Third Circuit Reverses District Court Order Compelling Arbitration, Highlighting That Arbitration and “Expert Determinations” Are Different Forms of Dispute Resolution

The Third Circuit Court of Appeals has reversed a district court decision compelling arbitration, finding that the parties’ designation of an accounting expert to resolve certain issues did not constitute an agreement to arbitrate their claims.

Kevin Sapp and Jamie Hopper entered into an asset purchase agreement with Industrial Action Services (IAS) memorializing the terms of Sapp and Hopper’s sale of their industrial businesses to IAS. The agreement included an “earn-out consideration” provision as part of the sale proceeds to be paid to Sapp and Hopper depending upon the performance of IAS over a three-year term and whether IAS reached certain performance benchmarks. The agreement included a provision that IAS would provide an earn-out statement at the end of the earn-out period, and Sapp and Hopper could submit a “notice of disagreement” with the statement, which would be resolved by an accounting firm. IAS provided an earn-out statement that showed the company did not meet its financial targets. Sapp and Hopper filed a notice of disagreement under the agreement and filed a declaratory judgment action in district court that its claims against IAS were outside the dispute resolution process set forth in the agreement. The district court granted IAS’ motion to compel arbitration, concluding that the agreement did include an arbitration agreement. The accounting firm selected by the parties to hear the dispute concluded that no additional compensation was owed to Sapp and Hopper. Sapp and Hopper moved to vacate the decision. The district court denied the motion and entered judgment for IAS. Sapp and Hopper appealed.

The Third Circuit reversed the district court’s order and vacated the judgment. The court first recognized that arbitration and expert determinations are “two distinct forms of private alternative dispute resolution that produce binding results,” noting that expert determinations involve a less formal process with the expert deciding more narrow issues. Reviewing the terms of the asset purchase agreement, the court concluded that the parties intended the accounting firm hearing disputes would be acting as an expert, not an arbitrator. The court pointed to the fact that the agreement did not include procedural rules that would govern an arbitration and further provided that disputes should be “submitted to non-binding mediation” and if unsuccessful, “either party may initiate litigation.” The court concluded that these and other terms of the agreement show the parties intended the accounting firm would serve as an expert, and not an arbitrator, and the parties were free to continue to litigate their claims in court. The court reversed the district court’s order, vacated the judgment, and remanded the case for further proceedings.

Sapp v. Industrial Action Services, LLC, No. 22-2181 (3d Cir. July 20, 2023).