submitted to an accounting arbitrator for a final and binding determination. The accounting arbitration process is often specifically provided for in purchase agreements for which such a process is relevant (i.e., transactions with post‐closing purchase price adjustment provisions related to an accounting metric such as net working capital).
The types of disputed items that typically end up being submitted to an accounting arbitrator for resolution – as opposed to being resolved through negotiation – are often proposed adjustments that are significant in dollar amount, involve real or perceived departures from the company's historical accounting practices, require significant judgment under GAAP, and/or involve real or perceived departures from provisions of the purchase agreement such as transaction‐specific non‐GAAP adjustments. For example, the buyer proposes to reduce accounts receivable by $1 million based on its assessment that certain older receivables should be written off in accordance with GAAP. The seller perceives the change as based on the buyer's preference for a strict accounts receivable aging methodology to determine the allowance for doubtful accounts. The seller disputes the proposed adjustment as violating the purchase agreement provision requiring the use of the seller's historical accounting policies.
The disputed items that end up being tendered to the accounting arbitrator for resolution are documented, discussed, and supported in the various submissions to the accounting arbitrator. After considering the information provided by the parties, the accounting arbitrator renders a determination on each of the disputed items, formally resolving the dispute.
THE DISPUTE RESOLUTION PROCESS
Purchase agreements commonly provide a framework for calculating net working capital as well as procedures to finalize the amount and resolve any related disputes. Purchase agreements, however, do not necessarily specify each element of the accounting arbitration process. Either way, a typical dispute resolution process includes the following steps:
1. Retention of the accounting arbitrator
2. Parties' initial submissions
3. Parties' rebuttal submissions
4. Arbitrator interrogatories and document requests
5. Hearing (optional and relatively uncommon)
6. Arbitration award
This section provides a brief overview of those major elements of the dispute resolution process (i.e., the activities from the engagement of the arbitrator through resolution). We discuss the mechanics of the arbitration process, including the selection of the accounting arbitrator and the various submissions to the accounting arbitrator, in more detail in later chapters.
The first step in the formal dispute resolution phase is the retention of the independent accountant. In order to retain the accounting arbitrator, the parties first have to agree on his or her selection. Purchase agreements vary in the extent of guidance they provide on the selection of the accounting arbitrator, ranging from very little guidance to highly specific instructions. For example, some purchase agreements simply state that the parties will jointly select and retain an accounting arbitrator while other purchase agreements include a list of individuals in order of preference. More is discussed on this topic in Chapter 11.
After selecting an accounting arbitrator, the parties have to agree with each other and the accountant on the terms of the engagement. That can involve substantial effort and multiple drafts of the accountant's engagement letter as that letter typically defines the dispute, lays out the procedures to be followed, and establishes the boundaries of the arbitrator's authority. As a result of the selection process and the detail commonly included in the engagement letter, the retention of the independent accountant can take much longer than the parties anticipated when the purchase agreement was drafted.
◼ Day 1: The parties agree to submit the disputed items to the independent accountant for resolution in accordance with the purchase agreement.
◼ Day 3: The parties approach the accountant named in the agreement to serve as the arbitrator.
◼ Day 9: The accountant declines the engagement due to a conflict of interest.
◼ Day 11: The parties identify another accountant at a similar firm and approach that accountant to serve as the arbitrator.
◼ Day 15: The second potential arbitrator makes a disclosure to the parties resulting from his firm's conflict check, but states that he or she believes it does not threaten his or her independence. The second potential arbitrator believes the disclosed item does not need to stand in the way of his or her retention.
◼ Day 18: The parties have a conference call with the second potential arbitrator.
◼ Day 21: The parties agree to proceed with the retention of the second potential arbitrator.
◼ Day 24: The second potential arbitrator provides a draft engagement letter to the parties.
◼ Day 28: Both parties provide comments to the draft engagement letter.
◼ Day 30: The second potential arbitrator circulates a revised draft engagement letter to the parties that incorporates the proposed changes.
◼ Day 32: The parties approve the engagement letter.
◼ Day 33: The engagement letter is finalized and executed.
Purchase agreements vary in the level of detail provided regarding the accounting arbitration proceedings. Purchase agreements can range from providing only general guidelines regarding the submissions to the arbitrator to including a detailed process.
It is not uncommon for the detailed arbitration process to be first set forth in the independent accountant's engagement letter or agreed to immediately after his or her retention. The process is generally more involved than a simple exchange of information and positions. By means of example, the following schedule, or some variation thereof, is commonly used for accounting arbitrations:
1. The parties simultaneously provide their initial submissions to the accounting arbitrator.
2. The parties simultaneously provide their rebuttal submissions to the accounting arbitrator.
3. The accounting arbitrator sends his document requests and/or interrogatories to the parties.
4. The parties submit responses to the accounting arbitrator's document requests and interrogatories.
5. An (optional) in‐person hearing may be held in some matters.
6. The accounting arbitrator issues the award.
The time between each step in the process varies from matter to matter depending on the scope of the items in dispute, scheduling conflicts of the parties and the accounting arbitrator, and other factors. The initial submissions, rebuttal submissions, and the parties' responses to the arbitrator's document requests and interrogatories are also provided to the opposing party. In practice, the arbitrator often cross‐forwards the parties' submissions upon having received the submissions from both sides.
The initial and rebuttal submissions should generally be accompanied by all supporting documentation necessary for the accounting arbitrator to review and assess the respective parties' position on each item in dispute. At a minimum, the parties typically include the purchase agreement, the preliminary closing statement, the buyer's proposed closing statement, and the seller's objections thereto as well as a selection of correspondence and supporting documentation already exchanged between the parties with their initial submissions. In addition, the parties can submit additional factual and financial supporting documentation, including, for example, various spreadsheets, company documents reflecting business or accounting practices, and historical financial statements. In addition to the typical supporting documentation, the parties can also include affidavits from individuals that are knowledgeable regarding the company's accounting or other relevant topics. The parties can also include expert reports or expert affidavits with their submissions, such as an expert report that discusses the industry in which the company operates