(Reuters) - Toshiba Corp’s (6502.T) claim that it is owed $2.15 billion by Chicago Bridge & Iron Co NV (CB&I) CBI.N hinges on how an independent auditor will calculate the net working capital of a U.S. nuclear power plant construction business that CB&I sold to Toshiba’s Westinghouse unit last year.
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The following are the main issues at stake.
Net working capital is a measure of the financial strength of a business, defined as its current assets minus its current liabilities.
When a company sells a business to another company, the sale agreement often includes a target figure for net working capital to ensure that the financial position of the business does not change materially from the time the deal is signed to when it closes.
The two companies agreed that CB&I would not be paid any money when the deal closed, and instead would receive earnouts down the line. How much CB&I stands to be paid by Toshiba, or owes to Toshiba, depends on how they calculate the net working capital of CB&I Stone & Webster Inc, the nuclear power plant construction unit that Westinghouse bought. What is more, CB&I funneled close to $1 billion to CB&I Stone & Webster between the end of June 2015 and the end of December 2015, when the deal closed, and therefore sees the net working capital mechanism as a way to be compensated for continuing to support the unit after the deal signed.
The agreed target for the net working capital was $1.174 billion, so CB&I would be owed money by Toshiba if CB&I Stone & Webster’s net working capital was more than $1.174 billion at the time the deal closed, while CB&I would owe money to Westinghouse if the unit’s net working capital amount was below $1.174 billion.
CB&I has calculated the net working capital to be $1.6 billion, suggesting it is owed $428 million by Toshiba. The Japanese company has calculated the amount to be minus $976.5 million, indicating it is owed $2.15 billion by CB&I.
The vastly different amounts stem from four changes that Westinghouse made to CB&I’s calculations. Westinghouse reduced by 30 percent an outstanding receivable on the unit’s balance sheet, it adjusted it to reflect the cost of design changes in its projects, it raised the estimates of the cost to complete the projects by 30 percent, and added back a $432 million liability that CB&I had deducted.
Westinghouse argued that CB&I’s methodology did not adhere sufficiently to Generally Accepted Accounting Principles (GAAP), while CB&I maintained that it has stuck to the accounting methodology it used before and Westinghouse previously accepted.
The contract for the sale of the business calls for an independent auditor to resolve accounting disagreements over the value of the net working capital, and this is expected to happen in 2017.
CB&I has sued to prevent Westinghouse’s interpretation of the liabilities to be included in the net working capital calculations from being put before the independent auditor. Earlier this month, the Delaware Court of Chancery dismissed that lawsuit, and an appeal by CB&I is pending.
There have been two previous cases in Delaware where net working capital calculations have been legally challenged; OSI Systems Inc v. Instrumentarium Corp in 2006, and Alliant Techsystems Inc. v. MidOcean Bushnell Holdings L.P. in 2015.
In the case of OSI, the judge found that the GAAP compliance of net working capital calculations should be the subject of legal, rather than accounting, arbitration.
In the case of Alliant, the judge found that it was for the independent auditor to decide on the admissibility of the accounting calculations, because it found the language of the contract to be more prescriptive.
In the case of Toshiba, the judge decided the language of the contract was more similar to the Alliant case, and so dismissed CB&I’s lawsuit.
The nuclear power plant construction unit’s liabilities affect not just the net working capital calculations, but also the valuation of the unit.
Toshiba initially estimated the goodwill resulting from the transaction at around $87 million, but said on Tuesday it could be hit by a writedown in the billions of dollars.
Toshiba executives have said it could take until February to pinpoint the exact impact.
Sources: Court filings
Reporting by Greg Roumeliotis in New York; Editing by Lisa Shumaker