Page 83 - M & A Disputes

In Hoeft, as part of a stock acquisition agreement, the parties agreed to defer a portion of the purchase
price until the following year when they would calculate a purchase price adjustment for the increased
value of the company over that time period. According to the stock purchase agreement, the purchase
price adjustment was to be based on calculations of earnings before interest, taxes, depreciation, and
amortization (EBITDA) at the closing and one year after the closing. In the event that a dispute arose
about the EBITDA value at either date, the parties were to submit the dispute to a neutral practitioner
"whose decision in such matters shall be binding and conclusive upon each of the parties hereto and
shall not be subject to any type of review or appeal whatsoever." Inevitably, a disagreement arose about
whether certain one-time payments to employees made in connection with the sale, including sale-
related bonuses and stock option extinguishment costs, reduced the income from operations component
of EBITDA. The parties brought the dispute before the neutral, who received documentary evidence and
expert reports from the parties. In his award, the neutral accountant adopted the position of the sellers
that one-time payments related to the sale did not reduce income from operations, even though that posi-
tion contradicted the majority interpretation of GAAP, as argued by the buyers and later found by the
courts.

The buyer petitioned a federal district court to vacate the neutral’s award under the theory that the neu-
tral’s failure to follow GAAP constituted a manifest disregard of the law, and the district court agreed
with the buyer. However, an appellate court overturned that ruling and reinstated the award. fn 2 The ap-
pellate court ruled that a party challenging an award must prove that "(1) the arbitrator knew of a gov-
erning legal principle yet refused to apply it or ignored it altogether and (2) the law ignored was well-
defined, explicit and clearly applicable to the case." The appellate court found that the neutral did not
manifestly disregard the law because "[a]s it relates to this case, GAAP is not sufficiently well-defined
or explicit to constitute ‘law’ within the meaning of the manifest disregard standard." Even recognizing
that the buyer’s "position may represent the clear majority view" regarding the application of GAAP, the
court found that there were at least two "reasonable" interpretations of GAAP standards, such that the
neutral did not commit a manifest disregard of the law.

The inherent weakness of any claim of manifest disregard of the law is demonstrated by a court deci-
sion, such as Hoeft, that confirmed the award. Even though it was clear that the neutral’s disposition did
not conform to the majority interpretation of GAAP, the court deferred to the neutral’s great discretion
in recognizing a more uncommon use of accounting principles.

The current judicial trend is to make arbitration awards even more unassailable. In 2008, the United
States Supreme Court put into serious question the viability of the manifest disregard of the law standard
(see Hall Street Associates, LLC v. Mattel, Inc., 128 S. Ct. 1396). The court held that the statutory
grounds for vacating an arbitration award under the FAA are exclusive. The court rejected the parties’
contract that purportedly granted a court-enhanced judicial review of an arbitrator’s award. More specif-
ically, the contract permitted a court to vacate the award if the award is "not supported by substantial ev-
idence," or the "conclusions of law are erroneous." The Supreme Court held that the parties could not
increase a court’s authority to review an arbitration award pursuant to the FAA because "§§ 10 and 11
respectively provide the FAA’s exclusive grounds for expedited vacatur and modification."

fn 2 It is also noteworthy that the district court permitted the buyers to depose the neutral in order to understand the reasoning behind
his decision. Although the appellate court would later find the lower court’s decision to allow for the deposition to be in error, all neu-
trals should be prepared for the fact that litigation arising out of their decisions may subject them to discovery and possibly even evi-
dentiary hearings or trials.

© 2020 Association of International Certified Professional Accountants 81