Post-M&A disputes in Italy
December 2018 | SPECIAL REPORT: INTERNATIONAL DISPUTE RESOLUTION
Financier Worldwide Magazine
December 2018 Issue
The broad definition of ‘post-M&A disputes’ can be held to encompass any cases related to sale and purchase agreements involving quotas or shares in companies (SPAs). More specifically, these disputes include matters stemming from the execution and performance of the SPA or from issues that arose during the negotiations. In this last respect, claims usually have to do with negotiations conducted in bad faith by one of the parties (culpa in contrahendo) or else with issues that arose prior to closing (e.g., issues inherent in the due diligence).
In the last few years, the Italian market has registered a significant increase in post-M&A claims. To be more precise, reports published by major insurance companies and insurance advisory firms show that, in Italy, 29 percent of policies stipulated in order to guarantee the transaction (warranty & indemnity policies) result in a notification of default. This figure is higher than the global average of 19.4 percent, with a peak of 24 percent for more important transactions.
These figures should be read in light of the fact that SPAs governed by Italian law increasingly include arbitration clauses for resolving post-M&A disputes, especially in cases where cross-border matters are involved. From a practical angle, though, many post-M&A disputes with Italian jurisdiction are handled by courts of arbitration.
Most of the events that give rise to post-M&A disputes are common to all jurisdictions. Breaches of representations and warranties (R&Ws) are the most common cause of post-M&A claims. It should be noted that there are no significant differences between the nature of R&W breaches under Italian jurisdiction compared to others. However, records show that the most common breaches of R&Ws are those concerning tax matters, financial statements and accounting records, compliance with applicable laws and regulations, authorisations and concessions, litigation, disclosure of material information and the due diligence process.
Furthermore, post-M&A disputes are frequently brought about by other circumstances as well, such as disagreements between the parties on how to calculate the earn-out payment (where provided), disputes arising from price adjustment clauses (e.g., appointment of the expert), negotiations conducted in bad faith or any other issues resulting in failure to close a transaction.
However, we need to bear in mind certain particularities of Italian law that are of relevance when dealing with post-M&A disputes.
Non-fulfilment of contractual obligations: burden of proof under Italian law. One of the main particularities of Italian law, compared to other legal systems, in the framework of non-fulfilment of contractual obligations, is that the burden of proof rests with the party in default.
To be more precise, the party alleging non-fulfilment of a contractual obligation will only be required to make the assertion and prove the existence of the relevant agreement, while the burden of proving that the obligation has been duly fulfilled will rest with the defendant. This has come about as a result of long-lasting conflicts and lively debate in Italian Civil Courts, as well as the Supreme Court. At long last, in judgment no. 826 of 20 January 2015, the Supreme Court stated its final position on the matter: “the burden of proving due fulfilment of the obligation rests with the defendant”.
It goes without saying that the principle set out above is of paramount importance not only when considering whether to bring a claim for non-fulfilment before an Italian court, but also in creating a defence strategy for the defendant. We are not aware of a principle of this kind in other jurisdictions.
Article 1229 of the Italian Civil Code and limitations of liability (indemnity caps and sole remedy clauses). SPAs commonly provide for indemnification clauses, which are intended to cover possible breaches of representations and warranties and usually take the form of setting a cap on the amount payable by the defaulting party, and ‘sole remedy’ clauses, which, generally speaking, exclude all remedies apart from the indemnification mechanism provided in the SPA for breaches of R&Ws.
When examining this point in the context of an SPA governed by Italian law, we need to consider carefully Article 1229 of the Italian Civil Code. Article 1229 provides that any contractual clauses containing an exclusion or limitation of liability will be considered automatically null and void in the event of conduct characterised by fraud or “gross negligence”. Consequently, the limitation of liability – whether it be a cap or a sole remedy clause – could be held ineffective by the court if the claimant is able to furnish evidence that the defendant’s actions should be considered fraud or gross negligence.
The concept of gross negligence is a unicum of Italian law, the precise scope of which has given rise to much debate among scholars and courts in recent years. Generally speaking, gross negligence can be described as a broad violation of the duty of diligence by which the parties are bound. In a 2013 International Chamber of Commerce (ICC) case, a court of arbitration defined gross negligence as conduct “less egregious than fraud” but “more egregious than negligence”. In other words, gross negligence would appear to be the degree of negligence closest to fraud.
It should also be considered that, whereas in cases of fraud the plaintiff is required to prove the existence of the fraud and deceit, the misleading nature of such conduct, the fraudulent intent and the causal link, gross negligence is far easier to prove, because proof of intention is not required.
In view of the above, particular care should be taken in drafting clauses setting a cap on the indemnity due to the buyer in the event of default and sole remedy clauses, because they may be considered null and void if raised before an Italian court.
Aliud pro alio. In the last few years, the scope and coverage of representations concerning authorisations and concessions granted by public authorities have been a source of debate, especially in ‘green energy’ disputes, and there has also been debate as to which is the most appropriate remedy following breaches. More specifically, the aliud pro alio principle has been increasingly invoked to justify claims for termination of the agreement and compensation for damages. The aliud pro alio principle acquires relevance in cases where the asset transferred differs significantly from the asset the buyer has been promised.
According to prevailing Italian case law, aliud pro alio can be raised in cases where the asset transferred is of a different genus to that established in the contract or where its typical features are lacking.
In this respect, it should be stressed that whereas, in the past, case law has been somewhat reluctant to uphold claims based on the aliud pro alio principle, in view of the difficulty of providing evidence that the asset transferred lacks the capacity to perform its natural and typical economic function, this is now less frequently the case. Courts are increasingly inclined to attach greater relevance to the economic goal effectively sought by the parties in the transaction, rather than a formal coherence between the result achieved and the result pursued.
When tackling claims based on the aliud pro alio principle in post-M&A disputes, parties often object that the aliud pro alio principle can only be invoked with reference to the object of the agreement (i.e., the SPA), that is to say the quota or shares (i.e., the direct object), and not to the assets of the target company (i.e., the indirect object).
Ordinary court or court of arbitration: which is the most appropriate venue?
It is highly probable that a court of arbitration will be called on to resolve a post-M&A dispute, as opposed to a state court. In various markets, including Italy, it is standard practice to include an arbitration clause in the agreement. Sources indicate that, in Italy, between 70 and 90 percent of share or asset purchase agreements include an arbitration clause.
As far as the Italian legal system is concerned, the main reason for such a proportion hinges on the slow pace of the courts. It can take up to three years to obtain a first instance decision, and this may be unacceptable to parties seeking to quickly resolve a dispute that could have an enormous impact on the business of all the parties involved. Swiftness is thus the main factor in favour of arbitration, which has now reached a new level thanks to the introduction of so-called ‘fast-track arbitration’. It is hoped is that this new instrument will see widespread adoption.
It should also be considered that arbitration awards are now broadly recognised following the New York Convention on the Recognition and Enforcement of International Arbitral Awards, which applies in almost 150 jurisdictions.
In addition to this, as opposed to litigation in state courts, the parties can use their influence in selecting arbitrators with experience as M&A practitioners and, even more importantly, they have the possibility of selecting the language of arbitration.
The costs of arbitration are, however, significantly higher than those of state courts, especially Italian courts. Consequently, parties will always need to consider the importance of the interests at stake when negotiating an arbitration clause, as opposed to a litigation clause.
Stefano Parlatore and Daniele Geronzi are partners and Bianca Berardicurti is a senior associate at Legance. Mr Parlatore can be contacted on +39 06 93 18 271 or by email: email@example.com. Mr Geronzi can be contacted on +39 06 93 18 271 or by email: firstname.lastname@example.org. Ms Berardicurti can be contacted on +39 06 93 18 271 or by email: email@example.com.
© Financier Worldwide
Stefano Parlatore, Daniele Geronzi and Bianca Berardicurti