There are several potential claims for losses under a merger agreement that the buyer could bring as either a working capital adjustment or a claim for indemnification. For instance, if the selling company failed to disclose the existence of a short-term contractual liability, the buyer could likely claim either that this should reduce the calculation of the closing working capital balance, or that it is a breach of a representation or warranty entitling the buyer to compensation for damages. The question arises as to whether the buyer should in all circumstances have full discretion over its choice of remedies, or whether there are limitations as to which type of claim may be brought under various circumstances. The practical difference is that working capital claims are not typically subject to the indemnification baskets or caps, but claims of breaches of most representations or warranties are subject to these.

This issue was addressed by the Delaware Chancery Court in OSI Systems, Inc. v. Instrumentarium Corp.1 In OSI, the buyer tried to bring a working capital claim that would have resulted in a 54% adjustment to the purchase price. Much of the adjustment it sought was based on the buyer’s allegations that the selling company used improper accounting principles in preparing its estimated closing balance sheet. The court found that working capital adjustments should be limited to changes in the amounts of working capital applying consistent accounting principles, and that any claims alleging that such principles were improper or inconsistent with GAAP must be brought as indemnification claims.

This ruling is important for merger parties and their advisors to consider in drafting merger agreements and in the event of a dispute related to working capital. If a dispute arises, the attorneys representing the shareholder representative or the selling shareholders may want to argue that the scope of issues that an independent accounting firm is permitted to consider is limited, and that it must apply the accounting principles used by the selling company at closing.

Additionally, SRS Acquiom suggests that the parties should strongly consider making clear what adjustments they desire to permit as working capital adjustments in their merger agreement. Parties should specify in the merger agreement whether working capital adjustments are permitted only to the extent of any changes that occur if consistent principles are applied, and whether any claims that such principles are improper can be brought only as indemnification claims.


1 892 A.2d 1086 (Del. Ch. 2006).

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