Richards Layton & Finger

Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co.: Delaware Supreme Court Reverses Trial Court Decision Construing Post-Purchase Adjustment Provision

March 8, 2018

In Chicago Bridge & Iron Co. N.V. v. Westinghouse Electric Co., 166 A.3d 912 (Del. 2017), the Delaware Supreme Court reversed the Delaware Court of Chancery’s grant of judgment on the pleadings. The Court of Chancery had held that a dispute over a post-closing purchase price adjustment under the terms of a purchase agreement was to be submitted to and resolved by an independent auditor. On appeal, the Supreme Court reversed and held that the buyer could not use the purchase price adjustment dispute resolution mechanism to remedy the buyer’s assertions that the seller’s historical financial statements did not comply with generally accepted accounting principles (“GAAP”). The Supreme Court further held that the Court of Chancery should, among other things, enjoin the buyer from submitting (or continuing to pursue already submitted) claims before the auditor that were not based on changes in facts and circumstances between signing and closing.

In 2015, an acquisition vehicle controlled by Westinghouse Electric Co (“Buyer”) purchased a subsidiary of Chicago Bridge & Iron Company N.V. (“Seller”). The purchase agreement between the parties provided for a purchase price of $0, subject to a post-closing purchase price adjustment (the “Closing Date Adjustment”) and the potential for deferred future payments. The Closing Date Adjustment was to be tied to the difference between the contractually defined target net working capital amount of $1.174 billion and the net working capital amount as calculated by the parties in accordance with the terms of the agreement (the provisions governing the calculation of such amount, the “True Up”).

Under the True Up, in advance of closing, Seller was required to prepare a closing payment statement containing a “good faith estimate” of the closing date purchase price. The closing payment statement was to be prepared in accordance with GAAP, applied on a consistent basis throughout the periods indicated in the purchase agreement and with the Agreed Principles (as such term was defined in the purchase agreement). The Agreed Principles similarly provided that the working capital would be determined in a manner “consistent with GAAP, consistently applied by [the subsidiary]” and, to the extent not inconsistent with the foregoing, “the past practices and accounting principles, methodologies and policies applied by [the subsidiary].” Three days before closing, Seller provided Buyer with a closing payment statement estimating net working capital as approximately $1.6 billion, exceeding the contractual target net working capital amount and suggesting that Buyer owed Seller $428 million.

After receiving the closing payment statement, Buyer chose to close the transaction. Under the terms of the purchase agreement, although Buyer could have refused to close the transaction if Seller had breached its representations and warranties (including its representation and warranty that its historical financial statements were prepared in accordance with GAAP), the purchase agreement provided that Seller would have no post-closing liability for any breach of representations and warranties and that none of the representations and warranties would survive closing (the “Liability Bar”).

In connection with the True Up, following closing, Buyer was required to prepare a final closing statement containing Buyer’s “good faith calculations” of the purchase price at closing. Buyer’s closing statement estimated the net working capital amount at closing as negative $976,500,000, which suggested that Seller owed Buyer $2.15 billion. The difference between the closing statements stemmed from four changes that Buyer made to Seller’s closing payment statement, including: (i) reducing an outstanding receivable identified on the subsidiary’s balance sheet as “claim cost” by 30% based on Buyer’s objection under GAAP to Seller’s estimate of “100 percent collectability” of this receivable; (ii) adjusting the claim cost receivable by establishing a claim cost reserve and deducting the amount of the reserve; (iii) increasing by 30% Seller’s estimate of the cost to complete the subsidiary’s ongoing projects; and (iv) deducting a liability of $432 million relating to Seller’s acquisition of the subsidiary that Buyer claimed was improperly omitted under GAAP.

Claiming that Buyer breached the terms of the purchase agreement and the implied covenant of good faith and fair dealing in its calculation of the Closing Date Adjustment, Seller argued that the purchase agreement’s terms precluded Buyer from “making any adjustments to items that appeared on the Company’s balance sheet or adding liabilities with the avowed goal of complying with GAAP.” Seller further argued that Buyer’s claims were actually claims for breaches of representations and warranties that had been extinguished at closing. In response, Buyer argued that it did not give up its right to raise issues of GAAP compliance when calculating the Closing Date Adjustment, and that in any event, the purchase agreement required the parties to submit their dispute to an independent auditor. Under the purchase agreement, the “determinations of the Independent Auditor were ‘final, conclusive, binding, non-appealable and incontestable by the parties . . . for any reason other than manifest error or fraud.’”

In rejecting the Court of Chancery’s reading of the True Up as providing Buyer “a wide-ranging, uncabined right to challenge any accounting principle used by [Seller], however consistent that principle was with the ones used in the financial statements represented to be GAAP compliant,” the Supreme Court stressed that the purchase agreement must be read together in its entirety. Viewed in its entirety, the Supreme Court found that the True Up “is an important, but narrow, subordinate, and cabined remedy available to address any developments affecting [the subsidiary’s] working capital that occurred in the period between signing and closing.” A contrary holding, the Supreme Court explained, failed to give adequate weight to the structure of the purchase agreement, including, without limitation, the Liability Bar.