May 27, 2020

May 27, 2020

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May 26, 2020

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View from London: Completion Accounts Case Law Every Dealmaker Should Know About

In the recent case of Shafi v Rutherford [2014] EWCA Civ 1186 (Shafi), the U.K. Court of Appeal was asked to examine an appeal from the High Court regarding the interpretation of a completion accounts mechanism, a commonly used price adjustment process in company and business acquisitions. The court’s decision will likely affect the way in which buyers and sellers describe the mechanism in sale documents and reinforce the importance of financial and legal advisors working closely together.

Completion Accounts: Background

In the sale and purchase of businesses (both share and asset transactions), completion accounts are an often-used mechanism which enable parties to agree the final price payable for the target. A purchaser who strikes a bargain for a business at a certain price can test its assumptions by agreeing with the seller to adjust the consideration paid if those assumptions prove to be incorrect. Completion accounts are commonly used by the buyer to confirm that the ’financial position of the company or business at completion is consistent with the accounts and other information it used to value the target when making its offer.

After the acquisition is completed, one of the parties draws up the accounts to the date of completion, which allows both parties to evaluate the state of the balance sheet at completion. The parties can then adjust the price paid up or down.

The agreement entered into by the purchaser and seller will set out the method to be used to draw up the completion accounts and how they may adjust the purchase price. Typically, such price adjustments will be based on a target’s net assets, or a component part such as working capital, cash and/or debt, and will measure the actual positions at completion against a target by reference to which the purchase price was agreed.

Ideally, in the relevant sale and purchase agreement, the parties will agree the basis of preparation of the accounts, including their form, content and the accounting principles to be used. They will also agree who will draw up the accounts, when and how disputes will be settled and how the price will be adjusted.

As the accounts are not finalized until after the transaction has closed, the parties may agree for the buyer to pay a provisional sum as part of the purchase price to limit any additional amount a buyer may have to pay post-completion or that the seller may have to hand back.

Basis of Preparation

The accounting standards and methodology applied to the accounts do not have to follow any particular policy or any practices previously adopted by the target. There is no legal requirement for the parties to agree to a specific approach; it is largely a question of accounting process and commercial agreement rather than law.

As far as possible, the buyer and its financial advisors should identify matters in the target’s audited or management accounts that might lead to disagreements when the completion accounts are drawn up. The accounting treatment of certain items, or the policies used, may contain significant scope for a range of treatment. Ideally, the buyer will want to agree the treatment of these in the terms of the acquisition agreement to avoid disputes.

A seller may be more willing to rely on general statements as to the application of consistent policies previously applied, because it should have a clear idea of what these are. Buyers and sellers will often agree to apply policies and practices in compiling the completion accounts in the following order of priority:

specifically agreed policies and practices or agreed values in respect of certain items;
accounting principles and practices adopted by the target in compiling its previous accounts; and
generally accepted accounting principles and practices under the accounting regime to which the target is subject (such as U.K. GAAP or IFRS).

Although the drafting of a specific agreement will always prevail, it may be said that the generally accepted approach was that the policies and practices described under the third limb, such as U.K. GAAP, would be used to fill the gaps left by the target’s past practices under the second limb. The “past practices” of the second limb were typically thought to be those actually adopted and used by the target irrespective of non-compliance with relevant accounting standards. However, in the Shafi case, the Court of Appeal cast doubt on this approach.

Shafi Case: Background and Decision

In May 2007, the claimant and defendant formed a company, the Shipley Dental Team Limited (the Company) to establish a dental practice. They each held 50 percent of the shares in the Company, which acquired equipment for the business under leases (the Leases).

On Dec. 17, 2009, the parties entered into an agreement (the Agreement) for the claimant to sell her 50 percent shareholding in the Company (the Shares) to the defendant.

The Agreement contained a completion accounts mechanism to determine the final amount to be paid by the defendant for the Shares. The Company’s accountants drew up two sets of completion accounts, but the parties failed to agree them. The parties appointed an independent chartered accountant, in accordance with the Agreement, as an expert to resolve the dispute.

The expert determined that the Leases were improperly treated as operating leases in the Company’s accounts for the year ending 2008 (the 2008 Accounts). He found they were in fact finance leases and, if treated as such in the completion accounts, would result in a significant downward price adjustment in respect of the Shares.

The Agreement contained the following provisions governing the preparation of the completion accounts:

“1.2 The draft completion accounts shall:

1.3 be prepared in accordance with the specific accounting policies and principles set out in [this Agreement] so that, in the case of any conflict, such policies and principles shall override the provisions of paragraphs 1.4 and 1.5;

1.4 subject to paragraph 1.3, be prepared in accordance with the accounting policies, principles, practices and procedures adopted by the Company in the preparation of the [2008] Accounts, which include the policies set out in [this Agreement], so that, in the case of any conflict, such policies, principles, practices and procedures shall override the provisions of paragraph 1.5;

1.5 where none of the accounting policies, principles, practices or procedures referred to in paragraphs 1.3 and 1.4 deal with the matter, be prepared in accordance with generally accepted accounting principles in the U.K. as applicable to small companies as at the Completion Date.”

The expert concluded that the policies adopted by the Company described in paragraph 1.4 required him to treat the Leases as operating leases even though such treatment was incorrect under the relevant accounting policies the Company purported to have adopted. This was also the claimant’s position, but the High Court ruled that the expert had incorrectly interpreted paragraph 1.4. The claimant appealed.


In dismissing the claimant’s appeal that paragraph 1.4 means the policies, principles, practices and procedures adopted by the Company in fact, and not those which it purported to have adopted, the Court of Appeal upheld the ruling of the High Court:

  • the completion accounts should have taken account of the proper treatment of the Leases because they were to be prepared in line with the policies of the 2008 Accounts, which specifically stated they were compiled in accordance with particular accounting standards (in this case, the Financial Reporting Standard for Smaller Entities);

  • when clause 1.4 of the Agreement refers to “the accounting policies, principles, practices and procedures adopted in the preparation of the Accounts,” it was referring to the policies used by accountants generally and not to the way in which the Company has actually applied those policies; and

  • as the 2008 Accounts were expressly stated to be prepared according to a particular policy, the parties cannot have expected the expert to ignore the correct implementation of the policy.

The Court of Appeal further stated that the liabilities of the Company should be drawn up using correct accounting policy regardless of actual past practices and the court could see no reason why the parties would have wished to carry forward an incorrect accounting treatment of liabilities. Instead, the court believed they would have been aiming to reflect the reality of the Company’s balance sheet.

The effect of the decision, which is not reported, is presumably that the claimant received far less consideration for the Shares than she had expected. As the 2008 Accounts treated the Leases as operating leases, it seems somewhat unlikely that either party would have anticipated their treatment to be any different in the completion accounts.

The case does not describe whether the buyer had any recourse under warranties in addition to the claim for adjustment pursuant to the closing accounts – in any event a buyer will always prefer a price adjustment to a warranty claim as it provides a far better chance of recovery from the seller and is generally not subject to the same hurdles to recovery such as thresholds and baskets. It is also not clear whether the claimant had any other recourse under the terms of the Agreement in respect of improperly prepared accounts, but given the claimant was the seller in this case, it seems unlikely.

Implications of Shafi

The judgment of the Court of Appeal in Shafi sets out some important guidance to sellers and buyers considering the completion accounts mechanism within a transaction:

  • if the parties want the policies and procedures used in the reference accounts to apply to the completion accounts irrespective of errors, omissions or irregularities in accounting methodology, specific drafting will be required to make this clear;

  • if the parties are in doubt as to how an item or policy has been applied in the reference accounts, specific policies to deal with them must be set out in the agreement; and

  • as always, financial due diligence and ensuring the principals and legal advisors of both buyers and sellers are involved from an early stage in setting out and negotiating each parties’ position are both crucial in any company or business acquisition.

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About this Author

Henrietta Walker, Greenberg Traurig Law Firm, London, Corporate Law Attorney

Henrietta Walker focuses on transactional and commercial advice for corporate clients. Henrietta has particular experience of cross-border transactions across a range of industries, including food, pharmaceuticals, chemicals and financial services.

Areas of Concentration

  • Mergers and acquisitions 

  • Joint ventures and shareholder arrangements

  • General corporate advice 

  • Commercial contracts...