Many of our previous posts delve into the benefits of resolution of a commercial or shareholder dispute without litigation. Cost, uncertainty and business distraction are factors which often weigh in favor of settlement even at a price which seems unfair. But making a deal necessitates a desire to do so from both sides. As they say, it takes two to tango. If one party is simply not so inclined or the final best offer is simply unacceptable, litigation may be inevitable, and the only mechanism available to bring about resolution.
In a corporate setting, that litigation may take several forms. Choosing the right path is fact intensive and dependent on the relative positions of the parties. Of course, the terms of agreement between business owners may either provide mechanisms for resolution or limit potential alternatives. Regardless, every course of action comes with significant consequences which must be carefully considered prior to embarking on what can be both emotionally taxing and expensive.
Minority Shareholder Strategies
A minority shareholder who is not actively involved in the business has limited options. Unless a shareholders’ agreement provide a mechanism for redemption or transfer, it may be difficult for a minority shareholder to compel a purchase. That minority shareholder would be left to argue that he or she has been “frozen out” from the business, i.e. excluded from information relating to management, oppressed or treated inequitably in terms of distributions of profits so as to trigger an obligation that the company redeem their shares at “fair value”. An action for the appointment of a custodian or receiver is the minority shareholders weapon of choice in that instance. Majority and controlling shareholders are loathe to lose control of what is often their economic life blood.
Majority Shareholder Strategies
A majority shareholder desirous of consolidation of ownership faced with a minority owner not interested in selling also has limited options to compel a sale. In the absence of an agreement which provides for same, there is no provision at law relating to corporations to simply expel a shareholder. With regard to llc’s, the Pennsylvania Limited Liability Company Act provides a limited number of circumstances where the right of expulsion may apply. In either case, involuntary expulsion of a minority interest is no easy task.
The Nuclear Option
The above being said, the nuclear option available to a controlling interest is dissolution. Blow it up, resign all positions which impose fiduciary obligations at law, liquidate the assets and start something new. While the process may be incredibly disruptive to the continuity of business and the personal finances of all the parties, if the separation of the minority interest holder is imperative dissolution may be the only option. The minority may scream breach of fiduciary duty, but in the absence of an agreement among shareholders that the shareholders would not move to dissolve, the success of such a claim at law is speculative at best.
In the end, the decision of whether to engage in such explosive tactics involves a financial analysis but also other factors such as whether the long term interests of the parties require same. In some cases, such as in professional settings, potential irreparable damage to reputation may demand action regardless of the short term pain such action may cause.
Regardless of whether you are a liability insurance provider or the person being covered by a liability policy, a threshold issue to nearly every coverage dispute is whether or not the insurance provider is obligated to defend its insured in court. If an insurer is not obligated to defend its insured, the insured party is left to his or her own devices to secure and pay for legal counsel.
If an insurer is obligated to defend, but breaches its duty to do so, then it leaves itself exposed to potential liability since it did not perform its obligations under the insurance policy. Both sides of the conflict benefit from understanding the circumstances under which an insurer must defend its insured at the onset of a lawsuit.
Pennsylvania, like many states, has adopted the general rule that a liability insurer’s duty to defend is determined by comparing the allegations of the complaint to the terms and exclusions of the policy. This approach is informally known as the “Eight Corners Rule” due to the law’s emphasis on limiting the analysis to those two documents (each document has four corners – get it?).
The Eight Corners Rule requires that an insurer treat all allegations of a complaint as true, even if there is reason to believe the allegations could be groundless or false. If the allegations set forth at least one injury that is or could potentially be covered by the policy, then the insurer has an obligation to defend its insured against the lawsuit.
There are circumstances where an insurance provider can be relieved of its duty to defend. Usually, this occurs where the insurance provider reserves its rights to disclaim coverage and later discovers facts that would operate to exclude coverage. For example, an insurer may accept defense of a waste management company when it is sued and the plaintiff’s complaint alleges that he or she was injured when she tripped on a dumpster that was negligently placed in a dangerous location by the company. But what if, during litigation, it is revealed that the plaintiff actually tripped while avoiding a dumpster as it was being unloaded by the company’s trash truck? Most commercial liability policies exclude coverage from any damages arising from the use of the insured’s vehicle, including any loading or unloading of that vehicle. In that scenario, the insurance company may be legally entitled to withdraw its defense, leaving the insured party to hire, and pay for, its own defense and ultimate liability.
While an insurer’s obligations to its insureds can evolve throughout a lawsuit, understanding the Eight Corners Rule can be used by insurance companies and policyholders at the start of litigation to determine whether any genuine dispute relating to the insurer’s duty to defend exists, allowing the parties to more efficiently navigate the initial stages of a lawsuit
A corporation or limited liability company provides multiple advantages to business owners which is why business lawyers so frequently recommend their use. Among the most significant of these advantages is limited liability, a concept grounded in the fact that the entity has a separate legal existence from its owners and therefore its obligations are not those of its shareholders or members. Of course an owner may voluntarily agree to be responsible for such obligations as, for example, would be the case if he or she guarantees the entity’s bank borrowing. The shield of limited liability is not, however absolute. It can be breached rendering owners financially responsible for the entity’s obligations. In Pennsylvania, as in most states, there is a strong presumption against ignoring the distinction between the entity and its owners. However certain conduct by business owners will result in the court’s “piercing the veil” – ignoring the distinction between the corporation or limited liability company and its owners. Generally, courts will pierce the veil when those in control of the entity use that control, or use the entity’s assets, to further his, her or their own personal interests. While there is no single test to determine when the piercing of the veil is appropriate courts look to many factors.
1. Is the entity undercapitalized?
2. Did the owners fail to adhere to requisite formalities such as holding shareholder and directors meetings and keeping appropriate records?
3. Was the entity insolvent at the relevant time?
4. In the case of a corporation were dividends paid or were corporate funds siphoned into the pockets of the controlling shareholders?
5. Was there a functional board of directors and corporate officers managing the affairs of the entity?
6. Was there substantial intermingling of the financial affairs of the entity and its owner(s)? 7. Under the circumstances, was the entity form used to perpetrate a fraud? Generally, the court will pierce the corporate veil when a review of these factors shows that the form is a sham, constituting a facade for the operations of the dominant shareholder or member making the entity effectively the “alter ego” of the individual(s).
People often ask, “What kind of lawyer are you?” After my stock (and feeble) comedic response of “a good one”, I often say I am a “commercial litigator”. I explain that our practice includes litigation of disputes which arise between businesses and business owners. Commercial litigation includes a wide range of potential issues ranging from business torts to breach of contract, both internal to a business entity, and between two or more separate entities. While there are a wide range of potential issues which must be considered, there are certain basic tenets which I always discuss with our clients before recommending litigation or taking on their representation.
First, do you have an agreement which might apply to the situation and, if so, what does that agreement say about your position? Agreements can come is various shapes and sizes, such as corporate by-laws, a formal shareholder agreement, a proposal combined with an acceptance or performance, or even a simple exchange of emails. Documentary evidence is key, as a litigator is challenged to explain why the written word should not be impactful.
Second, what is your goal? The kiss of death as to our representation is a client who says “it’s not about the money, it’s the principle”. When I was a young lawyer I had a mentor who gave sage advice when he communicated the firm’s policy that litigation was only appropriate when money was involved. He would politely say, “we don’t litigate over principle”. In many ways and in most situations that adage applies. However, in the corporate setting, sometimes the connection to money is not readily evident or direct such as with regard to disputes over corporate control or enforcing a covenant not to compete. In many situations, I caution stakeholders to take the long view and weigh the probable outcomes from a purely practical standpoint, taking care never to lose sight of their long range business goals.
Third, what is your capacity for litigation and business distraction? Litigation not only costs money in terms of attorney fees, accountant fees, experts and costs, but participation also requires commitment of a leader’s most valuable commodity; time. Business people are first and foremost concerned with business (daily operations, management and the bottom line). Litigation invariably requires substantial client involvement in developing strategy, reviewing pleadings, searching for documents, reviewing documents produced by other parties and preparation for testimony. I advise potential parties to litigation to think long and hard about the cost/benefit to the business of such an undertaking.
Fourth, what can you hope to recover or save; and what will it cost to do so? While a corollary to litigation about money, it is not the same question. The evaluation of potential cost is complex and issue dependent. In a recent case, settlement discussions in a commercial litigation setting were driven by the anticipated six figure cost to translate thousands of pages of information from Chinese characters to English. Costs of experts on any issue involving an opinion on issues ranging from the standard of care applicable to a corporate officer, to whether a machine functioned in the way represented, can rapidly accumulate. Unless there is a provision in an agreement which provides for the recovery of attorney fees or such recovery is otherwise permitted under law, those fees and costs are not recoverable.
The above is not to discourage litigation of bona fide disputes; of which we handle many. It is simply imperative that the lawyer and the client be on the same page as to expectations, risks and litigation management. These questions can assist in forming the framework of a solid attorney client relationship in a commercial litigation setting, which goes a long way toward developing realistic expectations, reducing the stress inherent in the process, and optimizing the chances of a successful outcome.
In my many years of practice as a commercial litigator dealing with conflicts between shareholders, it has become clear time and again that one of the best things business owners can do when in business with multiple shareholders or partners is to have a well-defined agreement which governs the operations of the business. Not only can that agreement memorialize the respective rights and obligations of the parties, it can also provide dispute resolution mechanisms which may serve the parties well in the event of material disagreement. Utilizing the powers granted by the Business Corporations Law and granted by the terms of an agreement governing business owners can be complex and risky but can often force an acceptable resolution when the status quo is no longer tenable.
In the case of a corporation, a shareholders agreement or by-laws will often identify the corporate office which holds supreme executive authority subject only to removal of that corporate officer by a vote of the directors. If the officer controls sufficient votes from the board, removal by a disgruntled shareholder may be impossible. The acts of the executive are subject to the business judgment rule and granted a certain amount of deference at law.
A majority shareholder who holds the top executive office is free to wield that power, consistent with the business judgment rule, in many ways - including business dealings with outside parties and, generally, with respect to employment decisions. If the disgruntled shareholder is an employee of the company, which is often the case in small business, that shareholder’s continued employment may be at the discretion of the majority. Termination of employment, if justified, is a use of corporate power which often impacts on the relative negotiating positions.
Of course, a majority shareholder who exercises corporate authority can be faced with claims that the minority has been “frozen” or “squeezed” out of the business. In such cases, it is important that the majority have “clean hands” and has avoided self-dealing, corporate waste or fraud as such allegations, if proven, could result in the appointment of a custodian or receiver and a loss of control. Certainly the majority cannot transfer the assets of the business to a new entity controlled solely by the majority. However, the existing entity can be managed in a way that maximizes benefit to the majority consistent with the exercise of business judgment. The existence of a dispute between shareholders does not in and of itself negate the discretion afforded by the business judgment rule.
AMM counsels clients through the minefield of corporate authority and with regard to available strategies to address disputes which arise between business owners.
It is not unusual for business owners such as manufacturers and their suppliers and consultants to enter into joint ownership in the pursuit of mutual business goals. Those pursuing this strategy should consider that such entanglements can lead to costly future litigation should circumstances change and interests of the parties diverge. In a recent case, a dispute arose between owners of a custom manufacturing limited liability company in which AMM’s client (and a supplier to that same LLC) possessed 33 1/3% of the issued and outstanding ownership interests. The firm’s client also owned 100% of the stock in a separate business entity which supplied materials to the jointly owned custom manufacturer.
When the owners had a falling out, an issue arose with regard to the payment of outstanding invoices generated by the supplier for materials provided to the jointly owned custom manufacturer. When a resolution could not be reached, AMM, on behalf of the supplier, commenced litigation. During the litigation, the majority member of the jointly held custom manufacturer transferred all of the inventory and other assets to a newly formed entity, owned entirely by him, without the payment of consideration, that is to say, without compensating the supplier entity. The transfer of assets left the jointly held entity with insufficient assets to meet its’ liabilities; including the liabilities to the supplier. As a matter of strategy, the controlling member of the jointly owned entity allowed default judgment in favor of the supplier and against the jointly held custom manufacturer. The newly created entity went about doing business utilizing the inventory transferred without regard to the liability to the supplier.
The transfers gave rise to new and additional claims under the recently adopted Uniform Fraudulent Conveyances Act and claims of breach of fiduciary duty; all of which had to be litigated while the newly formed company operated a separate business. Clearly, a small business owner can no longer simply set up shop as a new entity when things go bad and debt accumulates. However, the complexity of ownership structure and relationship between the various entities made judicial intervention very difficult. In the end, the newly formed entity was forced to file a general assignment for the benefit of creditors; the majority owner lost his interest in all of the respective entities and eventually filed for personal bankruptcy.
The above is just one of many “war stories” encountered in attempting to unwind jointly owned business enterprises. Business owners and potential investors should think very carefully before engaging in shared ownership. What may seem like a mutually beneficial relationship at the outset can be costly and challenging to undo if things go bad in the future.
The take away for business owners and potential investors is to think very carefully before engaging in shared ownership. What may seem like a mutually beneficial relationship at the outset can be costly and challenging to undo if things go bad in the future.
Reprinted with permission from the Spring 2018 Issue of the Pennsylvania CPA Journal
My partners and I were retained for a recent case that highlighted the value of tax and accounting expertise in litigation. We represented shareholders in a precious metals business who were embroiled in a difficult intrafamily dispute. The work illustrated a successful marriage of lawyers and accounting experts in a very complicated commercial case.
A platinum recycling company owned by three brothers – I’ll call them O, S, and K – acquired an interest in a company in Gibraltar and another company in the United Arab Emirates (UAE). Their creditor was a South African platinum company.
Trouble started in 2008. The company fell behind in payments to its South African creditor, and the brothers fought over their company’s future and strategies to repay their creditor. Litigation ensued.
Suits erupted in four different jurisdictions: in the London Court of International Arbitration (LCIA) in the High Court of Justice, Chancery Division (Chancery case), venued in London, England; in Bucks County, Pa.; in Burlington County, N.J.; and in federal court in the Eastern District of Pennsylvania.
Brother S and the company sued Brother K in New Jersey for failure to pay funds due under a loan from the company. The loan was to permit Brother K to purchase the UAE and Gibraltar companies, and then to transfer half of his interest to Brother S.
In the Chancery case, Brother S sued Brother K for K’s conduct in the transactions to purchase the UAE and Gibraltar companies.
Brother O sued Brothers S and K and the company in Bucks County for failure to make distributions to him, for mismanagement, and for self-dealing. Brother K, as an owner of the UAE and Gibraltar businesses, filed on behalf of those entities against the brothers’ company for failure to return metal or pay funds due.
In London, the South African company sued the brothers’ company for $200 million in loans owed to it. It filed the same action in the Eastern District of Pennsylvania.
The brothers eventually settled the Bucks County, London, and New Jersey actions, as well as one of the federal court actions. However, the dispute with the South African company in the LCIA went to trial. The South African company won a judgment for slightly more than $200 million.
The South African company then filed a new action in federal court, alleging that the earlier settlements amounted to fraudulent conveyances made to avoid the $200 million claim while the brothers’ company was insolvent and without fair value exchanged.
The dispute required forensic accounting experts on both sides to present on several issues, including maintaining the entity’s status as an S corporation, evaluating the solvency of the entity, providing insight into whether certain transactions amounted to fraudulent conveyances, and assisting counsel with cross-examination.
The accounting experts evaluated whether settling the Bucks County case to preserve an S election was a viable defense under the fraudulent conveyance statute, and provided advice, reports, and testimony to explain the S election, the steps the company could properly have taken to preserve the election, and the consequences of losing the election.
The parties sought expert opinions regarding the company’s insolvency, and the date it became insolvent. With a $200 million judgment looming, the issue of insolvency was a matter of “when,” rather than “whether.” The lawyers and accountants worked together to determine the date on which insolvency occurred and how to present that to the jury.
The most daunting issue in the case was the lack of professional recordkeeping by the brothers’ company. This issue is too common in family businesses, even among those that have been successful. Experts were required to recreate financial information from the reports generated related to the insolvency and tax issues. The forensic accountants provided support in cross-examination aimed at challenging those recreated reports.
The jury was called upon to answer the following question: Did the settlements amount to fraudulent conveyances? The jury answered “yes” with regard to the Bucks County settlement, but “no” to the settlement of the dispute with the UAE and Gibraltar entities. The jury found that the shareholders did not engage in actual fraud. It returned a verdict of $16 million in favor of the South African company.
The creditor portion of this case required extensive use of forensic accounting experts who expressed opinions on both sides of the Subchapter S and insolvency issues. They assisted in devising strategies to present highly technical topics to the jury. Accounting experts on both sides recreated financial records, and wrote reports addressing the issues. They assisted in devising strategies for cross-examination, and they testified. Together the lawyers and accounting experts were able to present very complicated evidence in a way that kept the jury engaged.
The words “I’m calling my lawyer” as famously spoken on the big screen are intended to inspire fear and trepidation. They often do; particularly where one side in litigation has a disproportionally strong legal position on a critical issue. The threat of litigation is certainly a motivating factor in pre-suit settlement discussion. Even before lawyers get involved in a dispute, the parties have often drawn their respective battle lines and prepared for the standoff.
Sometimes litigation is absolutely necessary. Where one party to a dispute unreasonably believes a legal position is infallible or is deluded by the grandeur of potential recovery, a third party, arbitrator, judge or jury may be necessary to convince that party otherwise. An inability to assess risk often results in a failure to completely evaluate ramifications. In such cases, litigation is inevitable and the best available alternative.
Under any circumstances, the parties must consider the impact of litigation. In business, that impact is not only the expenditure associated with legal fees, but also the distraction litigation brings to the business. Instead of pursuing the next lead, deal or development, the business can be dedicated to the completion of discovery, attendance at deposition or preparation for trial.
A couple of practical considerations:
First, involvement in litigation invites intrusion into a business’s management, internal affairs and financial information. Selecting appropriate individuals within your company who will be involved on a day to day basis and who have knowledge of the facts of the dispute can be a massive undertaking in and of itself, as the demands of producing needed information, data and research will inevitably interfere with that person or persons performing their normal duties and responsibilities for the business. More importantly, in some cases, litigation results in exposure or threatened exposure of otherwise secret information. Customer relationships can be impacted, particularly if those customers are forced to respond to subpoenas. It is critical under such circumstances that business owners and managers make sure a plan is in place to manage internal and external communication.
Other sensitive information may also be revealed. In a classic case of “I did not realize that was important”, clients often omit material facts which may not bear directly on their claim but which may be implicitly revealed. Tax issues are a prime example of such material facts. Any time money changes hands, the manner in which such proceeds are recorded will be addressed in litigation and to the extent either party has sought an unsupportable tax advantage, that act or omission will be revealed.
Undoubtedly, the party sued will seek retaliation and file counterclaims. For example, a contractor performs work for a homeowner which the homeowner fails to pay for. Contractor sues, only to have the homeowner raise counterclaims based on the Unfair Trade Practices and Consumer Protection law which provides for triple damages and attorney fees which can potentially dwarf the original claim. Now the contractor spends more defending the claim for treble damages than in pursuit of the recovery.
Finally, there is the issue of cost. Litigation is expensive. At the end of the day, the parties must consider the cost of a particular course of action and whether the potential for recovery is simply outweighed by that cost.
So before embarking down the road of litigation, be certain it is a path you wish to follow. Be sure to consider the impacts, both intended and incidental, to ongoing business operations. Be sure your house is in order and that the skeletons in the closets are not subject to reanimation. Finally, be confident in the analysis that money spent in litigation is a good investment.
By Patricia C. Collins
Reprinted with permission from the October 24th edition of the The Legal Intelligencer © 2017 ALM Media Properties, LLC. All rights reserved.Further duplication without permission is prohibited.
In Zuber v. Boscov’s, United States Court of Appeals for the Third Circuit, No. 16-3217, the Third Circuit reversed a decision of the Eastern District of Pennsylvania that dismissed an employee’s claims under the Family and Medical Leave Act (“FMLA”) and common law on the basis of a compromise and release agreement signed by the employee to settle his workers’ compensation claims.
The timeline is important to the Court’s determination. Zuber was injured at work on August 12, 2014. He filed a workers’ compensation claim and went out on leave, returning to work on August 26, 2014. His employment was terminated on September 10, 2014. On April 8, 2015, Zuber signed a Compromise and Release Agreement to settle his workers’ compensation claims. On July 9, 2015, Zuber filed his FMLA claims against Boscov’s.
Zuber’s Complaint alleged that Boscov’s interfered with his FMLA rights by failing to notify him of his rights and by failing to designate his leave as covered by the FMLA. He also alleged that Boscov’s retaliated against him for exercising his rights under the FMLA and for asserting a workers’ compensation claim under Pennsylvania common law.
Boscov’s moved to dismiss the Complaint on the basis of the Compromise and Release Agreement, and the Eastern District of Pennsylvania agreed. The district court found that the Compromise and Release Agreement was a general release meant to waive all claims, including the FMLA and common law claims. The district court opined that the release include “broad, all-encompassing language” relating to the work injury claim and its “sequela.” Specifically, the district court noted that the use of the words “sequela whether know or unknown at this time” broadened the scope of the release.
In so doing, the district court relied on two cases: Hoggard v. Catch, Inc., No. 12-4783, 2013 WL 3430885 (E.D. Pa. July 9, 2013)(Kelly, J.) and Canfield v. Movie Tavern, Inc., No. 1303484, 2013 WL 6506320 (E.D. Pa., Dec. 12, 2013)(Baylson, J.). In Hoggard, the release in question recited that it “completely resolves all claims and issues arising out of the claimant’s injuries….” The Hoggard court found that this language resulted in release of all employment claims against the employer which arose from the work injury, including wrongful termination claims. In Canfield, the release in question recited that it released all “workers’ compensation claims….” Because it was specifically limited to workers compensation claims, the Canfield court found that the release did not waive the employee’s employment law claims.
In reversing the district court to find that the Zuber release did not release the employee’s FMLA and common law claims, the Third Circuit analyzed the phrase “sequela, whether known or unknown at this time.” The Third Circuit found that the release was unambiguous of its face, and refused to review parol evidence. The Third Circuit noted that the word “sequela” means “suit,” and that the language of the release thus was intended to waive his work injury claims and any “work injury claim” suit. The modifier “its” before the word “sequela” renders the release limited to the workers’ compensation claim. Further, the Court noted that the agreement to forfeit any damages claims was also modified by the phrase “work injury claims.”
Interestingly, the Third Circuit also based its determination on the “structure” of the release. Elsewhere in the document, the agreement recited that its purpose was to resolve the work injury claim, and that it was a release of the employee’s workers compensation claims. Given this language, the Third Circuit reasoned, the release paragraph could not be read as a general release. Accordingly, the Third Circuit held that Zuber did not waive his FMLA and common law claims.
The issue of the impact of Compromise and Release Agreements in the context of later wrongful termination claims is a common one. The Third Circuit’s opinion, read with the opinions in Hoggard and Canfield, suggests that courts will meticulously review the agreement under general contract principles to determine whether there was a waiver of broader employment law claims. The interesting thing about the Zuber opinion is that both the district court and the Third Circuit engaged in this meticulous review of the language and came up with a different answer.
Likely, this results from the procedural posture of workers compensation claims. Those claims proceed on a completely separate track than any statutory or common law termination claims, and the issues are narrow: wage loss and medical expenses as a result of a work injury. Further, the workers compensation settlement is sometimes reached while the wrongful termination suit is pending. An unintended result to a challenge to a Compromise and Release Agreement (for example, a finding that a release is limited where one party intended it as general) might result from the procedural posture of both cases, error, or lack of precision in drafting. Courts will have to unravel imprecise language without reference to that context.
The Zuber opinion highlights the importance of clarity and consistency in a release. The issue of whether or not a release is a “general” release should be discussed, agreed to, and recited in the release. In the context of settling workers’ compensation claims, this might require discussing with the client any common law or statutory employment claims, and, for the employer, a discussion regarding the possibility of future claims. The opinion in Zuber reflects that it will be difficult to predict what a court will do with particular language in the agreement.
Patricia Collins is a Partner with Antheil Maslow & MacMinn, LLP, based in Doylestown, PA. Her practice focuses primarily on commercial litigation, employment and health care law. To learn more about the firm or Patricia Collins, visit www.ammlaw.com.
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”.