Page 26 - M & A Disputes

Purchase Price Adjustment Disputes

Purchase price adjustments arise in transactions because the target continues to operate the business
from the time of the agreement until the closing of the transaction. Due to the passage of time and the
seasonality of some businesses, the assets and liabilities of the target company will fluctuate — at times
significantly. To address this fluctuation and its potential impact on the value of the target at the time of
the close, agreements often incorporate a purchase price adjustment (as previously discussed). The pur-
chase price adjustment attempts to account for changes in the target’s financial position (for example,
working capital, net assets, or some other financial metric) between the preclosing balance sheet availa-
ble when the agreement was signed and the final closing-date balance sheet. The calculation of these ad-
justments frequently results in postacquisition disputes.

Many agreements require that the closing-date balance sheet be prepared in accordance with GAAP con-
sistently applied for some historical period or point in time predating the transaction. This requirement
often leads to disagreements regarding which accounting treatment constitutes GAAP, which accounting
treatment complies with the requirement of consistent application, and which contractual requirement
should be applied to calculate the closing balance sheet when compliance with both the GAAP and con-
sistency provisions is not possible. Other commonly encountered disagreements include whether the
closing balance sheet should be prepared using accounting procedures historically employed at interim
dates or closing dates and whether the preclosing-dated balance sheet (that is, the working capital or net
asset "peg") should be adjusted. These areas of dispute are addressed in further detail in chapter 2,
"Postclosing Purchase Price Adjustments," of this practice aid.

Earnout Disputes

As previously discussed, earnout clauses are incorporated into agreements as a means to base some por-
tion of the purchase price on the future performance of the target’s business. By the very nature of their
structure, which compensates sellers based on some measure of future performance as operated and ac-
counted for by the new owners, measurement of the purchase price adjustments from earnout provisions
can be the source of contention. This area of dispute is addressed in further detail in chapter 3, "Earnout
Provisions and Disputes," of this practice aid.

Claims for Indemnification

Claims for indemnification typically arise as a result of alleged breaches of representations or warranties
by the seller, whereby the buyer seeks indemnification for losses incurred as a result of the alleged
breach. In a claim for indemnification, the buyer will seek recovery of economic losses adequate to re-
turn the buyer to the financial position it would have been in but for the alleged breach. Depending on
the nature of the alleged breach, claims for indemnification may result in dollar-for-dollar damages to
recover out-of-pocket losses or damages subject to a multiplier in situations when a buyer can demon-
strate that it overpaid for the target based on the alleged breach. As previously discussed, recoveries
from claims for indemnification may be subject to both contractual deductibles and contractual caps.
This area of dispute is addressed in further detail in chapter 5, "Representation and Warranty Disputes,"
of this practice aid.

The Role of the Forensic Accountant in Preventing, Supporting, and Adjudicating M&A
Disputes

Practitioners provide a number of professional services to parties in M&A transactions, including assist-
ing other business professionals and attorneys with valuing the target; assessing the general, tax, and ac-

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