You’ve probably never had to decide what it means to agree to arbitrate. Usually, there is a written provision that references the AAA Rules and includes a consent to AAA’s procedures as to the appointment of the arbitrator(s) and the conduct of the procedure. And most usually, the word “arbitration” is used in the provision.
Lately, however, the NC Business Court wrestled with two cases in which there was no provision referencing the AAA, no mention of the words “arbitrate” or “arbitration” but only a provision deferring resolution of some financial issues to an accountant.
The more recent one is Martin & Jones, PLLC v. Olson, 2017 NCBC 85. The earlier case (unpublished) is Post v. Avita Drugs, LLC. It is worth it to me to point out that I would not have known about the Post decision if it wasn’t referenced in the Martin & Jones decision. Back before the Business Court revamped its filing system, my software program would have caught the Post decision. Now? Not possible. I hate that new filing system. Maybe those of you filing cases in the Business Court like it.
Anyway, having vented and now feeling a little better, I can turn to the Post decision. Post had sold his business to Defendant Avita. The purchase price included an deferred earnout payment based on “six times (6x) the difference between (a) Adjusted EBITDA and (b) $925,000.
After the sale was completed, Post disputed Avita’s calculation of Adjusted EBITDA. He contended that Avita had depressed the amount of the Adjusted EBITDA by using improper accounting standards.
A Dispute Can Be “Arbitrated” By An Accountant If The Procedure Resembles “Classic Arbitration”
The Stock Purchase Agreement specified how a dispute over Adjusted EBITDA should be resolved. It said that:
the determination of Adjusted EBITDA shall be submitted promptly to [an] Independent Accountant for determination in accordance with this Agreement and the determination of the Independent Accountant shall be binding and conclusive for the purposes of this Agreement absent manifest error by the Independent Accountant” (the “Independent Accountant Process”).
After Post sued Avita, Avita moved to stay the case pending the resolution of the “Independent Accountant Process.” It made that Motion per G.S. §1-569.7, which is a motion to compel or stay arbitration.
As Judge Conrad concisely framed the issue, it was “whether [the] independent accountant process is an ‘arbitration.'” Order ¶2. You might think that the Federal Arbitration Act, which governed that issue, would contain a definition of “arbitration,” but it doesn’t. Judge Conrad, looking to federal court decisions on whether an agreed dispute resolution procedure fit the definition of arbitration, held that:
courts routinely consider ‘how closely the specified procedure resembles classic arbitration.’ Fit Tech, Inc. v. Bally Total Fitness Holding Corp., 374 F.3d 1, 7 (1st Cir. 2004). The question is whether the agreement exhibits the ‘common incidents of arbitration’: a final determination by ‘an independent adjudicator,’ ‘substantive standards,’ ‘and an opportunity for each side to present its case.’ Id. at 7.
Order ¶13 (emphasis added).
Judge Conrad found that the terms setting out the Independent Accountant Process met the standard of “classic arbitration.” The parties had agreed to a “binding and conclusive” determination. The agreement required the application of “substantive standards” via a definition in the Stock Purchase Agreement of how Adjusted EBITDA should be calculated. Furthermore each side was afforded the opportunity to present whatever written materials it deemed relevant. Order ¶¶14-15.
This Procedure Did Not Resemble “Classic Arbitration”
The result was different in the second Business Court decision, Martin & Jones, which was a dispute among former law firm partners regarding the amount to be paid to the Plaintiff for his retirement benefits per the law firm”s Operating Agreement. That agreement, like the agreement in the Post case, called for the involvement of an accountant if there was disagreement. It said that:
in the event of a dispute among the Members with respect to the determination of the net cash flow, net profit, net losses or capital account balances of the Law Firm, an independent certified public accountant shall be engaged by the Law Firm at the Law Firm’s expense whose computation of such items shall be binding upon all the Members.
Op. Par. 15.
The two flaws in the argument that this accountant-oriented provision should be treated as an arbitration as pointed out by Judge McGuire were that:
the Operating Agreement does not set forth any ‘substantive standards’ such as procedural guidance for selecting the independent CPA,or the method by which the independent CPA will make a determination. Furthermore, the Operating Agreement does not state whether, or how, each side will have the ‘opportunity . . . to present its case.’
Op. Par. 19.
So if you want a CPA to be acting as the arbitrator of a dispute arising under a document that you drafted, set the appropriate rules of a “classic arbitration.”