McGraw-Hill Cos., Inc. v School Specialty, Inc.

[*1] McGraw-Hill Cos., Inc. v School Specialty, Inc. 2006 NY Slip Op 50000(U) [10 Misc 3d 1066(A)] Decided on January 3, 2006 Supreme Court, New York County Fried, J. Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431. This opinion is uncorrected and will not be published in the printed Official Reports.

Decided on January 3, 2006
Supreme Court, New York County

THE McGraw-Hill Companies, Inc. and MCGRAW-HILL INTERNATIONAL (U.K.) LTD., Plaintiffs,

against

School Specialty, Inc. and LIVING & LEARNING, LTD., Defendants.



600308/05



For Plaintiffs:

Paul, Hastings, Janofsky & Walker, LLP

Barry G. Sher, Esq.

Alastair Wood, Esq.

75 East 55th Street

New York, New York 10022

For Defendants:

Orrick, Herrington, & Sutcliffe, LLP

Richard W. Mark, Esq.

666 Fifth Avenue

New York, New York 10103

Of Counsel:

Howard A. Pollack

David G. Peterson

Godfrey & Kahn, S.C.

780 N. Water Street

Milwaukee, WI 53202

Bernard J. Fried, J.

The underlying dispute here involves defendants' claims for adjustments to the purchase price of a business purchased from plaintiffs. In this declaratory judgment action, however, the parties dispute whether defendants' claims should be submitted to a nationally recognized firm of public accountants (the Arbiter) for resolution, pursuant to an alternative dispute resolution (ADR) [*2]clause in the parties' Stock and Asset Purchase Agreement (the Agreement).

On January 30, 2004, the parties closed on the sale of certain assets of a business (Acquired Business) by plaintiffs, The McGraw-Hill Companies, Inc., a business and educational publisher and its subsidiary McGraw-Hill International (U.K.) Ltd. (together, McGraw-Hill) to defendants School Specialty, Inc. and Living & Learning Inc. (together, School Specialty), education companies which provide learning products and services for children.

McGraw-Hill seeks a declaration, pursuant to the Agreement and New York law, that any Arbiter selected by the parties, pursuant to Section 2.6 of the Agreement,[FN1] does not have the authority to determine whether the accounting methodology and practices utilized by McGraw- Hill in preparing the final balance sheet and asset value determination for the Acquired Business complies with United States' Generally Accepted Accounting Principles (GAAP). McGraw-Hill contends that the Arbiter must instead confine his or her determination to whether McGraw-Hill used consistent methodology and accounting practices in preparation of the pre-closing and post-closing financial statements.

School Specialty has counterclaimed, seeking a judgment, pursuant to CPLR 3001, CPLR 7503(a), CPLR 7601 and 9 U.S.C. §§ 1 et seq., dismissing or staying this action, compelling the parties to select an arbiter, and ordering the parties to engage in binding arbitration wherein the selected arbiter shall decide all issues concerning the parties' dispute regarding the purchase price adjustment. In the that School Specialty is not awarded such relief, it seeks at least $6,194,000 in damages from McGraw-Hill for breach of the Agreement.

Both parties move for summary judgment, each seeking the respective declaratory and injunctive relief discussed above, and to dismiss the claims of the other. Unless stated otherwise, the following is derived primarily from the pleadings and the Agreement.

The parties executed the Agreement on January 15, 2004. It provides that the purchase price [*3]for the Acquired Business, payable on closing, was $46,600,000 in cash. The dispute involves, primarily, Section 2.6 of the Agreement, entitled "Purchase Price for Shares and Assets; Post-Closing Adjustment; Allocation" (Price Adjustment Clause or PAC), which concerns adjustments to the purchase price for the Acquired Business. Section 2.6(a) provides that the purchase price shall be payable at closing, and Section 2.6 (b)(ii) states that a reference balance sheet, dated October 31, 2003, is attached to the Agreement (Reference Balance Sheet).Section 2(b)(ii) further provides that the Reference Balance Sheet shows the "Net Asset Value"[FN2] (Net Asset Value) of the Acquired Business to be $45,757,000 as of October 31, 2003. That section also states that the parties agreed that $45,757,000 was the "target Net Asset Value" (Target Net Asset Value) of the Company as of the closing date, which the parties then anticipated would be January 31, 2004. Section 2(b)(ii) further provides that the Reference Balance Sheet had been reviewed and approved by the parties and was to be used to determine the elements of Net Asset Value pursuant to Section 2.6.

According to Section 2.6(b)(iv), at least three days prior to the closing, McGraw-Hill was to prepare and deliver to School Specialty a balance sheet showing the projected Estimated Net Asset value of the Company as of December 31, 2003. The parties agreed that the purchase price, to be paid at closing, was to be adjusted at that time, dollar-for-dollar, in direct relation to the amount that the "Estimated Net Asset Value" was greater or less than the Target Net Asset Value. The PAC also provides that after the closing, "the Purchase Price will be finally determined pursuant to Section 2.6(b)(v) and, to the extent that a further adjustment to the amount paid by Purchaser at closing is necessary, a dollar-for-dollar adjustment will thereafter be made as set forth in Section 2.6(b)(v) " (Sher Aff., Exh. C, § 2.6[b][I]).

Section 2.6(b)(v) states that within 60 days after the closing, McGraw-Hill was to prepare, and deliver, to School Specialty a "Final Balance Sheet" (Final Balance Sheet) showing the Net Asset Value of the Acquired Business at the Closing Date (Final Net Asset Value), and its work papers in connection therewith. The Purchaser had 45 days after receipt of the Final Net Asset Value "to dispute any amounts contained therein" by delivering to McGraw-Hill a written notice of objection identifying the amounts in dispute and a "reasonably detailed" explanation of the basis for the dispute (Sher Aff., Exh. C, § 2.6[b][v]).

In the event an objection notice was delivered to McGraw-Hill, and the parties could not resolve any "disputed amount," the parties agreed to refer their positions on the amount in dispute to the Arbiter (id.). The Arbiter's resolution, which was to be final, was to address only matters of dispute between the parties, and "shall be in the range of values presented by [McGraw-Hill] and [School Specialty] for any amounts in dispute" (id.).

Section 2(b)(ii) of the Agreement states: [*4] The Estimated Balance Sheet has been and Final Balance Sheet shall be prepared in a manner consistent with the principles under which Sellers prepare financial statements for internal purposes and shall comply with GAAP in all material respects. The Estimated Net Asset Value and Final Net Asset Value shall be prepared on a basis consistent with, and utilizing the same categories of assets and liabilities, and using the same methodology and accounting practices (including the manner in which the reserves for accounts receivable, returns and inventory are determined) used by Sellers for the Reference Balance Sheet, which all comply with GAAP in all material respects in the form utilized to calculate the Target Net Asset Value.

(Sher Aff., Exh. C, § 2.6 [b][ii])[FN3].

In addition to the ADR provision discussed above, Section 10 of the Agreement contains indemnification provisions in which each of the parties agreed to indemnify the other for losses caused by certain breaches of representations, warranties and covenants, subject to certain conditions such as the survival of the representation or covenant. McGraw-Hill specifically agreed to indemnify School Specialty for McGraw-Hill's breach of any representation or warranty contained in Section 3 of the Agreement,[FN4] and/or any covenant in the Agreement. According to Section 10.7, McGraw-Hill and School Specialty's exclusive remedy against each other for damages arising in connection with the Agreement is pursuant to the indemnification provisions.

The closing took place on January 30, 2004, and the adjusted price paid by School Specialty to McGraw-Hill was $45,684,000, a reduction of $916,000 from the $46,600,000 purchase price, reflecting the Estimated Net Asset Value as stated on the Estimated Balance Sheet. On April 5, 2004, McGraw-Hill delivered the Final Balance Sheet which it revised and re-delivered on April 24, 2004. According to School Specialty, the April 24th Final Balance Sheet contained the same elements as the Reference Balance Sheet and the Estimated Balance Sheet, but the Final Net Asset Value was approximately $1,324,000 greater than the Estimated Net Asset Value. On May 19, 2004, School Specialty sent a letter to McGraw-Hill with certain objections to the Final Net Asset Value, totaling $6,194,000, in School Specialty's favor. School Specialty disputes seven items in the Final Balance Sheet, and also claims that McGraw-Hill has admitted that it owes School Specialty $353,000 for a mistake related to certain inventory. Three of the seven objections, as described by School Specialty, are that: "The [Final Balance Sheet] did not calculate a reserve for un-saleable stock based on actual 2003 year-end sales data. Rather, [McGraw-Hill] had based this reserve on forecasts of such data and consequently overstated the Final Net Asset Value by [*5]$3,700,000.[The Final Balance Sheet] did not apply actual historical carrying costs data against McGraw-Hill's estimates of the value of overstock inventory and consequently overstated the Final Net Asset Value by $1,400,000.

. . . [The Final Balance Sheet] did not completely account for invoices that were outstanding as of the Closing Date, and consequently overstated the Final Net Asset Value by $177,000."

(School Specialty's Memo. of Law in Opposition, at 7-8).

The parties were unable to resolve their dispute over School Specialty's objections. This suit followed.

On a summary judgment motion, the movant bears the initial burden of proving entitlement to summary judgment (Winegrad v New York Univ. Med. Ctr., 64 NY2d 851 [1985]), "by tender of evidentiary proof in admissible form" (Zuckerman v City of New York, 49 NY2d 557, 562 [1980], quoting CPLR 3212 [b]). If the moving party establishes a basis for a grant of summary judgment, then to defeat the motion, the opposing party must present evidence that there is a triable material issue of fact (Zuckerman, 49 NY2d 557, supra )

McGraw-Hill argues that while School Specialty admits that McGraw-Hill used consistent accounting methods and practices in the Reference Balance Sheet and Final Balance Sheet, it nevertheless improperly seeks to submit its claim to the Arbiter in an attempt to vary these previously agreed upon methods and practices. McGraw-Hill contends that School Specialty should not be permitted to make use of the PAC to challenge or depart from accounting methods and practices that were consistently applied between the Reference Balance Sheet and Final Balance Sheet, and that the declaratory relief it has requested is necessary to ensure that this does not happen.

Citing to In the Matter of Westmoreland Coal Co. v Entech, Inc. (100 NY2d 352 [2003]) for support, McGraw-Hill argues that, as a matter of law, an arbitrator does not possess the authority to reconsider whether the accounting methods and practices utilized in preparing the Final Balance Sheet complied with GAAP, but must confine his or her determination to whether the Final Net Asset Value was prepared on a basis consistent with the Reference Balance Sheet. In further support, McGraw-Hill notes that the parties agreed that the methodology and accounting practices used in the Reference Balance Sheet comply "with GAAP in all material respects in the form utilized to calculate the Target Net Asset Value" (Sher Aff., Exh. C, § 2.6 [b][ii]). McGraw-Hill also argues that because the Agreement's "exclusive remedy" (Section 10), provides for indemnification as the exclusive remedy for breach of the Agreement, permitting School Specialty to assert GAAP violations in arbitration would subvert that provision, as well as the Agreement's "due diligence" and "sophisticated party" provisions.

School Specialty responds that it properly presented objections to amounts contained in the Final Balance Sheet from McGraw-Hill, and not to procedures and methods of calculations. In fact, it agrees with McGraw-Hill that the accounting methods and practices used to set the reserves in the [*6]Final Balance Sheet are consistent with the methods and practices used in the Reference Balance Sheet. Thus, School Specialty argues that it is not attacking the consistency of the accounting methods and practices used in the Reference Balance Sheet, but McGraw-Hill's failure to update its forecasts with historical year-end and January data that became available between the time that the Reference Balance Sheet and the Final Balance Sheet were prepared.[FN5] Consequently, School Specialty argues, the Final Balance does not comply with GAAP, and contains other "errors and omissions" as well.

Although claiming otherwise, each party argues the merits of its "accounting methods" position. For example, McGraw-Hill argues that using forecasts was a judgment call on its part that cannot now be assailed through the PAC. School Specialty argues that GAAP requires that actual data be used when available. Since Section 2.6 of the Agreement contains an ADR clause, however, the issue here is the applicability of this clause, the PAC, to the parties' dispute.

It is the responsibility of the court to interpret written instruments in order to determine the intention of the parties from the language employed (Mallad Constr. Corp. v County Fed. Sav. & Loan Ass'n., 32 NY2d 285, 291 [1973]). "A written contract will be read as a whole, and every part will be interpreted with reference to the whole; and if possible it will be so interpreted as to give effect to its general purpose" (Westmoreland, 100 NY2d at 358, quoting Empire Props. Corp. v Manufacturers Trust Co., 288 NY 242, 248 [internal quotation marks omitted]). The entire contract must be considered, and an interpretation is favored which will make every part of the contract effective (150 Broadway NY Assocs., L.P. v Bodner, 784 NYS2d 63, 66 [1st Dept 2004]). Thus, an interpretation which renders a clause absolutely meaningless should be avoided (ibid; see also Graphic Scanning Corp. v Citibank, N.A., 116 AD2d 22, 25 [1st Dept 1986]); however, care should be taken not to give undue force to single words or phrases, lest the meaning of a writing be distorted (Westmoreland,100 NY2d 352 at 358).

In Westmoreland, supra , the Court of Appeals interpreted a stock purchase agreement (SPA) between sophisticated parties which contained a price adjustment provision. The parties disputed whether the buyer's objections to asset values in closing date financial statements were subject to ADR, pursuant to the SPA's price adjustment provision. Through the SPA, and a later agreement, the "Guiding Principles for Calculation of Net Asset Value and Net Revenue Amount" (the Guiding Principles), the parties stressed the importance of consistency in preparation of the pre- and post-closing financial statements, which they intended to use as comparative tools to measure the difference in asset values due to the operations of the acquired companies in the time period between acquisition pricing and the closing. The Court noted that while GAAP may provide more than one applicable accounting methodology, when preparing financial statements for comparison, consistency between the accounting conventions and methods used to prepare the financial statements is important (Westmoreland, 100 NY2d at 358-59). This consistency helps to ensure that changes between financial statements from different time periods reflect changes in the value of the business due to its operations during the relevant period, and not merely differences in choices of acceptable accounting methods, and reflected the intention of the parties in Westmoreland to flag changes between the acquisition and closing date. [*7]

In Westmoreland, however, unlike this case, the seller represented that the pre-closing financial statements complied with GAAP (id. at 354). Thus, the Court determined that the purchaser's objections to asset value figures in the post-closing financial statements that the seller had merely carried over from, and that were common to, the pre-closing statements were objections that the seller had misrepresented that the pre-closing financials had been prepared in accordance with GAAP. As the SPA's indemnification clause provided for a court of competent jurisdiction as the exclusive forum for breach of the warranty and representations provision of the SPA, the Court determined that the parties intended that the dispute be litigated, and not submitted to ADR (id. at 360). It is evident that Westmoreland interpreted the intentions of the parties to the SPA, as expressed in the SPA and the Guiding Principles (100 NY2d at 358). It did not prescribe a blanket prohibition regarding price adjustment provisions, or against sophisticated parties using ADR to resolve disputes of any nature.

Significantly, a review of the Westmoreland record on appeal, maintained by the New York County Clerk (Index No. 122049/01), reveals that SPA did not contain an express provision regarding the post-closing financial statements and GAAP. Notably, however, here Section 2.6(b)(ii) of the Agreement expressly provides that the Final Balance Sheet, which was to prepared by the McGraw-Hill, "shall comply with GAAP in all material respects." In fact, as shown above (supra at 5), this "GAAP requirement" and the requirement that the Final Net Asset Value be prepared using the same methodology and accounting practices as the Reference Balance Sheet, are both included in Section 2.6(b)(ii).

McGraw-Hill does not dispute that any disagreement between the parties as to issues of the consistency of preparation of the Reference Balance Sheet and Final Balance Sheet, pursuant to Section 2.6(b)(ii), may be resolved at ADR, yet seeks to preclude the Arbiter from examining GAAP compliance, which is also part-and-parcel of Section 2.6(b)(ii). There is no explanation why, as conceded by McGraw-Hill, the Arbiter is empowered to consider the "consistency issue" regarding the Final Balance Sheet and not to also consider the GAAP issue where. Indeed, the very same section of the Agreement requires the Final Balance Sheet to both be "consistent with the [Sellers'] principles" and to "comply with GAAP." To me, this compels the conclusion that the parties also intended to submit to the Arbiter questions of GAAP compliance.

Moreover, the plain language of the Agreement expressly provides that the purchase price will be finally determined in accordance with Section 2.6(b)(v) (Sher Aff., Exh. C, § 2.6[b][I]). Section 2.6 (b)(ii) discusses the parties' requirements for preparation of the Reference Balance Sheet and Final Balance Sheet and states that the Final Balance Sheet "shall be prepared in a manner consistent with the principles under which Sellers prepare financial statements for internal purposes and shall comply with GAAP." Section 2.6(b)(v) provides that School Specialty had 45 days after receipt of the Final Net Asset Value "to dispute any amounts contained therein" and that in the event that the parties could not resolve their dispute, the parties were to submit their positions regarding same to the Arbiter. School Specialty objects to amounts used to determine the Final Net Asset Value, including whether the Final Balance Sheet complied with GAAP. Even reading the PAC conservatively, there can be little doubt of its applicability to the parties' dispute and whether, as McGraw-Hill contends, School Specialty is improperly attempting to vary the methodology and accounting practices, is properly before the Arbiter.

Nothing in this decision and order shall be construed as an opinion as to the merits of the purchase price dispute between the parties. [*8]

Accordingly, it is

ORDERED that the plaintiffs' motion for summary judgment dismissing the counterclaims and for declaratory relief is denied; and it is further

ORDERED that the defendants' motion for summary judgment to dismiss the complaint is granted, and the complaint is dismissed; and it is further

ORDERED that defendants' motion for summary judgment on its counterclaim for a declaratory judgment is granted as set forth herein; and it is further

ADJUDGED and DECLARED that the parties are to proceed to alternative dispute resolution forthwith pursuant to Section 2.6 of the Stock and Asset Purchase Agreement and t

hat it is within the scope of Section 2.6 for the arbiter to consider whether or not the Final Balance Sheet complies with GAAP.

Dated:___________

Enter:

_______________________________

J.S.C. Footnotes

Footnote 1:Section 2.6 (b)(v) provides that: Within sixty (60) days after the Closing Date, Sellers shall prepare and deliver to Purchaser the Final Balance Sheet showing the Final Net Asset Value at the Closing Date and its work papers in connection therewith . . . . Purchaser shall have a period of forty-five (45) days after its receipt of the Final Net Asset Value to dispute any amounts contained therein by delivering to Sellers a written notice of objection (an "Objection Notice") identifying the amounts in dispute and setting forth a reasonably detailed explanation of the basis of such dispute. The Purchaser and its accountants and advisors (ii) will be permitted to review the books and records of the acquired Business and the working papers related to the preparation of the Final Balance Sheet showing the Final Net Asset Value (including the determinations included therein), and (ii) will be given reasonable access to knowledgeable employees and accounting professionals of Sellers in order to facilitate their review of the Final Balance Sheet showing the Final Net Asset Value. . . . If an Objection Notice is delivered to Sellers . . . the parties shall cooperate in good faith to resolve any disputed amounts. In the event that Sellers and Purchaser are unable to resolve such dispute within sixty (60) business days after the date an Objection Notice was delivered to Sellers . . . Sellers and Purchaser shall refer the issues in dispute to a nationally recognized firm of public accountants . . . . Seller and Purchaser shall submit their positions on the amounts in dispute to the Arbiter within ten (10) business days after its selection and the Arbiter shall resolve the dispute within sixty (60) days after such submission or as soon thereafter as is reasonably practicable . . . which resolution shall address only matters of dispute between the parties and shall be within the range of values presented by Sellers and Purchaser for any amounts in dispute. Such resolution shall be final and binding upon the parties.

Footnote 2: Section 2.6[b][iii] provides that Net Asset Value of the Acquired Business was to be computed by subtracting the "Net Asset Value Liabilities" from the "Net Asset Value Assets." Net Asset Value Assets is defined as the categories of assets set forth in the Reference Balance Sheet, excluding certain agreed upon assets, and Net Asset Value Liabilities as the categories of liabilities set forth in the Reference Balance Sheet, excluding certain agreed upon liabilities.

Footnote 3:Interestingly, in its complaint, McGraw-Hill quotes this portion of the Agreement, however, its underlining does not extend to the phrase "which all comply with GAAP in all material respects in the form utilized to calculate the Target Net Asset Value." (Sher Aff. A, ¶ 14).

Footnote 4:Section 3 of the Agreement contains the parties' representations and warranties. Section 3.8 discusses certain financial statements that the Seller represented comply with GAAP. The financial statements referred to in the PAC, and not those discussed in Section 3, are the focus of the parties' briefs.

Footnote 5:School Specialty states that it re-calculated the amounts, using the same accounting methods and practices as McGraw-Hill, but using, as it claims is required by GAAP, updated information reflecting actual data that only became available after the closing.