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Completion Accounts: Court of Appeal plugs the GAAP

The Court of Appeal recently considered the enforceability of an expert’s determination of whether a company’s historic accounting practices should be applied, despite such practices being inconsistent with UK GAAP.

In Shafi v Rutherford [2014], the court was asked to consider the provisions of a share purchase agreement (“SPA”), which stated that, in relation to a customary, post-completion price adjustment mechanism, the following “waterfall” of accounting principles would be used in determining any outstanding balance between the parties:

  • first, the accounting principles expressly set out in a schedule of the SPA;
  • then, “the accounting policies, principles, practices and procedures adopted by the Company in the preparation of the Accounts”; and
  • finally, where neither of the above applied, UK GAAP.

Following a dispute regarding the correct accounting treatment of certain equipment leases, an independent accountant was instructed by the parties.  The expert held that the historic “Accounts” (as defined) had incorrectly treated the equipment leases as operating leases, when they should have been characterised as finance leases.  However, the expert also held that he was obliged to apply the waterfall of principles set out above, so that he also treated the equipment leases as operating leases.

Both the High Court and the Court of Appeal held that the expert was wrong to do so.  The definition of “Accounts” in the SPA stated that the accounts had been prepared in accordance with UK GAAP, and so the Court of Appeal interpreted limb (ii) of the waterfall above as referring to the policies on which the accounts were stated to have been drawn up – not to those on which they were actually drawn up.

Comment – this case highlights the need for parties to be very specific in their drafting as to which accounting policies and principles will apply to the preparation and interpretation of accounts that they agree to use as a reference for a price adjustment mechanism.  Had both parties intended that the historic, non-UK GAAP compliant treatment of equipment leases should apply, then (i) the definition of Accounts should have been amended, and (ii) the waterfall of policies should have specifically stated this intention.

It is also worth noting that it is customary in M&A transactions to exclude from the buyer’s right to bring a warranty claim any matter which is dealt with under the price adjustment mechanism.  In the light of this case, purchasers should consider a carve-out from this exclusion to allow them to recover for losses resulting from the historic and incorrect application of GAAP.


For more information, please contact Andy Moseby