Price adjustments in M&A transactions: the role of the independent expert accountant

April 2024 | EXPERT BRIEFING | MERGERS & ACQUISITIONS

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A key element of any M&A transaction is the contractual provisions governing the purchase price – one of the most heavily negotiated aspects of a share purchase agreement (SPA). With M&A transactions becoming increasingly complex and sophisticated, especially in the case of cross-border deals, purchase price clauses are affected accordingly.

The fact that M&A disputes are often related to discrepancies in the purchase price makes it imperative to draft and negotiate an SPA with potential discrepancies in mind.

Purchase price provisions in an SPA can include the following concepts: (i) a fixed purchase price; (ii) a deferred portion of the purchase price, if any; (iii) a contingent price, if any; (iv) an earn-out or variable purchase price, if any; (v) the closing accounts adjustment; and (vii) the locked-box mechanism and the concepts of leakage and permitted leakage.

All of these items will not necessarily be found in every SPA. In addition, items (v) and (vi) are typically regarded as alternative, usually applying to one or the other. There are many differences, both from a financial and a contract drafting perspective, between the closing accounts and the locked-box mechanism. Such issues are not, however, covered in this article.

Rather, this article will focus on situations in which a post-closing discrepancy arises between the buyer and the seller in relation to the purchase price and its related items. In particular, those disputes typically concern one or various of the following matters. First, the calculation of the contingent price. Second, the calculation of the earn-out or variable purchase price, which depends on the target’s business activity growth during a certain period. Lastly, the contractual provisions dealing with the determination of the purchase price (i.e., the closing accounts adjustment and the locked-box mechanism).

Standard practice between sophisticated parties is to set forth in the SPA that any unresolved discrepancies regarding assessment of the aforementioned items will be submitted for consideration to an independent expert accountant.

A key advantage of including a contractual provision to appoint an expert accountant for this kind of dispute is to avoid judicial or arbitration proceedings. Such proceedings normally take more time and incur higher costs than determination by an expert accountant.

Moreover, judicial or arbitration proceedings imply an escalation of the conflict between parties, which should be avoided especially when the seller remains a minority shareholder in the target company. This is quite common in industrial M&A transactions when the buyer is a private equity player. Only if parties fail to resolve their dispute through an expert accountant should judicial or arbitration proceedings be sought.

The following are key aspects of this contractual provision.

Expert accountant vs arbitrator. Submitting a dispute to an expert accountant does not imply that the resolution process is an arbitration proceeding. On the contrary, it is not. Rather, the role of the expert accountant is to determine the accuracy of the calculations made by the parties, on the basis of the formulas, accounting rules and criteria set forth in the SPA. This is a technicality that may differ across jurisdictions. Under Spanish law, for instance, the standard course of action is to stipulate in the SPA that the expert accountant will act as an expert in accordance with article 1447 of the Spanish Civil Code, and not as an arbitrator.

Appointing the expert accountant. It is crucial to carefully draft the clause governing the appointment of the expert accountant. Standard practice is to appoint by mutual agreement between the seller and the buyer. In the event the seller and buyer are unable to agree within a given time period, the SPA should state that the buyer will provide the seller – or vice versa – with the names of three recognised international accounting firms from which the other party will select one. If that party fails to do so, the SPA clause should state that the expert accountant will be selected by the other party. The ultimate goal is to ensure that an expert accountant is actually appointed, even if one party chooses not to cooperate. A contractual provision that does not foresee all such scenarios may be problematic to enforce.

List of potential expert accountants. The knowledge and expertise to act as an expert accountant on an M&A price determination dispute is possessed by a relatively small group of accountants. Consequently, the SPA should include a list of specific firms with strong forensic departments. The list should not be too short, however, and thought should be given to potential conflicts of interest.

Conflicts of interest. A properly drafted SPA typically states that the expert accountant should not be from a firm that audits the seller, buyer or target company. The goal here is to ensure the expert accountant is independent in executing their duties. Even if the SPA does not contain such a provision, top accounting firms that are usually listed as candidates for the expert accountant have strict internal procedures and policies for checking conflicts of interest, as they usually provide a wide range of professional services, including financial forensics.

Formal engagement. Even though the SPA outlines the process for appointing the expert accountant, the only rules that actually govern the professional services rendered by the expert accountant are contained in the engagement letter between the expert accountant, the buyer and the seller. The letter should detail the expert accountant’s role, the applicable fees and expenses and who will bear them, how the role should be performed, applicable timings and deadlines, and the liability regime vis-à-vis the buyer and seller. Aspects included in the SPA but not reflected in the engagement letter will not be binding upon the expert accountant. This is why it is of utmost importance to review, negotiate and amend, to whatever extent necessary, the engagement letter, so that the role of the expert accountant is aligned with what the parties envisaged in the SPA.

Collaboration and providing information. The buyer and seller should collaborate under a bona fide basis throughout the whole process. To this end, it is customary to include specific contractual provisions in the SPA, such as an obligation to cooperate as reasonably necessary to appoint an expert accountant. This should include complying with reasonable requests made by the expert accountant in carrying out their appointment (including providing any documents or other information the expert accountant may reasonably request).

Challenging the determination made by the expert accountant. It is common to stipulate that the expert accountant’s decision will, in the absence of fraud or manifest error, be final and binding on the buyer and seller. According to Spanish law and case law, when such a provision is included in an SPA, challenging an expert accountant’s determination requires evidence that it is fraudulent or blatantly erroneous.

In summary, for both buyers and sellers it is advisable to include in an SPA a properly drafted contractual provision governing the role of the expert accountant. This clause is sometimes regarded as too technical or unnecessary, but recent M&A practice has proven them to be not only useful, but crucial.

Should a discrepancy arise, the parties should seek external advice both from legal counsel and a specialised financial forensic expert, to properly and successfully present their case to the expert accountant.

Bojan Radovanovic is a partner at Cases & Lacambra. He can be contacted on +34 600 914 571 or by email: bojan.radovanovic@caseslacambra.com.

Bojan Radovanovic

Cases & Lacambra