the third-party independent accountant was tasked with resolving a post-closing financial calculation; (2) the underlying dispute required resolution of embedded legal questions; and (3) the governing agreement did not reference a set of procedural rules to govern the dispute process. Despite the material parallels, the court in Ray Beyond held that the parties had agreed to an expert determination, not arbitration, and the court in Agiliance held that the parties had agreed to arbitration. A critical distinction between the facts in Agiliance and Ray Beyond is that the operative agreement in Ray Beyond expressly provided that the third-party accountant would be “an expert, not an arbitrator.”
Although the purchase agreement did not expressly state that the independent accountant was “an expert not an arbitrator,” the court in Stone found that the dispute-resolution provisions in the purchase agreement “do not bear the hallmarks of an arbitration provision; they do not include procedural rules mimicking the judicial process, broadly encompass all legal disputes, or speak to issues typically resolved by legal professionals.” Based on these hallmarks, the court held that “it is safe to conclude that a contractually-designated accountant is intended to serve as an expert, not an arbitrator.” The court explained, “under Delaware law, an expert’s scope of authority is ‘limited to deciding a specific factual dispute concerning a matter within the special expertise of the decision maker, usually concerning an issue of valuation.’”
The court in Stone rejected the buyer’s argument that the independent accountant was to act as an expert, not an arbitrator, since the buyer’s counterclaims raised legal arguments and sought equitable relief. The court explained that the buyer’s argument “elevates form over substance” because the counterclaims raise issues that are “contractually delegated to the independent accountant for resolution.”
It is further true that, as drafted, [the counterclaims] appear to raise legal issues and seek equitable relief beyond the scope of the Independent Accountant’s authority. Each Counterclaim is styled as a request for an order of specific performance for various provisions of the Purchase Agreement “directing Sellers to prepare and submit a corrected [statement of price adjustment disputes].” And each Counterclaim purports to raise an issue of contract interpretation.
Although all of the premises of [the buyer’s] argument are true, the result [that buyer] seeks does not follow. At bottom, [the buyer’s] argument elevates form over substance. In substance, [the counterclaims] raise issues necessary to determine the amount of any [disputed price adjustment inputs], an issue contractually delegated to the Independent Accountant for resolution. They all involve accounting methodology issues that fall squarely within an accounting firm’s expertise. That [the buyer] and the Sellers disagreed concerning the application of contractually called-for accounting principles in the first instance does not strip the Independent Accountant of the authority to resolve their disputes. [The buyer’s] attempts to plead around this reality is unsuccessful.
The court explained how “Delaware courts have rejected contractual parties’ efforts to plead around the scope of a third-party decision-maker’s authority by couching delegable disputes in questions of law.” The court followed those prior decisions and rejected the buyer’s attempt to plead around the dispute-resolution provisions in the purchase agreement, holding that an expert – not an arbitrator – must resolve the price-adjustment issues embedded within the buyer’s counterclaims.
Guidance gleaned from “expert-not-arbitrator” decisions
The analysis and reasoning in Stone and other Delaware decisions analyzing expert-or-arbitrator issues, including Ray Beyond and Agiliance, provide the following guidance to commercial parties and practitioners regarding important dispute-resolution issues under Delaware law:
- Questions of law are typically resolved by arbitrators, not experts.
- The absence of procedural rules governing the dispute-resolution process is indicative of an expert determination.
- Nomenclature alone is not dispositive of the parties’ intent to arbitrate or seek an expert determination.
- If arbitration is desired, the contract should (1) repeatedly reference arbitration, arbitrate, arbitrator, or similar terms and (2) specifically make reference to a set of procedural rules to govern the arbitration (such as the American Arbitration Association’s Commercial Arbitration Rules and Mediation Procedures).
- If an expert determination is desired, the strongest way to express that intent is to include language in the contract stating the an expert is “to act as an expert and not as an arbitrator.”
Client alert 2020-474
