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Viacom International, Inc. v. Winshall: Delaware Supreme Court Reaffirms Judicial Deference to Arbitrator's Decisions on Procedural Arbitrability

December 2, 2013

In Viacom International, Inc. v. Winshall, 72 A.3d 78 (Del. 2013), the Delaware Supreme Court affirmed the Court of Chancery’s decision to uphold an arbitration determination resolving a dispute between Viacom International, Inc. (“Viacom”) and the stockholders of Harmonix Music Systems, Inc. (“Harmonix”). The disagreement concerned an “Earn-Out” payment provision adopted under the 2006 Agreement and Plan of Merger (“Merger Agreement”) between the two companies. The Court held that the arbitrator’s decision to exclude evidence that was not identified in Viacom’s initial submission, supporting its argument that there should be an inventory write-down, did not constitute misconduct, and that the arbitrability of the inventory write-down dispute was an issue for the arbitrator to decide.

In 2006, Viacom acquired Harmonix for $175 million in cash plus a contingent right to receive uncapped Earn-Out payments based on Harmonix’s 2007 and 2008 gross profits. Walter A. Winshall, the designated representative of Harmonix’s former stockholders, disputed Viacom’s calculation of the 2008 Earn-Out statement, from which Viacom deducted the cost of Harmonix’s unsold inventory. In accordance with the Merger Agreement, Winshall presented his disagreements in a Summary of Issues. The parties were unable to resolve the dispute and submitted the Earn-Out disagreement to arbitration, with a nationally known accounting firm serving as the arbitrator.

In its pre-hearing submission, Viacom argued that if it were unable to properly deduct the cost of Harmonix’s unsold inventory, it could account for that inventory by taking an inventory write-down deduction. Winshall countered that because this argument was not included in the 2008 Earn-Out statement, it could not be considered in arbitration. As the inventory write-down was not included in the original submission of unresolved items from the Summary of Issues, the arbitrator asked for the parties’ consent to consider it in reaching its decision, which Winshall refused to grant. The arbitrator issued its decision in December 2011, agreeing with Winshall that costs of unsold inventory should not be deducted from net revenue. The arbitrator did not address the inventory write-down.

Viacom filed a complaint in the Court of Chancery seeking a declaration vacating the arbitrator’s determination. Viacom alleged that the arbitrator disregarded the terms of the Merger Agreement and failed to consider Viacom’s arguments in reaching its decision, as well as that Winshall breached the Merger Agreement by refusing to consent to the arbitrator’s consideration of Viacom’s argument. The Court of Chancery granted Winshall’s motion for summary judgment and confirmed the arbitrator’s decision.

On appeal, the Delaware Supreme Court considered two issues. First, the Court considered whether the arbitrator’s refusal to consider evidence of the inventory write-down amounted to misconduct requiring the Court to vacate its decision. The Court then addressed whether the question of whether to consider the inventory write-down provision in reaching its determination was a question of procedural arbitrability that was properly decided by the arbitrator.

The Court found that the arbitrator properly limited its analysis of the Earn-Out dispute and did not ignore any relevant evidence. The Merger Agreement required the parties’ initial submissions to include all matters to be decided by the arbitrator. The question of whether the inventory write-down was an appropriate method of accounting for unsold Harmonix inventory was not identified in the initial submissions. The arbitrator’s determination that it could not consider the issue absent the express consent of the parties was thus appropriate and did not constitute misconduct.

In addition, the Court found that the arbitrator’s unwillingness to consider the inventory write-down issue constituted a decision that the issue was not arbitrable, a determination that the arbitrator was entitled to make because the question was one of procedural arbitrability.

The Court defined issues of procedural arbitrability as those concerning whether or not the parties have complied with the terms of an arbitration provision; for example, a determination of whether certain conditions precedent to arbitration have been met. These issues are presumptively handled by arbitrators. In contrast, the Court defined issues of substantive arbitrability as those that necessitate a determination of the scope of a given arbitration provision and its applicability to a given dispute. Answering a question of substantive arbitrability effectively determines whether the parties should be arbitrating at all, a gateway question that is presumptively decided by a court.

Overruling certain earlier decisions of the Court of Chancery, the Court explained that, whether an arbitration provision is broad or narrow, the only issue of arbitrability that should be decided by the court is “whether the subject matter in dispute falls within it.” Where the subject matter generally in dispute (e.g., in this case, the calculation of an earn-out) falls within the arbitration provision, subsidiary questions like “what financial or other information should be considered in performing the calculation” are questions of procedural arbitrability and are properly decided by the arbitrator. Finally, the Court determined that whether or not the Court of Chancery was correct in agreeing with the arbitrator’s decision was irrelevant, as the decision was properly made by the arbitrator.