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Does That Dispute Resolution Clause Constitute Arbitration Under the FAA?

Thursday, 29 June 2017 15:42 Written by  Thomas P. Donnelly

Reprinted with permission from the June 27th edition of the The Legal Intelligencer © 2017 ALM Media Properties, LLC. All rights reserved.Further duplication without permission is prohibited.

Earn out clauses in business acquisitions are notoriously fertile ground for disputes.  Complicated post-closing performance metrics, access to information, modifications to accounting methodologies after closing, tracking and collection of revenue information all present opportunities for buyer and seller to disagree.  The classic struggle of seller’s effort to maximize sale return juxtaposed against buyer’s focus on transforming the operations of the acquired enterprise for long term success necessarily create friction.  Both sides bring their unique perspectives to the interpretation of the exhaustively negotiated purchase agreement with the new benefit of hindsight. 

Certainly, arbitration pursuant to the Commercial Rules of the American Arbitration Association is common in any number of business contracts.  When the parties elect that process, they accept the applicable Rules and agree to adopt the procedures which have been developed by AAA.  In the earn out or deferred consideration context, however, acknowledging the sheer number of potential conflicts surrounding inherent accounting practices, scriveners often  incorporate a unique mechanism for dispute resolution in their  transactional documents.   When the issue is theoretically limited to a calculation, the parties go to great pains to define the applicable accounting terms and may design a system of dispute resolution which does not contemplate many of the applicable provisions of the Commercial Rules or empower any judicial or quasi-judicial third party to control the process. 

Indeed, transactional practitioners have developed language which seeks to avoid the intricacies of AAA arbitration in preference for what should be a predictable accounting calculation based on verified numerical results of operations.  In such cases, parties most commonly agree to submit any dispute related to the earn out to an informal resolution process using mutually agreed upon accountants to serve as “expert consultants and not as arbitrators.” The sole purpose of the accountants’ participation is the review of financial information relating to post closing operations and the calculation of deferred consideration; which calculation would be “final and binding”. 


Notwithstanding the clear expression of intent manifested in the use of phrases such as “expert consultants and not arbitrators” in defining dispute resolution processes, there remains a split in the United States Circuit Courts of Appeal as to whether the chosen language should be entirely disregarded and the dispute resolution process deemed “arbitration” for purposes of the Federal Arbitration Act (“FAA”).  Adding to the confusion, the FAA does not define arbitration.  While traditional concepts of contract interpretation at common law in Pennsylvania would seem to require interpretation which gives effect to the parties’ intent and precludes application of the FAA, the Third Circuit has not yet addressed the issue and significant authority from other Circuit Courts has held otherwise.

For example, the Seventh Circuit specifically rejected language adopting a dispute resolution procedure utilizing “experts and not arbitrators” as distinct from arbitration when deciding post- closing adjustments to purchase price in Omni-tech Corp. v. MPC Solutions Sales, LLC, 432 F.3d 797 (2005).  The court focused on the parties agreement that the results of the accountant’s analysis would be final and binding in concluding that the resolution of the dispute fell within the parameters of arbitration and thus subject to the FAA.

An unreported report and recommendation authored by Magistrate Judge Eddy from the Western District of Pennsylvania in Dominion Retail, Inc. v. Rogers, 2012 WL 2405254 relies upon Dominion Retail to hold that the findings of accountants pursuant to a dispute resolution process adopted by parties to an asset purchase agreement could not be assailed in the District Court.  In Dominion Retail, the parties had participated in the calculation process and received the results.   The court concluded that the result of the accountant analysis was entitled to the deference that would be accorded an arbitration award.    

In contrast, years earlier, the Eighth Circuit Court of Appeals held contrary in a similar case.  In PVI, Inc. v. Ratiopharm GMBH, Corporation, 1356 F.3d 1252 (8th Cir. 1998) the court addressed a dispute resolution clause involving the appointment of a “neutral” expert and containing the “final and binding” language.  PVI pertained to valuation of the exercise price of stock options granted under a stockholders’ agreement.  The PVI court concluded confirmation of the independent valuation as an arbitration award based on the FAA was unavailable under the circumstances.  Reasoning that the parties had not included a provision in their agreement which permitted the findings of the neutral expert to be reduced to judgment under §9 of the FAA, the PVI court concluded that the Act was inapplicable by its own terms.    The PVI court opined, in dicta, that the parties may have arguments as to whether the expert’s valuation was an arbitration (such as pursuant to relevant state law), but that confirmation under the FAA was not an available vehicle within which to raise such argument in the absence of an agreed upon provision for entry of judgment.  Finding “enforcement under the FAA brings all of the substantive provisions of the act to bear on the arbitration and the award in dispute”, the PVI court affirmed the district court’s denial of confirmation under §9 of the Act.

The argument against application of the FAA to dispute resolution procedures is founded on principles of contract interpretation.  In Pennsylvania, in order to form a valid agreement to arbitrate, common law requires that there be a mutual manifestation of an intention to be bound, sufficiently definite terms, and consideration. Agreements to arbitrate in Pennsylvania are upheld only when it is “clear and unmistakable” that parties have agreed to arbitrate their disputes.   Traditional notions of contract interpretation apply, including the obligation to ascertain the parties’ intent from the language of the agreement which cannot be assumed to have been chosen carelessly or in ignorance.   

Imposing the FAA on parties who have specifically rejected arbitration does not appear to comport with Pennsylvania principles of contract interpretation.  In doing so, Courts bring about a result exactly the opposite of what the parties clearly expressed in their writing.  Ramifications of such decisions would include preclusion of any appeal rights related to the accountants’ flawed calculation or process, the timing, quality or quantity of information exchanged or even the extent to which one party fails to participate in good faith.  Unlike an AAA arbitration, there are no rules which govern the proceeding or penalties which can be imposed based on conduct.  Accordingly, the disclaimers commonly included in commercial agreements as referenced above may no longer be sufficient to avoid the final, binding and unappealable ramifications of “arbitration” even when the parties clearly and unambiguously expressed a contrary intent.  

Tom Donnelly is a Partner with Antheil Maslow & MacMinn. His practice focuses primarily on commercial litigation and transactions, employment disputes and personal injury.  

Last modified on Friday, 30 June 2017 14:26
Thomas P. Donnelly

Thomas P. Donnelly

Tom’s practice focuses on commercial litigation and transactions. In litigation, Tom represents both Plaintiffs and Defendants. Throughout his career, he has undertaken the representation of both individual and corporate clients in subject matters concerning fraud, contracts, employment agreements, breach of fiduciary duty, securities violations, real estate and insurer bad faith. Tom’s clients include individuals and businesses local to the Philadelphia area, as well as national corporations.

To view Thomas' full bio, click here.

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