Del. High Court Revives Arbitration Award In Dispute About Stock Purchase Agreement

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June 17 — An accounting firm serving as arbitrator in a dispute between parties to a stock purchase agreement didn't manifestly disregard the law when it interpreted the contract in the seller's favor, the Delaware Supreme Court concluded June 16 .  

“That interpretation may have been wrong,” Justice Carolyn Berger opined in reversing the chancery court's decision, “but it was not without a basis in the contract and the parties' submissions.”

SPA Dispute Leads to Arbitration

The court recounted that in 2006, SPX agreed to sell the stock of a subsidiary to Garda USA Inc. and its parent company for $67.25 million. However, the actual purchase price was subject to adjustment based on differences between SPX's pre-closing balance sheet, produced five days before closing, and the effective data balance sheet, produced within 60 days after closing.

On both balance sheets, working capital was to be calculated pursuant to a schedule in Section 1.3 of the SPA. According to the court, the schedule generally defined the subsidiary's working capital as assets minus liabilities. However, there were certain specified exceptions, one of which addressed the treatment of incurred but not reported claims—IBNR—relating to workers' compensation liabilities.

In May, the court recounted, Garda challenged SPX's calculation of the workers' compensation reserve listed on the effective date balance sheet. Unable to resolve their differences, the parties entered into arbitration, with Ernst & Young LLP serving as arbitrator.

Ultimately, the court continued, the accounting firm concluded that Garda failed to demonstrate that SPX failed to comply with Section 1.3. “E&Y gave no other explanation for its decision.”

‘Manifest Disregard' Review Standard

Thereafter, Garda filed a complaint in the Delaware Chancery Court seeking to vacate the arbitrator's decision. The chancery court concluded that E&Y manifestly disregarded the terms of the SPA and ruled in Garda's favor.

Reversing and remanding, the state high court noted that under the Federal Arbitration Act, an award may be vacated when an arbitrator acts in manifest disregard of the law. Under that standard, a party seeking vacatur must show that the arbitrator:

  •  was aware of the relevant legal principle,
  •  understood that the principle controlled the outcome of the dispute, and
  •  “nonetheless willfully flouted the governing law by refusing to apply it.”
  • In this case, the state high court noted, the chancery court decided that Section 1.3 clearly required IBNR to be included in the reserves and that E&Y knew what Section 1.3 required—because it was given the contract—but “refused to apply it `for whatever reason.'” As such, the chancery court concluded that E&Y manifestly disregarded the law.

    The supreme court, however, disagreed, concluding that the chancery court failed to consider whether E&Y's decision “rationally” could be derived from either the agreement or the parties' submissions.

    Those submissions, the court determined, establish that the parties “presented two colorable interpretations of the relevant SPA provision.” A “reasonable inference” to be drawn from E&Y's award is that the accounting firm adopted SPX's interpretation.

    “That interpretation may have been wrong, but it was not without a basis in the contract and the parties' submissions. Therefore, under the `manifest disregard' standard, the arbitrator's award is not subject to vacatur,” the state high court concluded.

    To see the decision, go to