Burroughs International Co. v. Datronics Engineers, Inc.

Singley, J., delivered the opinion of the Court. This controversy is an entirely typical aftermath of the corporate merger or take-over which has become commonplace in our business community. It brings before us for interpretation that portion of an agreement for the sale of the stock of Strand Engineering Company (Strand) in which the seller, Datronics Engineers, Inc. (Datronics), warranted to the purchaser, Burroughs International Company 1 (Burroughs), that the liabilities of ³³⁰ Strand as of 30 June 1962 would not exceed its assets by more than $220,000 and provided how any such excess would be treated. Unhappily, the resolution of the problem calls for an involuntary excursion into the terra incognita known to accountants as GAAP (generally accepted accounting principals).

As Judge Henry J. Friendly wisely observed, “* * * Accounting concepts are a foreign language to some lawyers in almost all cases, and to almost all lawyers in some cases.” 2 Strand, incorporated in Michigan, had outstanding 6,000 shares of common stock, $10 par, all of which were owned by Datronics. Strand’s corporate career had been something less than successful: at 30 June 1962, it had an accumulated deficit of some $140,000, even after capitalizing “Patent Development and Application Costs” of some $311,000 and goodwill at $43,000. Its current liabilities were almost twice its current assets, and operating losses for the month of June, 1962 had been some $27,000. We can only judge that it was being kept alive by liberal infusions of cash, which appear to have amounted to more than $200,000, from Datronics, its parent.

Into this desperate situation came Burroughs. After what we can only assume to be protracted negotiations, on 13 August 1962, Burroughs and Datronics entered into an agreement (the Agreement) under which Burroughs agreed to purchase and Datronics agreed to sell the 6,000 shares of Strand stock owned by Datronics for $183,600 in cash and 3,410 shares of the common stock of Burroughs Corporation. 3 As will be later explained, the stock was given an “agreed” value of $40 per share and was to be placed in escrow to secure the performance by Datronics of the representations, warranties and covenants contained in the Agreement. The Agreement is a typical example of the sophisticated draftsmanship customarily encountered in such ³³¹ transactions. Its provisions are unremarkable, except that it provided for closing at 3 P.M. on the day it was executed, thus denying Burroughs any opportunity to make an independent inquiry into Strand’s affairs prior to the closing date.

This is a possible reason for the escrow arrangement. The provisions of the Agreement which are relevant to the present controversy are these: “1. Seller represents and warrants that: “(e) The unaudited Balance Sheet of Strand as at June 30, 1962, the unaudited Profit and Loss Statement of Strand for the month of June, 1962, and the four months ended June 30, 1962, the unaudited Balance Sheet of Seller as at June 30, 1962, and Seller’s unaudited Profit and Loss Statement for the five months ended June 30, 1962, copies of all of which have heretofore been furnished by Seller to Purchaser and are attached hereto as Exhibits 1, 2, 3 and 4, respectively, and made a part hereof, are correct and truly and fairly present the results of the operations of Strand and Seller for the respective periods covered thereby, and their financial condition as of the ends of such period, except that Seller makes no representation or warranty as to the value, if any, of the assets designated ‘Other Assets’ 4 on Strand’s Balance Sheet as at June 30, 1962. Said Profit and Loss Statements and Balance Sheets were prepared in accordance with generally accepted principles of accounting, consistently maintained by Strand and Seller throughout the periods stated. “Since June 30, 1962, there have been no changes in the assets, liabilities or condition, financial or otherwise, of Strand or Seller, ex ³³² cept as consented to in writing by Purchaser and except changes arising from transactions in the ordinary course of business and none of such changes have been materially adverse.

Since June 30, 1962, neither the business nor any of the properties of Strand or Seller have been substantially and adversely affected in any way by any cause whatsoever, including, but in nowise limited to, act of God, fire, explosion, earthquake, accident, strike, lockout, combination of workmen, flood, drought, embargo, riot, condemnation, confiscation, activities of Armed Forces or order of the United States of America, any of the several States, or municipalities thereof, or any department, agency or commission of any of them. The Seller further expressly represents, warrants and covenants that to the extent the total liabilities of Strand, actual and contingent, exceed the total assets of Strand (excluding ‘Other Assets’ of $354,670.16) as of June 30, 1962, by an amount greater than Two Hundred Twenty Thousand Dollars ($220,000.-00), as determined by generally accepted principles of accounting, the Purchaser may, without limiting its other remedies, charge any such excess against the Escrow hereinafter provided.” “(n) Strand is the owner of all of the outstanding capital stock of Automatic Controls Corporation, a Michigan corporation, which corporation is solvent and has a net worth of not less than $3,000.00; and Strand will deliver to Purchaser as an enclosure to the Letter a true and correct Balance Sheet of said corporation as at July 31,1962; and Seller warrants that the assets and liabilities shown on said Balance Sheet will not be adversely affected prior to Closing.” ³³³ “11. All of the covenants, representations and warranties of the parties hereunder shall survive the Closing Date subject to performance under this Agreement.” Attached to the Agreement as Exhibit 1 was the unaudited balance sheet of Strand as at 30 June 1962. This showed that Strand’s assets, after deducting “other assets” of $354,670.16 referred to in paragraph 1(e) of the Agreement, were $266,856.12 and that its liabilities were $485,723.45.

Liabilities therefore exceeded assets by $218,867.33 but this excess was $1,132.67 less than the representation that liabilities at 30 June 1962 would not exceed liabilities as at that date, “determined by generally accepted principles of accounting” by an amount greater than $220,000. There is no doubt that the seller of shares of corporate stock may warrant that the financial condition of the corporation is that represented by financial statements, or guarantee that the corporation has no indebtedness or that the indebtedness does not exceed a certain amount. 12 A Fletcher, Private Corporations § 5615 (1957) at 247, 252. Agreements containing warranties substantially similar to those of the Agreement have been before the courts in Coilings v. Bush Mfg. Co., 256 F. 2d 573 (2d Cir. 1958); Automatic Canteen Co. of America v. Butler, 177 So. 2d 712 (D.Ct.App. Fla., 1965) ; Adzigian v. W O R L Broadcasting Corp., 348 Mass. 777 , 202 N.E.2d 915 (1964) ; Carolet Corp. v. Garfield, 339 Mass. 75 , 157 N.E.2d 876 (1959); Consolidated Freightways Corp. v. Wilhelm, 238 Ore. 518 , 395 P. 2d 555 (1964) ; In re Carter, 390 Pa. 365 , 134 A. 2d 908 (1957).

It will be remembered that the Agreement provided that 3,410 shares of Burroughs Corporation stock were to be placed in escrow. The escrow agreement, executed at the closing, provided, in part : “5. [Burroughs] and Datronics agree that: (a) They shall jointly order the Escrow Agent to deliver to [Burroughs] such stock (in- ³³⁴ eluding dividends paid thereon), at an agreed value of Forty Dollars ($40.00) per share, as is necessary to hold [Burroughs] harmless from Datronics’ breach of any of the representations, warranties, covenants, terms or provisions of said Agreement of Sale dated August 13, 1962; and (b) Except as provided in paragraph 5(a) hereof, [Burroughs] and Datronics agree that they shall jointly order the Escrow Agent to deliver said stock to Datronics as follows: (i) One Thousand (1,000) Shares on September 15,1962; (ii) Five Hundred (500) Shares on October 15,1962; (iii) Five Hundred (500) Shares on November 15,1962; (iv) Five Hundred (500) Shares on December 15,1962; and (v) Nine Hundred Ten (910) Shares on December 15,1963; Provided, however, that if at any time in the good faith opinion of [Burroughs] it appears that Datronics has breached or threatens to breach any of the representations, warranties, covenants, terms or provisions of said Agreement of Sale dated August 13, 1962, [Burroughs] may refuse to execute such joint order to the Escrow Agent with regard to such shares not then delivered to Datronics which are deemed by [Burroughs] necessary to secure itself against loss resulting from said breach or threatened breach. (c) In the event either [Burroughs] or Datronics shall refuse to execute such joint order directing said Escrow Agent to deliver said stock to [Burroughs] or Datronics, the Escrow Agent shall continue to hold such stock not previously delivered pursuant hereto, until such ³³⁵ joint order is obtained or until otherwise directed by court order. (d) Dividends on all Burroughs Corporation Common Stock held by the Escrow Agent shall be delivered to said Escrow Agent to be held and delivered by it to [Burroughs] or Datronics under the same conditions and at the same time as the shares on which such dividends have been declared are delivered.” It would appear that Burroughs, from and after the closing, assumed the active management and direction of Strand and devoted a year or more to an independent examination of its affairs. 2,500 of the Burroughs Corporation shares held in escrow were released to Datronics during the period 15 September 1962 to 15 December 1962, as provided by subparagraphs 5(a) (i) through (iv) of the escrow agreement.

When it came time to release the remaining 910 shares on 15 December 1963, Burroughs refused to join in an authorization to release, claiming that it had the right under the Agreement to assert a claim of $91,044.93 against the escrowed shares. When Burroughs and Datronics failed to reach agreement, Burroughs instituted suit against Datronics and the escrow agent in the Circuit Court for Montgomery County, claiming that an audit had disclosed that the liabilities of Strand, as at 30 June 1962, exceeded its assets by $91,045 more than the $220,000 maximum represented by the agreement; that judgment for $91,045 and costs should be entered in its favor against Datronics; and that $36,400 of the judgment be satisfied by the entry of an order directing the escrow agent to deliver to Burroughs the 910 shares of Burroughs Corporation stock which remained in escrow. The escrow agent deposited the stock which it held and the dividends which it had received with the registry of the court, and there after took no part in the proceeding. Burroughs’ original claim, actually in the amount of $91,044.93, was reduced at trial by a stipulation that $21,- ³³⁶ 684.48 represented an account or accounts receivable not properly chargeable against the escrow.

The trial court found that there had been a further reduction of $5,-537.64, consisting of adjustments made by Burroughs’ witnesses. Consequently, at the conclusion of the trial, the court was dealing with a revised claim of $63,822.81. It allowed all of the adjustments made by Burroughs’ auditors except four which aggregated $41,902.84. With the elimination of these, adjustments totalling $21,919.97 remained.

The court entered judgment in Burroughs’ favor against Datronics in the amount of $21,920 and directed that this be satisfied by the delivery to Burroughs of 548 of the escrowed shares of Burroughs Corporation stock, which, at $40 per share, had a value precisely equivalent to the amount of the judgment. The order also provided that the 362 shares remaining be delivered to Datronics. Under the order, each party was to receive the dividends which had accumulated on its shares. Neither party was satisfied with the result: Burroughs, because $41,902.84 of the adjustments which it had claimed had been disallowed; Datronics, because Burroughs had been allowed to make any adjustments at all.

Burroughs, treating the judgment of 20 March as a judgment nisi entered in accordance with Maryland Rule 564 b'l, 5 filed a motion for a new trial as provided by Rule 567 a. On the same day, Datronics filed a “Motion for Reconsideration”, which we will consider to the extent that it extended the time within which Datronics could appeal, as a motion for a new trial. The court denied both motions by order entered 3 May 1968. We will regard this denial as equivalent to the entry of a judgment absolute from which an appeal may be taken.

Merlands Club, Inc. v. Messall, 238 Md. 359, 362-63 , 208 A. 2d 687 (1965). Both parties appealed. Counsel for Datronics, at argument before us, conceded that the proceeding below was in the nature of a declaratory action and suggested that, ³³⁷ if there had been error in the declaration below, both parties were agreed that it could readily be corrected by us on the record before us without remand. The thrust of Burroughs’ appeal is that the court’s refusal to allow the four adjustments totalling $41,902.84 constituted reversible error.

Datronics, on the other hand, vigorously attacks the propriety of the adjustments which the court permitted and denies that any additional ones are justifiable. Burroughs rests its case on the interpretation to be given Datronics’ representation and warranty that: (i) the balance sheet of 30 June 1962 is correct, was prepared in accordance with generally accepted principles of accounting, and truly and fairly presents the financial condition of Strand as at that date; and (ii) from 30 June 1962 to 13 August 1962 (the date of the Agreement) there had been no changes in the financial condition of Strand, except those arising in the ordinary course of business, which had not been materially adverse. 6 Datronics says, on the other hand, that “[t]here is not a scintilla of evidence to show that Strand’s [Acquisition] Balance Sheet was not prepared in accordance with generally accepted principles of accounting.” We shall consider these contentions, and later, the other points made by Datronics in the context of Maryland Rule 886 a: where a case has been tried below without a jury, we may review the case on the law and the evidence, but will not set aside the judgment of the lower court on the evidence unless it is clearly erroneous, Space Aero Products Co. v. R. E. Darling Co., 238 Md. 93 , 208 A. 2d 74 (1965), and the evidence must be viewed in the light most favorable to the party prevailing below, Goodwin v. Lumbermens Mut. Cas. Co., 199 Md. 121 , 85 A. 2d 759 (1952) : “* * * Before a determination can be made that ³³⁸ such a decision is clearly erroneous, the evidence must be viewed in a light most favorable to the prevailing party below.

If, viewed in that light, there is substantial evidence to support the factual conclusion, then the appellate court should accept that conclusion. But if there is no such substantial evidence, then the conclusion may be designated as arbitrary, and may be disregarded. If the trial court does not say what it finds to be the facts, no presumption as to them arises merely from the decision. Obviously, then, if there is no factual statement or conclusion, there is no reason for the appellate court to examine the record with an evidentiary slant in favor of the appellee in order to sustain a non-existent presumption.” 199 Md. at 129-30 .

We now turn to a detailed consideration of the disputed adjustments. (i) American Radio Telephone Company — $15,205.98 Among the accounts receivable included in the 30 June 1962 balance sheet was an amount of $15,205.98 representing the total of three invoices issued by Strand for design services performed under an American Radio Telephone Company purchase order. Performance of the contract was terminated on 17 January 1962 at American Radio Telephone’s instruction. There was testimony that by May 1962, the controller of Strand knew that American Radio Telephone was “near the bankruptcy stages.” The account had been placed for collection in the hands of Strand’s attorneys who, on 28 May 1962, had recommended the rejection of a $3,500 settlement offer because they believed that a substantially greater amount could be obtained.

Burroughs produced testimony that sound accounting principles would have demanded that Strand’s 30 June balance sheet set up a 100% reserve against this account. Datronics’ expert testified that there was insufficient evidence to justify a 100% write-off and ³³⁹ that there was some evidence that a substantial distribution might be received in bankruptcy. The court below declined to allow the $15,205.98 adjustment on the ground: “No proof was ever established that the account was without value, so there was not a decrease in accounts receivable as of the date of the acquisition, even though there was no provision for bad debts on the books of the Strand Company. No convincing testimony was adduced to establish that the lack of such a reserve was not in accordance with generally accepted accounting principles.

Rather than accounting, this would appear to be a business judgment. There was also some indication in the file that the American Radio Telephone Company, upon liquidation, would be able to pay a substantial part of the Strand claim.” The point here, of course, is that Datronics did not, by signing the Agreement, guarantee the collectibility of Strand’s accounts receivable. The real question is whether, as a matter of accepted accounting principles, the receivable was properly treated in the balance sheet. As to this, the experts disagreed.

Based on our review of the evidence, we cannot say that the lower court’s conclusion was clearly erroneous. The court could properly find, as it did, that under all the circumstances the adjustment was not properly allowable. (ii) Bendix Systems Division — $586.28 The 30 June 1962 balance sheet included an account receivable from Bendix Systems Division in the amount of $2,598.97 for services rendered during the period 1-28 February 1961. Of this amount $586.28 was disputed by United States government auditors, and an amended billing was submitted by Strand after the take-over to correct a “clerical error”.

Since the 30 June 1962 balance ³⁴⁰