E-Alert Case Updates
Delaware Supreme Court Clarifies Standard Required To Vacate An Arbitration Award Under The Delaware Arbitration Act
SPX Corp. v. Garda USA, Inc.
In SPX Corp. v. Garda USA, Inc., a case involving the appeal of a Court of Chancery decision to vacate an arbitration award, the Supreme Court of Delaware held that the arbitration award was not without basis in the parties’ contract and submissions, and thus was not subject to vacatur under § 5714(a)(3) of the Delaware Arbitration Act. The Supreme Court reversed the judgment of the Court of Chancery vacating the arbitration award and remanded the case for further proceedings consistent with its opinion. Justice Berger wrote the opinion, in which Justices Strine, Holland, Jacobs and Ridgely joined.
By way of factual background, in November 2005, SPX Corporation ("SPX") entered into a contract to sell all of the capital stock of its subsidiary, Vance International ("Vance"), to Garda USA, Inc., and its parent company, Garda World Security Corporation (collectively, “Garda”). The parties entered a Stock Purchase Agreement (the “SPA”), under which Garda agreed to purchase Vance's stock for $67,250,000 plus Net Cash. The actual purchase price was subject to adjustment based on differences between SPX's Pre–Closing Balance Sheet, produced five (5) days before closing, and the Effective Date Balance Sheet, produced within sixty (60) days after closing.
On both balance sheets, Working Capital was to be calculated in accordance with Section 1.3 of the SPA, which defined Working Capital as “current assets minus current liabilities, calculated in accordance with U.S. GAAP....” with several, specified exceptions. Under Section 1.3(a)(v) of the SPA, "incurred but not reported"(IBNR) claims related to risk management programs were excluded from the Working Capital calculation, with the exception that claims related to workers' compensation liabilities were to be included in calculating current liabilities. Additionally, Section 1.3(c) of the SPA required that reserves be calculated in a manner that was consistent with the methods used to prepare Vance’s interim financial statements before the parties entered into the SPA.
Throughout the sale process, SPX included Vance's workers' compensation reserves in calculating Working Capital. SPX listed workers' compensation reserves of: $1.4 million on Vance's interim financial statements; $1.4 million again on Vance's Pre-Closing Balance Sheet; and $1.366 million on Vance's Effective Date Balance Sheet. SPX did not include however, IBNR in making any of those calculations. In May 2006, Garda challenged the workers' compensation reserve SPX listed on the Effective Date Balance Sheet. Unable to resolve the dispute, the parties entered into arbitration and selected Ernst & Young, LLP (“E&Y”) to act as their arbitrator. E&Y prepared a Statement of Work, that required E&Y to "base the Award solely upon the presentations of the Parties, and not based upon an independent review or any other source of information," to issue its Award “in writing, in summary form, setting forth the determination(s) as to the disputed items," and to not “make any legal determinations or otherwise rule upon issues of law in rendering the Award.”
In their opening briefs, Garda argued SPX understated the workers' compensation reserve because less than a week after closing, SPX's own actuary estimated the reserve at approximately $3 million and an outside consultant estimated $3.5 million to $3.9 million. SPX argued no adjustment to the $1.366 million reserve was necessary because its use of “the actual reserve amounts maintained by Vance's workers' compensation carriers to compute the reserve …” was proper; the calculation was in accordance with Section 1.3(c) of the SPA; and all Vance's relevant workers' compensation claims were now closed.
Subsequently, E&Y asked SPX to explain why its $1.366 million calculation is appropriate, despite the much higher estimate of its own actuary, and asked Garda to explain why actuarial estimates should be used when real data was available to determine the workers' compensation liabilities Vance had actually incurred. In its reply brief, SPX argued that its actuary’s analysis was not applicable because it was not designed to “review loss histories or estimate future claim payments at the level of individual business units,” and reiterated that its calculations were in accordance with Section 1.3(c) of the SPA. In its reply brief, Garda argued SPX violated Section 1.3(a)(v) of the SPA by failing to include IBNR related to workers' compensation liabilities in its calculations and that SPX’s use of claims payment data to show the $1.366 million reserve had been sufficient thus far was improper as it failed to consider potential new payments that could result from the recurrence or worsening of injuries to workers with “closed” claims.
In October 2011, E&Y issued a determination letter stating only that “no adjustment to Closing Date Working Capital is warranted for workers' compensation liabilities as [Garda] has not demonstrated that [SPX] failed to comply with Section 1.3 [of the SPA].” Garda appealed to the Court of Chancery and after briefing and argument, the Court of Chancery vacated the arbitrator's decision on the ground that the arbitrator manifestly disregarded the terms of the SPA. SPX appealed to the Supreme Court of Delaware.
Under § 5714(a)(3) of the Delaware Arbitration Act, an arbitration award will be vacated when “[t]he arbitrators exceeded their powers, or so imperfectly executed them that a final and definite award upon the subject matter submitted was not made.” This provision tracks an analogous provision in the Federal Arbitration Act (FAA), and the Court looked to federal case law for guidance. Under federal court precedent, vacatur is authorized where the arbitrator acts in “manifest disregard” of the law. To meet this standard, a party must prove “that the arbitrator (1) knew of a [clearly defined] relevant legal principle, (2) appreciated that this principle controlled the outcome of the disputed issue, and (3) nonetheless willfully flouted the governing law by refusing to apply it.” As long as the arbitrator is "even arguably construing or applying the contract and acting within the scope of his authority, that a court is convinced that he committed serious error does not suffice to overturn his decision.”
The Court of Chancery had concluded the arbitrator manifestly disregarded the law because: 1) Section 1.3 unambiguously requires inclusion of IBNR in the reserves; 2) the arbitrator knew what Section 1.3 required, as he was given the contract; and 3) the arbitrator refused to apply it “for whatever reason.” The Supreme Court concluded that the Court of Chancery incorrectly applied the “manifest disregard” standard as it failed to consider whether the arbitrator's decision “rationally can be derived from either the agreement of the parties or the parties' submissions to the arbitrator....” The Supreme Court stated that the parties' briefs establish two potential interpretations of the relevant SPA provisions: Under Garda's interpretation, failure to include IBNR violates Section 1.3(a)(v), Under SPX's, including IBNR violates Section 1.3(c). The Supreme Court reasoned that E&Y's questions indicated it considered whether the contract required IBNR to be included in the Working Capital calculation and that a reasonable inference was that the arbitrator adopted SPX's interpretation of Section 1.3. While that interpretation may have been wrong, because it was not without a basis in the contract and the parties' submissions, the Supreme Court concluded that the arbitrator's award was not subject to vacatur under the “manifest disregard” standard. The Court reversed the judgment of the Court of Chancery and remanded the case for further proceedings consistent with its opinion.
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