Chancery Court Finds Prices Need 'Compliance, Not Consistency' With M&A Agreements

Kirkland partner Erin Johnston is mentioned in Delaware Business Court Insider regarding her representation of Shareholder Representative Services.

A Court of Chancery decision has found that the terms of a contract come first when determining a final sale price in Delaware.

In his Jan. 29 opinion, Vice Chancellor Paul Fioravanti wrote that accounting principles used to calculate the final price Golden Rule Financial Corp. owed to acquire USHEALTH in 2019 were used according to the agreement between the companies, even though they differed from the principles used to estimate that price at the time the agreement was signed.

The decision to dismiss Golden Rule’s case against Shareholder Representative Services, a Colorado LLC serving as the representative for USHEALTH’s former shareholders, pairs the Delaware Supreme Court’s 2017 decision in Chicago Bridge & Iron v. Westinghouse Elec. with the court’s stance on giving companies significant leeway in making agreements with one another.

In both cases, the company value calculated by the buyer in a true-up was significantly higher than the value estimated at the time of signing due to different accounting principles being used. In the Chicago Bridge case, the Supreme Court found the same accounting measures should be applied at both points when finding the value, as specified in the merger agreement.

But in last week’s decision, Fioravanti found the key to be what valuation procedures are specified in the agreement, not that calculations be made the same way. In the Chicago Bridge case, the terms of the agreement happened to be that the same accounting principles be used at signing and closing.

Fioravanti referenced Chicago Bridge extensively in his opinion, frequently quoting sections of the Supreme Court’s opinion that mentioned the importance of the overall purchase agreement in the case.

“It demands compliance, not consistency,” he wrote.

In dispute in the newly dismissed case was exactly how much Golden Rule, represented in this case by Michael Maimone of Faegre Drinker Biddle & Reath, was to pay to acquire USHEALTH.

According to the opinion, the merger agreement between the companies set a base purchase price of $750 million, which could be adjusted after closing the deal based on where accounting metrics fell at closing compared to the time the deal was signed. Faegre Drinker representatives declined to comment on the court’s decision.

In particular, the amount being questioned was USHEALTH’s tangible net worth. The agreement set that amount at a targeted $52 million. Shortly before closing, USHEALTH adjusted that estimate down, about $11.25 million in Golden Rule’s favor, but a USHEALTH employee reportedly later disclosed Topic 606 had been applied incorrectly in those later calculations.

After closing, Golden Rule reportedly found out USHEALTH had been calculating its net worth using accounting principles different from its own. Specifically, the discrepancy arose from differing applications of  Topic 606, a newer accounting standard that changed how a company can recognize revenue from long-term contracts.

When Golden Rule did its own calculations in a way it thought to be correct, it set the tangible net worth at $73.7 million and included those calculations in a reconciliation statement to USHEALTH. USHEALTH then rejected Golden Rule’s final adjustment statement post-closing and triggered the dispute resolution procedure outlined in the agreement to try to sort out the discrepancy. Golden Rule eventually filed its case in the Court of Chancery when a resolution wasn’t reached after a few months.

Under the agreement, Fioravanti wrote, both parties would have been aware that as a private company, USHEALTH didn’t have to use Topic 606 in its original financial statements, and the company never suggested it did when determining its tangible net worth at signing. But at closing, the parties had agreed to use Topic 606.

“It is not the role of this court to second-guess the parties and read into their agreement what they have omitted,” he wrote. “The agreement in Chicago Bridge lent itself to being interpreted as demanding consistency across all relevant time frames. The Agreement here does not.”

David Ross and Elizabeth Taylor of Ross Aronstam & Moritz and Erin Johnston with Kirkland & Ellis, all of whom represented Shareholder Representative Services, did not comment on the case Tuesday.