What happens if working capital adjustments are determined through the dispute process to be invalid adjustments, and the dispute resolver (e.g., independent accounting firm, mediator or arbitrator) rules in favor of the selling shareholders? Should the buyer be able to revisit the issue as a breach of a representation or warranty?

A buyer may argue that a “second bite at the apple” is allowable because there could be claims knocked out of the working capital calculation that still constitute a breach of a representation or warranty. For instance, an independent accountant may have determined that a liability should not be included in working capital because it is a long-term liability rather than a short-term liability. It could, however, still be a breach of a representation if it is a liability that was not properly disclosed. In this case, the accountant’s determination should not preclude the buyer from bringing an indemnification claim.
On the other hand, if it is determined in the working capital dispute process that the buyer’s position is factually invalid, the buyer might nevertheless bring, or threaten to bring, the same issue as an indemnification claim. This is basically a way to get a free appeal on the accountant’s ruling. It is very difficult for the shareholders to do the same thing when they lose on a working capital issue, because there typically is no second venue to have the issue reviewed again under the merger agreement.
In order to address this issue in merger agreements with working capital adjustments, consider adding language such as this:

In the event that Buyer believes there are any facts or circumstances that are the basis for any adjustments to the [Preliminary Working Capital Statement] delivered by the Company at Closing, Buyer shall be permitted to pursue a remedy based on such facts or circumstances either as an adjustment to the Preliminary Working Capital Statement (“Adjustment”) or as an indemnification claim, but not both, other than as set forth below. Nothing in the preceding sentence shall prevent Buyer from bringing an indemnification claim based on the same facts and circumstances as a proposed Adjustment if a final, independent determination is made that (i) the proposed Adjustment is not proper based solely on the long-term or short-term nature of the applicable asset or liability, (ii) the proposed Adjustment is not being considered in connection with Working Capital because it is determined to be a legal issue rather than an accounting issue or (iii) [ ].

Alternatively, a seller may negotiate for language that provides for an election of remedies by the buyer, so that if a working capital adjustment is sought, there is no indemnification available for the facts underlying the notice of purchase price adjustment.
Counsel especially familiar with accounting issues should help define the circumstances in which a claim may be denied under the working capital provisions, but might be properly indemnifiable. While many auditors are not familiar with these issues, accounting firms often have specialized technical groups to handle such problems. When drafting a provision along these lines, SRS Acquiom suggests seeking specialized level of expertise, which is normally beyond a discussion with the individual who handles the company’s audits.

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