M&A disputes

December 2019  |  SPECIAL REPORT: INTERNATIONAL DISPUTE RESOLUTION

Financier Worldwide Magazine

December 2019 Issue

The principle of caveat emptor, meaning ‘let the buyer beware’, has meant that sophisticated M&A lawyers have long since mitigated a buyer’s risk through expansive due diligence exercises and tight contractual controls. In particular, M&A deals feature often heavily negotiated representations, warranties and price adjustment mechanisms designed to provide a purchaser with a cause of action against the seller, post-completion.

Getting what you pay for

Representations and warranties are statements of fact that a particular state of affairs exists at the time the statement is made. These usually pertain to the target business’ financial and operational health. A common example is that “the company is not currently engaged in any litigation”. If, after closing, that statement turns out to be wrong, the buyer has a contractual cause of action, usually a claim to monetary damages.

Representations and warranties have become increasingly expansive in the hands of corporate lawyers, designed to provide extensive protection to a buyer and plug gaps (known and unknown) in the buyer’s due diligence exercise. Sellers’ lawyers have also looked to protect the seller by including terms designed to exclude, reduce or carefully delimit the seller’s liability within sale and purchase agreements. Examples of such mechanisms include disclaimers or exclusions, contractual limitation periods, de minimis and de maximis thresholds for claims and no double recovery clauses.

Price adjustment mechanisms, such as earn-out provisions, are another important means for the buyer to ensure that it only pays for what it gets and that the seller gets fair value for what it sells.

Risk mitigation means disputes

Disputes can arise at all stages of an M&A transaction. At the pre-signing stage, disputes commonly relate to alleged breaches of memoranda of understanding or letters of intent. In between signing and closing, it is common for disputes to arise over the non-fulfilment of conditions precedent or other contingent obligations set out in the agreement, such as putting in place appropriate escrow arrangements.

Post-closing disputes can often be the most difficult. Although designed to reduce and mitigate risk, representations, warranties and price adjustment mechanisms are themselves a common source of disputes, given that in essence they each provide a means for one party to challenge the quantum of the transaction consideration after the event, which is a recipe for a bitter fight.

Arbitration of M&A disputes

Arbitration is an increasingly prominent forum for the resolution of corporate disputes, including those arising from M&A deals. The London Court of International Arbitration’s (LCIA) 2018 Annual Casework Report records that 2018 saw a significant increase in the number of shareholder, share purchase and joint venture agreements being referred to LCIA arbitration. The proportion of total LCIA cases involving such disputes was 21 percent in 2018, up from 15 percent in 2017.

One particular advantage of LCIA arbitration in the context of an M&A dispute is that the LCIA Rules contain an express confidentiality obligation. Transaction parties will often prefer to address disputes over the deal, particularly price adjustments, in private.

Another attraction of arbitration is the parties’ ability to choose their arbitrator, thus tailoring the expertise of the tribunal to suit the particular facts at issue. Post-closing disputes often centre on factual, accounting or technical issues rather than purely legal issues.

The international nature of large M&A deals means that arbitration also offers two significant advantages driving its increased popularity: (i) the neutrality of arbitrators; and (ii) the relative ease of international enforcement of awards, in comparison to court judgments.

Evolution of arbitration

There is sometimes a broad sense that arbitration might have risked becoming a victim of its own success as a means of resolving commercial disputes. Having begun life as a shorter, cheaper, alternative process for resolving disputes privately on a bi-partisan basis, its huge growth to become a predominant forum for cross-border commercial cases has meant that it has had to evolve to meet the needs of more complex circumstances. Big-ticket arbitrations are now likely to involve at least the same time, costs and complexities as English litigation.

Recent years have accordingly seen significant efforts by the leading arbitral institutions to ensure that arbitration remains flexible and effective and able to meet the challenges of complex corporate disputes.

In particular, M&A deals often involve a suite of transaction documents between multiple parties. This might include the buyer, seller and the target company but also other shareholders, any guarantors and even key suppliers, subsidiaries or other stakeholders. As most arbitral rules are written on a bi-partisan basis – i.e., assuming a claimant versus a respondent – arbitration does not at first sight readily lend itself to disputes arising from such multi-party, multi-contract disputes, particularly where each transaction document might have its own arbitration agreement. Such an arrangement runs the risk of multiple parallel proceedings relating to the same set of facts.

Many institutions, including the International Chamber of Commerce (ICC), have therefore added clear provisions on consolidation and joinder into their procedural rules and by incorporating such rules into their arbitration agreement, parties will normally have consented in advance to the possibility of the consolidation of proceedings and the joinder of third parties in disputes arising under compatible arbitration agreements.

However, although the institutional rules provide a clear procedure for consolidating proceedings or adding parties, arbitration is still a consensual process and the clear consent of all of the parties to arbitration is needed. This means that arbitration clauses containing consolidation or joinder provisions are notoriously difficult to draft, generally requiring either something entirely bespoke and very specific, or else, at the complete opposite end of the spectrum, something very light touch and flexible.

To address time and cost concerns, many institutions have introduced or clarified rules designed to provide for expedited arbitration, with simplified procedures and restrictive time limits, including the ICC expedited procedure rules, for example.

Finally, the seat of an arbitration is an important choice in M&A disputes, which may require interim measures on an urgent basis, in particular in those cases arising between signing and closing, for example to compel or prevent actions being taken by either party that might affect the value of the target. Although arbitral rules have long since recognised the right of parties to go to a competent local court to obtain such relief on an urgent interim basis, the introduction of emergency arbitrator provisions to provide interim relief from a promptly appointed sole arbitrator – who is thereafter prevented from acting in the main dispute on the merits – has reinforced the ability of parties to obtain urgent relief within the arbitration itself.

The decision of the English High Court in Gerald Metals SA vs Timis Trust (2016) further underlines the shift. The effect of the decision in that case was that by opting the availability of emergency arbitrator relief into the scope of their arbitration agreement – by incorporating by reference institutional rules containing emergency arbitrator provisions – parties are likely to have limited the jurisdiction of an English court to grant that interim relief.

It remains to be seen how different jurisdictions will evolve to approach these questions of the potentially competing jurisdictions of national courts and emergency arbitrators.

Future trends

Like many areas of legal practice, technology is changing the way that parties approach M&A deals and disputes. As processes become more standardised in order to be capable of being better managed by computers, so the data relating to such matters becomes more consistent. Consistent data sets and machine learning (ML) then allow for more exciting uses of artificial intelligence (AI), including useful and error-free data analysis and, with that, outcomes prediction.

Many M&A disputes turn on accountancy data and the purchase price ultimately paid, and any adjustment to it, is often linked to the company’s accounts or other financial reporting, carefully compared to contractual reference dates. Presently this typically requires an accountancy or valuation expert witness to undertake a forensic exercise, reviewing relevant data and documents, before filtering and analysing the information revealed in order to opine on the outcome of those data and documents in a written report upon which the expert will be cross-examined in front of a tribunal.

Numerous legal technology tools are already available and utilised by the best legal and accountancy teams to assist and streamline this traditional approach – including e-disclosure tools that utilise predictive coding to sort data sets and data visualisation and analytics tools that sort and present such data to the tribunal in the most comprehensible and persuasive way. This is the advocacy of the now, rather than the advocacy of the future.

However, as the objectivisation of data continues, and particularly as legal technology solutions are increasingly used at the front end of a transaction, we will increasingly see innovative process-led solutions being applied as genuine alternatives to those traditional approaches. A dispute over whether a condition precedent has been complied with, a representation was true, or a price adjustment is required will, for example, become increasingly the product of a computer’s infallible reading of the consistent and objective data at the computer’s disposal in relation to those contract terms, and less and less about fallible human interpretations.

 

James Rogers is a partner and Matthew Buckle is a senior associate at Norton Rose Fulbright. Mr Rogers can be contacted on +44 (0)20 7444 3350 or by email: james.rogers@nortonrosefulbright.com. Mr Buckle can be contacted on +44 (0)20 7444 5054 or by email: matthew.buckle@nortonrosefulbright.com.

© Financier Worldwide

BY

James Rogers and Matthew Buckle

Norton Rose Fulbright

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