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Post-acquisition disputes inmerger and acquisition transactionscan arise for a number ofreasons, and preparing a persuasiveargument in the face of such a disputecan present a challenge. As an activeparticipant in the planning, preparationand consummation of the transaction,corporate counsel is in a key position tonavigate the post-acquisition disputeresolution process from involvement inchoosing an arbitrator to framing argumentsin support of the organization’sposition. Often, arbitrators who resolvethese disputes are accountants, due inlarge part to the prevalence of utilizinggenerally accepted accounting principles(GAAP) in many post-acquisitiondisputes, such as purchase price adjustmentcalculations. Therefore, counselshould be aware that in resolving thedispute, experienced accounting arbitratorswill expect to be presented withcompelling arguments that speak directlyto an entity’s financial position. Theparty who presents the most compellingargument, consistent with the terms ofthe purchase agreement, could have asignificant advantage in the resolutionprocess. DISPUTES ARISE Typically, buyers and sellers to amerger and acquisition transaction usean “initial balance sheet” prepared bythe seller as the basis for negotiating apurchase price. The “closing balancesheet” can be prepared by either thebuyer or the seller and is updated toreflect the entity’s financial position asof the closing date. After the “closing balancesheet” is submitted, the otherparty then has a period of time to agreeor object. Due to the prevalence of utilizingGAAP in preparing closing balancesheets, many post-acquisition purchaseprice adjustment disputes center onGAAP accounting issues. GAAP is often at the heart of post-acquisitiondisputes because inherentin these accounting principles is theuse of judgments and estimates. Reasonablebusiness people — and competentaccountants — can often differ intheir judgments and estimates relatingto identical fact patterns. Therefore,when two management teams have adifferent vision for an industry ororganization, the likelihood of a disparityin the estimates and judgmentsis increased. It is often these differingviews that lead to post-acquisition disputes. Examples of accounting issues thatrequire judgments and estimates andwhich commonly arise in post-acquisitiondisputes include whether: � the allowance for doubtfulaccounts receivable is sufficient; � a reserve for excess and obsoleteinventory is required; � the accounting requirement forrecording contingent liabilities hasbeen met; � certain long-lived assets areimpaired. SELECTION PROCESS Parties to merger and acquisitionagreements often include specific arbitrationclauses in the document thatrequire post-acquisition disputes to be resolved before an accounting arbitrator.Some agreements identify a specificaccounting firm or a named accountantwhile other agreements state a moregeneral approach requiring that the disputebe resolved by a national accountingfirm or by an accounting arbitratorthat is selected by the parties at the timeof the dispute. Even when an agreement has identifieda specific accounting firm to serveas the arbitrator, the parties must stillselect a specific accountant within theaccounting firm to serve as the arbitrator.Particular consideration should begiven, in the selection process, to theaccounting professional who would bemost appropriate to resolve the particularmatter in dispute. For example,some questions that may be consideredin selecting an accounting arbitratorinclude: � Does the accountant specialize inlitigation services? � Has the accountant previouslyserved as an arbitrator? � Do the issues require an accountantwith a particular industryexpertise? � Has the accountant had previousexperience in merger and acquisitiontransactions? � Do you need an accountant whohas unique qualifications on a complicatedtechnical accounting issue? � Does the accountant’s firm havethe depth of resources and technicalexpertise? THE DISPUTE PROCESS Once the accounting arbitrator isselected, the parties may discuss theparticulars of the dispute process whichmight include: types and timing of submissions;whether there will be hearingswhere testimony/oral arguments will bemade; and whether the accounting arbitratorwill have the opportunity to askquestions of the parties. Experiencedaccounting arbitrators expect that theywill be presented with competing argumentsrevolving around an entity’s financialposition. The task for counsel inpreparing and presenting such an argumentis essentially to: (1) assist theaccounting arbitrator in understandinghow the financial statements for onecompany at a point in time could beviewed differently by two different managementteams; and (2) present a persuasiveargument that the casepromulgated by counsel’s team is morecompelling. Upon notification that a disputeexists, counsel should again review thetransaction agreement to determine theprocedural steps that must be taken inan attempt to resolve the dispute. At thesame time, counsel should coordinate ameeting with key management personnelto review all of the relevant transactiondocumentation and thecontemporaneous documentationunderlying the disputed balance sheets.Therefore, very early in the process,counsel should review potential argumentsthat can be made to support theorganization’s position. All involved should be aware that it ishelpful to present a clear, concise andsupported argument to an accountingarbitrator. To help clarify an accountingargument, counsel may find it helpful toreview and reference the specificaccounting literature, together with therelevant provisions of the merger and acquisition agreement, and demonstratehow the organization’s managementappropriately applied particular accountingprinciples in its calculations. In addition,counsel, and the company’saccounting personnel, may consider seekingthe assistance of professional advisors,consultants and experts to increasethe likelihood that the organization hasthoroughly explored and considered allavailable support for its position. EXPLAINING ORIGINAL APPROACHES There are several critical factors thatare commonly considered by accountingarbitrators when evaluating the claimsmade by the parties and when formulatingtheir decisions. Often it is the applicationof judgments and estimates thatthe parties to a transaction commonly disputewhen a post-closing price adjustmentis calculated. Therefore, it is important tounderstand how accounting judgmentsand estimates were made originally in thecalculation in order to fashion a persuasiveargument to an arbitrator. To assist the accounting arbitrator withthe task of determining the appropriateestimates and judgments that were usedin preparing a party’s balance sheet, counselmay strengthen the clarity and persuasivepower of their submissions byconsidering the following: � Understanding and explaining theoriginal accounting approaches; � Presenting arguments that arespecifically linked to accounting literature;and � Reviewing changes in the accountingliterature. RELEVANT ACCOUNTING LITERATURE When GAAP is the basis for the preparationof the post-closing purchase priceadjustment, the accounting arbitrator istypically focused on whether the parties’arguments are linked to the relevantaccounting literature. Many principles ofGAAP provide guidance on factors thatmay be considered in recording financialstatement accounts. When putting fortharguments, it can be helpful to an accountingarbitrator if specific reference is madeto the actual procedures that aredescribed in the accounting literature andthat were followed by the organization’smanagement in determining the post-closingpurchase price adjustment. In addition,arguments should be made based onthe supporting materials that the organizationintends to submit to the arbitrator. There may be instances where, after consultationwith accounting personnel, anargument will be made that the accountingprocedure for a financial statement lineitem or transaction was computed in compliancewith an accounting standard andthat standard will be cited. The arbitratormay then be provided with an explanationof the general procedures that the organizationfollowed rather than a discussionand documentation of each factor as outlinedin the accounting literature. However,demonstrating to an accountingarbitrator how management evaluatedeach of the factors contained in the relevantaccounting standards may prove tobe a more persuasive argument and canresult in a more detailed and completemethod of presentation as opposed to puttingforth arguments in general terms. For example, Emerging Issues TaskForce 03-01: The Meaning of Other-ThanTemporary Impairment and Its Applicationto Certain Investments (“EITF 03-01″)provides a listing of factors to consider inorder to determine if certain investmentsare impaired and possibly need to be writtendown on the balance sheet. The”impairment indicators” listed in EITF 03-01 include, but are not limited to: � A significant deterioration in theearnings performance, credit rating,asset quality or business prospectsof the investee; � A significant adverse change in theregulatory, economic or technologicalenvironment of the investee; � A significant adverse change in thegeneral market condition of either thegeographic area or the industry inwhich the investee operates; � A bona fide offer to purchase(whether solicited or unsolicited), anoffer by the investee to sell or a completedauction process for the sameor similar security for an amount lessthan the cost of the investment; � Factors that raise significant concernsabout the investee’s ability tocontinue as a going concern, such asnegative cash flows from operations,working capital deficiencies or noncompliancewith statutory capitalrequirements or debt covenants. Therefore, if the parties in a post-acquisitiondispute are arguing about whetheran investment is impaired, a detailedexplanation should be made to theaccounting arbitrator which addressesmanagement’s assessment of each ofthese particular factors in support of itsposition. POLICIES AND PRACTICES In some instances, GAAP may not bethe standard by which the post-closingpurchase price adjustment is calculated.Merger and acquisition agreements mayrequire that the post-closing purchaseprice adjustment be consistent with theselling company’s policies and practices.Depending on the provisions of the agreement,counsel may find it compelling todemonstrate how the organization complied,or the opposing party failed to comply,with the terms of the purchaseagreement as opposed to utilizing GAAP. In this situation, providing support as tohow management applied the relevantcompany policies and practices may be amore persuasive argument — and morehelpful to the accounting arbitrator, whomay need to gain an understanding of theselling company’s practices — than merelyciting the GAAP literature. As an example,merger and acquisition agreements mayinclude a reference to the selling company’spolicies which may include formulasfor calculating financial statement reserves.Demonstrating how these formulas wereapplied historically and in the preparationof the initial and closing balance sheets canprovide a “window” through which theaccounting arbitrator can gain insight intothe process that management utilized toarrive at its determination. CONSIDER CHANGES IN GAAP Counsel should be aware that GAAP maychange over time as new accounting pronouncementsare issued and old standardsmodified. In fashioning a persuasive argument,it may be important for counsel tofamiliarize themselves with any changes inGAAP that are relevant to their organization’sposition. Thus, in citing GAAP in argumentsto an accounting arbitrator, it mightbe important, depending on the languagecontained in the merger and acquisitionagreement, to reference which GAAP versionwas in effect as of a certain date andwhich was utilized in calculating the post-closing purchase price adjustment. Additionally, changes in GAAP can havean impact on purchase price adjustmentsthat might not have been anticipated byeither the buyer or seller at the time theagreement was executed. Provisions withinmerger and acquisition agreements mayprovide for additional payments over timeto the seller if the company meets certainearnings targets in the future, which could,in essence, extend the period of time overwhich GAAP could change. As an example,earn-out targets are typically set at the timethe transaction is consummated and areincluded in the acquisition agreement. However, GAAP might have changedbetween the time the earnings targets wereset and the measurement date, and newaccounting standards may have come intoeffect that now require a company torecord additional expenses, causing theearnings of a company to be reduced.Application of this new standard to thecompany’s financial results may cause acompany to miss earnings targets set inthe merger and acquisition agreementresulting in the seller not receiving additionalpayments. Therefore, counsel mayfind it helpful to make the accounting arbitratoraware, early on, of changes in theaccounting standards that might not havebeen contemplated by the parties at thetime the agreement terms were establishedand develop arguments as to theappropriate accounting standard to applyin the matter. CONCLUSION While post-acquisition disputes arecommon and the areas of dispute areoften similar, the facts, circumstances andwording of each provision of the mergerand acquisition agreement can rendereach post-acquisition dispute unique.Although specific fact patterns and agreementsvary, accounting arbitrators typicallyapproach post-acquisition disputeswith an expectation that the parties willcite accounting guidance and compare itto the steps that were taken in preparingthe initial and closing balance sheets orearn-out calculations, and also demonstratecompliance with the contractualprovisions of the transaction agreement.By understanding the types of informationaccounting arbitrators generallyfind compelling, counsel, in considerationof the above, will be better able to putforth a persuasive and meaningful argumentbefore the accounting arbitrator. Jeffrey M. Katz, a CPA, is a director in BDO Seidman’s litigation and fraudinvestigation practice in New York. Robin J. Zablow, an attorney, is a senior manager in BDO Seidman’s litigation and fraud investigation practice in New York.

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