Supreme Court of Delaware: Purchase price adjustment must be ‘proper’ if not ‘consistently’ applied | McGuireWoods LLP
In a recent case examining the purchase price adjustment clause after the closing of a purchase agreement, the Delaware Supreme Court ruled that the agreement required the provision to be applied correctly when determining the price. final purchase, even if this application is incompatible with previous practice.
Golden Rule Financial Corp. vs. Shareholder Representative Services, LLC dealt with a dispute between a buyer and a seller regarding the final purchase price of the company involved. The parties’ purchase agreement included a mechanism that provided for the purchase price to be adjusted up or down after closing, depending on whether certain metrics were below or above the targets the parties had established at the time of closing. signature. To determine whether the adjustment would result in an additional payment to the seller or a credit to the buyer, the agreement stated in the relevant part that the purchase price adjustment would reflect a specified accounting standard — ASC 606 — which was already incorporated in the objective financial statements of the company. With respect to the dispute between the parties, the purchase agreement also stipulated that the purchase price adjustment would be prepared using “consistently applied” accounting principles.
In calculating the post-closing purchase price adjustment, the buyer determined that the company had consistently, but incorrectly, applied ASC 606 in its pre-closing financial statements. Using the correct application of ASC 606, the buyer calculated that the final purchase price would be to augment of several million dollars. By using the incorrect application that the company used previously, the purchase price would be to diminish of several million dollars. The seller has taken the position that the correct application should be used. The buyer disagreed and sought relief by asking the Delaware Chancery court to find that the purchase agreement required consistent, but incorrect, application of ASC 606.
The chancery court disagreed, and on December 3, 2021, the Delaware Supreme Court upheld. Given the plain language of the purchase agreement and the specific reference to the application of ASC 606, as opposed to the more general reference to the consistent application of accounting principles, the Supreme Court agreed with the decision of the Chancery Court that the emphasis on the term “consistently” ignored both the parties’ agreement to use ASC 606 and the fact that the agreed accounting principles must also be “applied”. the Supreme Court explained that blessing an improper application of ASC 606 would result in that standard “not being applied, notwithstanding the parties’ express agreement to apply ASC 606”. parties to continue to incorrectly apply ASC 606, even if consistent with prior treatment, would result in it not being applied at all, contrary to the purchase agreement.
In light of the Delaware Supreme Court’s decision, parties to purchase agreements governed by Delaware law should pay particular attention to the clarity of the drafting of purchase price adjustment provisions and the calculation details of these adjustments. Buyers, in particular, should take steps to ensure during the due diligence process that they understand how the target company prepares its financial statements.