Page 37 - M & A Disputes

Another issue relating to type I subsequent events is how long a period of time after the closing date the
parties can consider subsequent information. Typically, the agreement calls for one party to prepare the
final closing-date balance sheet 30, 45, 60, or 90 days after the closing. This period pending preparation
of the closing financial statements is usually the period of time for which subsequent information is con-
sidered and used to derive estimates. Information becoming available after this period is usually not con-
sidered. However, some parties have argued that information through the final arbitration decision
should be considered. Another issue that frequently comes up is how to deal with extensions of time. For
example, if the agreement provides the buyer 30 days to produce the final closing balance sheet, but the
buyer needs more time, the buyer and seller may agree to a 1-month extension. This extension would
now require the buyer to provide the final closing-date balance sheet 60 days (versus 30 days) after clos-
ing. This time extension frequently leads to items of dispute. The buyer may view the extension as more
time to consider additional subsequent events information. In contrast, the seller may view that infor-
mation as becoming available after the original due date of the closing financial statements; therefore,
the seller could conclude that such information should not be considered.

Materiality

The parties may dispute the accounting concept of materiality to individual adjustments in relation to the
balance sheet as a whole. In purchase price disputes, the buyer usually will claim that all purchase price
adjustments, if deemed proper, should be awarded to it, regardless of materiality, unless the contract
contains a threshold, a basket, or another similar clause. Alternatively, the seller may argue that certain
adjustments are not material and should be ignored based on GAAP consistently applied.

The practitioner should review the agreement to determine whether adjustments should be made on a
dollar-for-dollar basis or be limited by materiality. In the latter case, the dollar amount of materiality
should be defined in the agreement.

Some agreements may contain clauses indicating a postclosing adjustment payment is only required if
the adjustments exceed a specified dollar amount in the aggregate: a materiality threshold. The contract
clause may provide that once the adjustments exceed such levels, the purchase adjustment is based on
the gross amount. Alternatively, the clause may read that the purchase adjustment is based on the
amount by which the adjustments exceed the specified level. In many cases, however, the agreement
does not address materiality. In such a situation, a level of materiality may be implied through other con-
tract clauses. For instance, a contract may read that no postclosing adjustment is necessary at closing if
the net asset value changes less than 5% from the net asset value in the financial statements used in the
negotiation process to set the target. This clause implies that the parties agreed upon a materiality level
of 5% of the net asset value.

Practitioners typically evaluate materiality with respect to the financial statements as a whole. If the
agreement does not address materiality in any context, the seller may have a difficult time arguing that a
materiality threshold should apply to the buyer’s proposed purchase price adjustments. The seller may
still argue that it represented that the financial statements would be prepared in accordance with GAAP,
which contains the concept of materiality. However the accounting definition of materiality is based on
amounts that would influence a financial statement user. Because the parties are both financial statement
users and use financial statements to derive a purchase adjustment, it is difficult to accept the conclusion
that any amounts are not material because they affect the transaction price.

© 2020 Association of International Certified Professional Accountants 35