Delaware court rules on post closing purchase price adjustment

A March decision of the Chancery Court in Matria Healthcare v. Coral SR LLC is an essay on post-closing adjustment (true-up) provisions and the interplay of dispute resolution mechanisms in a purchase agreement.

The case involved a merger between two companies in the disease management and wellness business, Matria and CorSolutions. Apparently, before the closing CorSolutions received some complaints from a key customer about their bill and failed to disclose that to the buyer. Matria got the call from the customer – one day after closing – and then spent the next six months negotiating what turned into a $4 million settlement. This was done without discussion with the seller and without their consent. After the settlement, Matria sought relief from the seller for their payment and the dispute ensued.

To complicate things, this agreement had four different types of dispute and resolution mechanisms, two of which are relevant here. The first was a typical post closing adjustment (true up) provision relating to balance sheet adjustments for things like working capital, cash on hand, indebtedness, etc. Disputes arising from adjustments would be submitted to an outside accountant (a “Settlement Accountant”). These claims were not limited by a cap and would be adjusted on a first dollar basis.

Other claims by the parties relating to the transaction, such those arising from breaches of representations, warranties or covenants, would be handled by a AAA arbitration. These claims would be resolved against a $20 million escrow fund, and were subject to a basket (i.e. deductible) of $4.5 million. The agreement also provided a typical exclusive remedy clause where all claims other than fraud or for injunctive relief would be limited to the escrow fund.

The court noted that, in anticipation of a potential hierarchy issue stemming from the different ADR provisions, the parties also provided that any claim that could be brought related to the financial statement adjustments will be subject to that provision and not subject to the escrow fund. (“The items set forth on or reflected in the [financial statements delivered in connection with the true-up] and any matters relating thereto that could have been subject to adjustment or dispute pursuant to [the true-up] are subject solely to the adjustments set forth in Article II [i.e. by the Settlement Accountant] . . . and accordingly shall not be subject to any claim by [Matria]… on the Escrow Fund.”)

If the claim went before the Settlement Accountant, Matria may recover fully on its $4 million claim; if it goes before the AAA, they will likely get nothing since it will be wiped out by the $4.5 million basket. Therefore, it is not surprising that the parties could not agree on the forum.

The interesting part of this decision is the analysis of how Matria’s claim arising from the customer complaint could be characterized under the agreement. The Court noted that the claim could be (1) a potential claim, serious enough to be reflected on CorSolutions’ balance sheet, and therefore properly before the Settlement Account on a first dollar basis; (2) a misrepresentation based on a failure to disclose and a breach of various representations and warranties and, thus properly before the AAA and subject to the cap and basket ; and (3) a Third-Party Claim pursued by the customer, where yet a third mechanism from indemnity and damage relief would apply. The discussion appears on pp. 15-16 of the decision.

At the end of the day, the court being predominately known for its strict construction, directed the dispute to the Settlement Accountant on the basis of the hierarchy clause that was in the agreement, albeit with some reluctance. (“The result reached here is, in large part, unpalatable; it is the product, however, of words chosen by sophisticated parties who drafted a complex and comprehensive agreement. More importantly, it is not for some judge to substitute his subjective view of what makes sense for the terms accepted by the parties.”).

The moral of the story here is that these are very complex provisions that really need to be tested by the drafters in advance to make sure that they will work in the field. The Matria decision has a lot of other interesting nuggets for transactional lawyers relating to arbitrability, contract constuction and drafting examples (that may or may not work, depending on one’s viewpoint) and therefore worth a closer a read.

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