Chancery Court Confirms Limited Scope of Authority of Expert-Not-Arbitrator Dispute Resolution Provisions
In Ray Beyond Corp. v. Trimaran Fund Management, L.L.C. and The Halifax Group, LLC, Memorandum Opinion, Civil Action No. 2018-0497-KSJM, the Court of Chancery denied a motion for judgment on the pleadings brought by Ray Beyond Corp. (“Buyer”) seeking to specifically enforce a dispute resolution provision referring an escrow dispute to an independent accounting firm as an “expert, not arbitrator” and the related counterclaims. The Court granted the motion for judgement on the pleadings brought by Buyer’s parent affiliate, The Halifax Group, LLC (“Halifax”) on Trimaran Fund Management, L.L.C.’s (“Seller”) third-party claim for tortious interference for refusing to execute a joint instruction to release escrow funds.
On April 13, 2018, Buyer acquired ChanceLight, Inc. (“Target”) from Seller, among other selling security holders, pursuant to the terms of an Agreement and Plan of Merger (the “Merger Agreement”). Buyer paid a base price of $125 million, $23.1 million of which was placed in escrow at closing. Release of the escrowed funds was contingent on the Target’s subsidiary, Ombudsman Educational Services, Ltd., entering into a “qualifying contract” with the Chicago Public Schools (“CPS”) post-closing. The sections of the Merger Agreement governing the release of the escrowed funds delegated the resolution of certain matters to an independent accounting firm (the “Settlement Accountant”) as an “expert, not arbitrator.” The parties dispute whether a one-year extension of the CPS contract constitutes a “qualifying contract” requiring that the escrowed funds be released and whether such disagreement must be referred to the Settlement Accountant for resolution. Buyer brought this action seeking an order to force Seller to resolve the dispute using the Settlement Accountant.
The Court reviewed the text of the expert-not-arbitrator provision in light of the entire Merger Agreement and the shared intentions of the contracting parties. The provision provides that in the event the escrowed funds were not fully distributed prior to July 1, 2018, and the Buyer and Seller were “not able in good faith to agree upon an appropriate distribution of the [escrowed funds], the matter shall be referred to the Settlement Accountant.” The Court analyzed whether the Settlement Accountant’s authority to determine the “appropriate distribution” should be broadly interpreted to include the authority to resolve all matters, including the legal question of whether a qualifying contract had been executed.
The Court relied on Chicago Bridge & Iron v. Westinghouse Electric, 166 A.3d 912 (Del. 2017); Penton Business Media Holdings v. Informa, (Del. Ch. July 9, 2018); and AQSR India Private v. Bureau Veritas Holdings, (Del. Ch. June 16, 2009), in determining the scope and intent of the expert-not-arbitrator provision. In Chicago Bridge, the Delaware Supreme Court concluded that, as a result of an expert-not-arbitrator provision, the third-party expert lacked authority to consider legal issues when calculating a post-closing purchase price adjustment because such matters were outside of the third-party’s expertise. Similarly, in AQSR and Penton, the Court of Chancery explained that when parties call for an expert determination, the expert’s scope is limited to technical questions within their expertise and the contracting parties are not granting the expert authority to make binding decisions on general issues of law or legal disputes.
Following this guidance, the Court held that a broad interpretation of the expert-not-arbitrator provision in the Merger Agreement was inconsistent with Delaware authority and the parties’ intent to narrow the Settlement Accountant’s role to discrete, non-legal issues within the scope of an independent accounting firm’s expertise. The Court denied Buyer’s request for specific performance and Seller’s related counterclaims for judgment on the pleadings.
Finally, the Court reviewed Seller’s claim against Halifax for tortious interference with a subsidiary’s contract for refusing to execute a joint instruction to release escrow funds. The Court noted the strong economic interest of a parent corporation in its subsidiary and held that a parent corporation could not be liable for tortious interference with a subsidiary’s contract without evidence of bad faith or malicious conduct. The Court found that Seller failed to present evidence Halifax acted maliciously or with bad faith, nor allege that it was Halifax that denied Seller the escrowed funds. Based on the insufficient evidence, the Court granted Halifax’s motion for judgment on the pleadings as to Seller’s claim for tortious interference.