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A Working Capital True Up is not an End Run on a Liability Bar

by   |   June 27, 2017

In Chicago Bridge & Iron Co. N.V. v. Westinghouse Electric Co. LLC, the Delaware Supreme Court examined the interaction between a working capital true up and alleged breaches of financial statement representations and warranties in a purchase agreement for an acquisition of a subsidiary.  The purchase agreement was certainly unusual.  The expected purchase price at closing was expected to be zero, subject to a working capital true up.  The representations and warranties did not survive closing. Buyer Westinghouse’s sole remedy for breaches of representations and warranties was to refuse to close and seller Chicago Bridge would have no liability for monetary damages post-closing.  Chicago Bridge’s business of participating in the construction of nuclear power plants with Westinghouse had gone south, and it was seeking a clean exit.

After the closing, Westinghouse claimed that Chicago Bridge owed it nearly $2 billion for the working capital true up. Westinghouse admitted that the overwhelming percentage of its claims were based on the proposition that Chicago Bridge’s historical financial statements were not based on a proper application of GAAP.  In other words, the amount owed under the true up would have been far less if working capital were calculated in accordance with Chicago Bridge’s historical practices.  Westinghouse knew of these matters before closing, but closed anyway.

The Court rejected Westinghouse’s claims. According to the Court, the true up language emphasized that net working capital should be determined using the same accounting principles that were used in preparing the financial statements represented by Chicago Bridge to be GAAP compliant. The purchase agreement did so by stating that working capital was “to be determined in a manner consistent with GAAP, consistently applied by [Chicago Bridge] in preparation of the financial statements of the Business, as in effect on the Closing Date.”  A new assessment of Chicago Bridge’s GAAP compliance was not permitted.  Any other interpretation would render the limitations on liability meaningless.

The Court also noted the reasons for working capital true ups:

  • The true up was not meant to aid Westinghouse’s investigation of the business or to otherwise provide a historical picture of the purchased operations.
  • Buyers want protection against value depletion before they take over the business, and, at the same time, sellers want to ensure that they will be compensated for effectively running the business.
  • Purchase price adjustments account for the normal variation in business from signing until closing to assure the buyer and seller that the purchase price accurately reflects the target’s financial condition at the time of closing.