High Court Resolves $2B 'True Up' Dispute Against Acquirer
The Delaware Supreme Court's recent decision in Chicago Bridge & Iron v. Westinghouse Electric, resolved a $2 billion post-closing dispute about the interplay between common features of acquisition agreements: sellers' representations of the accuracy of the target's financial statements, and so-called "true up" provisions for purchase price adjustments for working capital changes between signing and closing. The Supreme Court harmonized the provisions by addressing, among other things, the limited purpose of true up provisions. It accordingly rejected the acquirer's attempt to raise longstanding accounting issues to obtain a large price adjustment through the true up process, when the purchase agreement barred the acquirer from any post-closing relief for breach of a similar warranty.
Appellant/plaintiff-below Chicago Bridge & Iron is a construction contractor that built nuclear power plants through its subsidiary, CB&I Stone Webster (Stone). Appellee/defendant-below Westinghouse Electric Co. (Westinghouse) designs nuclear power plants. In 2008, Stone and Westinghouse were hired to build two plants. After years of delays and cost overruns resulting in disputes between the parties, in 2015 they agreed that Chicago Bridge would sell Stone to Westinghouse and exit the project.
The governing purchase agreement (the purchase agreement) was unusual in some respects. Chicago Bridge accepted a price of $0, with the possibility of future consideration pursuant to earn-out provisions. Also, Westinghouse was required to indemnify Chicago Bridge for any claims arising before or after the closing. Relatedly, Chicago Bridge's obligation to close was conditioned upon its receipt of liability waivers from the power plants' owners.
In addition, a provision the Supreme Court dubbed the "liability bar" stated that none of Chicago Bridge's representations and warranties "shall survive the closing (and there shall be no liability for monetary damages after the closing in respect thereof) ..." Thus, while Chicago Bridge represented that Stone's financial statements "have been prepared in accordance with GAAP," in the event of a breach Westinghouse could refuse to close but could not bring a post-closing claim.
The liability bar expressly did not apply, however, to the true up process. In this regard, the purchase agreement provided for purchase price adjustments for differences between an agreed target working capital amount ($1.174 billion) and Stone's actual working capital at closing. The possible adjustment was uncapped. To determine it, the parties exchanged closing statements "prepared and determined from the books and records of the company and its subsidiaries and in accordance with United States generally accepted accounting principles (GAAP) applied on a consistent basis throughout the periods indicated and with the agreed principles." The agreed principles similarly stated that working capital "will be determined in a manner consistent with GAAP, consistently applied by [Stone] in preparation of the financial statements of the business ..." They continued, "to the extent not inconsistent with the foregoing, working capital ... shall be based on past practices and accounting principles, methodologies and policies adopted by [Stone] ... and the business ..."
If the parties did not agree, either could apply to an independent auditor for resolution. The auditor's decision ("a brief written statement") would be based only on written submissions, issued within thirty days, and "final, conclusive, binding, nonappealable and incontestable."
After closing, Westinghouse submitted a working capital calculation of negative $976.5 million—more than $2 billion less than the target working capital amount–and demanded that Chicago Bridge pay. Most of the adjustments were not attributable to changes in Stone's business between signing and closing. Rather, they were challenges based on the closing statement's alleged non-compliance with GAAP, although the approach used was consistent with Stone's past practices and financial statements previously provided to Westinghouse.
Faced with the prospect of liability based on an auditor's view of GAAP, Chicago Bridge filed suit in the Delaware Court of Chancery claiming that Westinghouse's adjustments violated the liability bar. Westinghouse responded that the liability bar applied only to breaches of representations, and the true up process independently mandated GAAP compliance. Westinghouse moved for judgment on the pleadings that the dispute was for the independent auditor to decide. The Court of Chancery agreed and granted Westinghouse's motion. Chicago Bridge appealed.
The Supreme Court's Opinion
Reviewing the decision de novo, the Supreme Court reversed the decision below.
Chief Justice Leo Strine wrote for the court, which viewed the agreement as unambiguous when read as a whole "and situated in the commercial context between the parties." Reviewing the unusual provisions described above—including the $0 purchase price, the indemnification provisions in favor of Chicago Bridge, the condition precedent that plant owners execute liability waivers and the liability bar–the court reasoned the "essence of the deal" was that "Chicago Bridge would deliver Stone to Westinghouse for zero dollars in up front consideration and, in return, would be released from any further liabilities connected with the projects."
The True Up's role was "limited and informed by its function" in the overall agreement. As a general matter, the court reasoned, purchase price adjustments "account for changes in a target's business between the signing and closing of the merger." The "fundamental nature of net working capital adjustments" is that "buyers want protection from value depletion before they take over the business," and "sellers want to ensure that they will be compensated for effectively running the business." Thus, purchase price adjustments "account for the normal variation in business from signing until closing" to ensure the price "accurately reflects the target's financial condition at the time of closing."
The true up provisions (quoted above) reflected this because, in providing that closing statements be consistent with Stone's historical financial statements, they "require the use of Stone's past accounting practices, rather than a new assessment of those historical practices' compliance with GAAP." This standard recognized that "GAAP allows for a variety of treatments and different accountants may come to different views ... but for the purpose of these calculations, [the parties] must hold the accounting approach constant." Keeping the approach constant furthered the True Up's purpose: to "account for changes in Stone's business" leading to closing.
The court reasoned that the True Up dispute resolution process also belied any suggestion of a broader role. Under the agreement, the auditor was an "expert" not an "arbitrator," and its review was "confined to a discrete set of narrow disputes" that, per the agreement, were to be resolved in an abbreviated fashion.
Finally, the court reasoned this reading was necessary to avoid rendering the liability bar meaningless. In this regard, Westinghouse argued that the true up permitted it to accept non-GAAP compliant financial statements before closing, wait until the true up process to raise GAAP issues and then seek changes to the purchase price. The court rejected this proposition, stating it "eviscerates the basic bargain" between the parties.
The court accordingly held that Westinghouse should be enjoined from presenting claims to the auditor "based on arguments that also would have constituted arguments that Chicago Bridge breached the Purchase Agreement's representations and warranties," which would be subject to the liability bar.
While the purchase agreement had unusual features, the court reasoned broadly concerning the typical, limited role of True Up provisions. They generally are intended to measure financial changes between signing and closing, rather than permitting large downward adjustments to a key term of any acquisition agreement—the purchase price—based on disagreements with a target's historical accounting practices. By contrast, a representation affirming the accuracy of the target's financial statements, which the court stated is "the most important representation in a typical purchase agreement," more directly serves the purpose of reinforcing the value judgments that underlie agreements on a purchase price.
Should practitioners desire that true up provisions in their clients' contracts are read in this manner, the Supreme Court provided specific guidance. It focused on the fact that the true up provisions contemplated working capital calculations based on GAAP as applied consistently with Stone's historical practices. The court harmonized certain Court of Chancery decisions on this basis. In OSI Systems v. Instrumentarium, (Del. Ch. 2006), it reasoned, the true up similarly was based on accounting "applied consistently with their application" in financial statements, which supported that the process for addressing breaches of financial statement representations should govern. By contrast, the Supreme Court reasoned, the true up provision in Alliant Techsystems v. MidOcean Bushnell Holdings, (Del. Ch. 2015) imposed GAAP compliance as an independent requirement for closing statements, meaning that the True Up process should govern. Accordingly, practitioners should consider whether their true up provisions could be read to make GAAP-compliance a supervening requirement, regardless of the target's past practices. If so, sellers wishing to avoid the risk of similarly momentous post-closing purchase price adjustment disputes should conform their true ups to include language like that which the Chicago Bridge court found persuasive.Share