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Kevin D. Kreb and Thomas K.

There are many opportunities for CPAs to become involved in alternative dispute resolution (ADR) proceedings. The most common "first experience" with ADR for CPAs is usually being involved in disputes emanating from merger, acquisition, and divestiture transactions resolved through negotiation or arbitration. Our experience has confirmed many of the perceived advantages of ADR over traditional litigation, including the relatively speedy and cost effective resolution of disputes, along with allowing the participants significant ability to dictate and influence the format and timing of the proceedings.

Common Disputes Arising from
M&A and Divestiture Transactions

Two major areas of disputes that we, as accountants, have seen arising from M&A and divestiture transactions include disputes relating to 1) purchase price adjustment calculations and 2) earn-out provisions.

A purchase price adjustment is a mechanism used to adjust the purchase price based upon a change in a specified benchmark (such as net assets or net working capital) between the date of the financial statements used to negotiate the purchase price (often referred to as the reference balance sheet) and the closing date financial statements. Purchase price adjustments are common in M&A transactions, as they are a means of allowing the benefits, or detriments, of operating the business during the period between the agreement signing and the closing to inure to the seller. Disputes often arise when one party, usually the buyer, objects to the preparation of the closing balance sheet upon which the purchase price is ultimately determined. Most agreements specify the requirements to be followed in the preparation of the closing balance sheet, a common standard being "in accordance with GAAP prepared on a consistent basis..." However, buyers can contend that the seller did not prepare the closing balance sheet on such a basis (or if the buyer prepares the closing balance sheet, the seller may have some objections). Common issues raised by the buyer include inadequate accounts receivable reserves, obsolete or excess inventory, unrecorded liabilities, the inconsistent application of accounting methods, non-GAAP accounting, and errors in the reference balance sheet or the closing financial statements.

Earn-out provisions, in which the seller receives additional purchase price based upon the future performance of the business sold, are another area fertile for post-transaction disputes. After the purchase, buyers may impact earnings, for example, by changing accounting policies or assessing corporate charges that can reduce earnings. Also, a buyer may materially alter the operations of the business (e.g., selling a portion of the business, merging operations into other business operations, etc.) after the purchase making it difficult to prepare accurate earn-out calculations consistent with the terms of the agreement.

Since these types of disputes revolve around accounting and financial reporting matters, CPAs are ideally suited to assist in the resolution of such disputes. In fact, most purchase/sale agreements containing purchase price adjustment clauses also provide a dispute resolution process, which includes the specification that if the parties cannot agree upon the adjustment, an independent third party accountant will be retained as an arbitrator to determine the final resolution of the disputed items. However, as discussed below, there are also opportunities for CPAs to assist their clients in ADR proceedings in the role of expert witness or consultant.

Assisting Clients Involved in Disputes As a Consultant or an Expert

Accountants can assist parties involved in the resolution of these types of disputes through ADR. Often companies involved in disputes attempt to use their own personnel to prepare the claim or responses to the claim. These individuals, although familiar with the accounts and records, and perhaps even involved in the transaction, may be too close to the issues to offer an objective and independent analysis. In addition, client personnel are usually busy in their normal functions and may not be able to devote the potentially substantial time necessary to resolve large and complex issues. Outside CPAs can offer unbiased and independent opinions and advice with respect to the issues at hand. The experience and independence of a CPA allows him or her to assist a client in gathering the appropriate data, objectively analyzing its claims or exposure, and formulating negotiating strategies, without harboring any emotional attachment to the transaction.

With respect to purchase price adjustment disputes, areas in which the CPA can assist clients include the following:

    * Evaluating the appropriateness of the buyer's notice of objection to the closing balance sheet received by the seller, or if the client is the buyer, in preparing a notice of objection which is in compliance with the agreement specifications;

    * Proposing appropriate arbitration procedures so that the client has ample time and opportunity to evaluate the issues and put forth its positions;

    * Identifying the documents and information that will be necessary to evaluate the disputed issues;

    * Performing an analysis of the issues and formulating positions;

    * Reviewing and interpreting technical accounting literature;

    * Drafting submissions to the arbitrator;

    * Assisting in evaluating settlement proposals;

    * Providing expert witness testimony; and

    * Preparing demonstrative exhibits for hearings.

Likewise, in the event of disputes arising from earn-out provisions, a CPA can assist clients in many of the same ways mentioned above in focusing upon reviewing or preparing earn-out calculations, evaluating the opposing party's calculation, offering settlement alternatives, and perhaps rendering expert witness testimony.

Serving as an Independent Arbitrator Or Neutral in Purchase Price Disputes

While CPAs cannot serve as the arbitrator of purchase price disputes in which their attestation clients are involved, they are allowed to serve in the capacity of arbitrator for other parties. CPAs are often chosen as arbitrators in resolving M&A disputes because they are experienced in the accounting and financial reporting issues on which such disputes usually focus. A CPA may be selected as an arbitrator based upon his or her industry experience, functional experience (e.g., inventory valuation, accounting for pension liabilities, etc.), or transactional experience (e.g., joint ventures or purchase/sale transactions).

As arbitrators, accountants may set the agenda for the arbitration proceeding by identifying the written submissions to be filed with the arbitrator, establishing the time frame for their receipt, and holding hearings on the evidence. In the role of arbitrator, the CPA will evaluate the merits of each party's position and ultimately rule on the items in dispute. Rather than presenting evidence and a position, the arbitrator evaluates the positions of the parties, interprets the purchase/sale agreement, reviews the relevant technical accounting literature, and then renders a decision. Serving as arbitrators allows CPAs to experience the role of trier of fact and enhances their ability to represent other clients in consulting or expert witness roles.

CPAs can use their knowledge of accounting principles, accounting systems, and financial reporting requirements, along with general business understanding to assist clients in the resolution of disputes through ADR in the role of arbitrator, consultant, or expert. In addition, a CPA who becomes experienced in the types of disputes arising from M&A transactions can provide his or her clients with valuable, up-front consulting advice through reviewing draft purchase/sale agreements, identifying potential dispute areas before the contract is signed and proposing alternative language or provisions. *

Kevin D. Kreb, CPA, and Thomas K. Riordan, CPA, are members of Price Waterhouse LLP's Financial Advisory Services Group. Mr. Kreb, a director in the Chicago office, has served in the capacity of arbitrator and consults with clients in the prevention and resolution of purchase price and other M&A related disputes. Mr. Riordan is a senior consultant in the Chicago office.


By Philip Zimmerman, CPA

New Method of Choosing Arbitrators

CPAs registered as National Association of Securities Dealers (NASD) arbitrators for securities industry disputes will have a better chance of being chosen by investors and brokerage firms beginning in July 1998 under a new NASD arbitration system. A computer will select the highest ranked arbitrators chosen by the parties from a randomly selected list of 15 arbitrators. Previously, NASD staff picked the panel presented to the parties, and there were complaints that the same names were frequently selected.

Use of Mediation on the Rise

NASD announced the rapid growth of mediation as a method of resolving securities industry disputes. In 1997, 15% of the cases used mediation as compared to half that number in 1996. Of these mediation cases, about 80% were settled and closed. In 1998, it is expected that the number of parties in NASD dispute cases choosing to use mediation will grow to 20%. Mediation has had similar growth in the CPA profession for resolving disputes with clients.

Other Professions Use It

The American Institute of Architects (AIA) revised its model contract to
promote the use of mediation prior to
arbitration. *

Philip Zimmerman, CPA
Mediator and Arbitrator

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