In many M&A transactions litigators become involved only after a dispute has arisen. However, a litigator’s experience in handling post-M&A disputes can give them an insight into the risks and common problems that arise in M&A transactions post-completion, and how these may be best mitigated at the contract drafting and management stage.
At Baker McKenzie our M&A disputes specialists work as a team with our corporate colleagues in order assist in managing and mitigating risk at both the drafting stage and post-completion. Here are ten of our top tips for minimising M&A risk.
1. Non-Disclosure agreements and letters of intent
Before parties start with detailed negotiations about a potential M&A transaction, they often agree on a Non-Disclosure Agreement (NDA) to ensure that confidential information will not be disclosed by the other party. Often the mere existence of negotiations will need to be treated as confidential. NDAs are sometimes contained in letters of intent (LOI) outlining the key terms of the proposed transaction. Though generally LOI are not intended by parties to be legally binding in all respects, often there are disputes regarding this and as to which provisions were intended to be binding. The possibility of the LOI creating a binding acquisition agreement becomes a significant risk factor if the LOI is not drafted properly.
2. Locked box accounts
Locked box accounts are proving increasingly popular and research suggests that they significantly reduce the risk of accounting related disputes compared with completion accounts. The clean break on completion, reduction of scope for dispute and the ability to focus on integration after completion are all benefits. However, the lack of postcompletion adjustments means the buyer assumes the economic risk before the target’s ownership is transferred. Any permitted value extraction (permitted leakage) from the target between the locked box date and closing therefore benefits the seller.
3. Warranties, representations and indemnities
Common practice today is for sellers to avoid warranties also being given as representations. Buyers should be aware of how this may impact the calculation of damages under some governing laws and the sums that might be recoverable. Framing warranties as also being representations provides the option of a tortious claim which can sometimes lead to a higher damages recovery depending on the facts. This is especially the case where the buyer has over paid for the business in any event and is looking to recover value through damages by reference to the amount of its original outlay.
Often parties will seek to deter any breach by including a penalty provision should a breach occur. The concept of a penalty covers not just monetary sums which are referred to as such by name, but also other payment obligations, and obligations to repay a proportion of the consideration representing goodwill should there be a breach of the non-compete covenant or an obligation to transfer shares at some form of discounted price. Such penalty provisions can be effective in ensuring compliance with the terms of the SPA, but they can be found to be unenforceable as an illegitimate penalty. As such, significant care needs to be taken in the structuring and drafting of such clauses to ensure that they are strong enough to deter a potential contract breaker, but still remain enforceable.
5. Limitation provisions
The inclusion of financial limitations of liability (usually for the seller) is one of the main ways for a party to manage its liability risk. It allows both parties to know at the outset what the potential exposure and scope for recovery might be and to mitigate this risk accordingly (e.g. through insurance or an adjustment to the purchase price).
6. Structuring your investment
Where an acquisition is made overseas, the investment should be
structured to ensure not only favourable tax treatment but also to ensure
that the investment benefits from investor protections under a bilateral
investment treaty (BIT) or similar public international law instrument.
This may require the acquisition to be structured in a particular manner,
for example through an SPV based in a specific jurisdiction which has a
BIT with the country in which the target is located.
A BIT offers protections to investors against unlawful acts of the
host state. Such protections often include requiring the payment of
compensation in the event of expropriation, requiring the treatment of
the investor to be no less favourable than the treatment of nationals of
the host state or investors from other countries, and fair and equitable
treatment (including the right to procedural fairness, due process and
transparency, and freedom from coercion or harassment). BITs can be seen
as a free form of (limited) insurance against political interference in the
investment and should be considered for all overseas acquisitions.
7. Dispute resolution clause and disclosure
The negotiation of an appropriate dispute resolution forum to resolve any
disputes that might arise out of the transaction is critical to the management of risk. A carefully drafted SPA needs to be capable of being enforced through a high-standard, quick and impartial dispute resolution mechanism resulting in a fair determination of any dispute, which can then be effectively enforced against the losing party wherever required.
8. Restructuring the acquisition and saving important knowledge
Often following an acquisition the business is restructured or people otherwise leave. Such people may hold key information about the business, including facts that might give rise to a claim against the seller, which might be lost.
9. Post-completion audit
While the processes for the preparation and closing of transactions – due
diligence, valuation and negotiating the purchase agreement – are carried out with great attention to detail and price adjustment for any issue discovered, often the focus post-completion is on integrating the business rather than ensuring the business is as warranted.
Many companies do not use standardized processes to uncover claims arising following corporate transactions. In many cases, the lack of targeted and standardized processes means that potential deficiencies in the acquired
company are only identified when pointed out by external third parties or
when obvious inconsistencies turn up. Deficiencies tend to be identified most
often in an ad hoc manner in connection with the preparation and auditing
of the annual financial statements. Such an approach means that claims
(and potential value) might be missed or picked up too late for a claim to be
brought under the purchase agreement.
10. Notification of claims
A key risk area and an area where disputes frequently arise is the notification of claims. Under many governing laws the failure to strictly comply with such notification obligations both in terms of their timing and their form will result in the seller’s liability being excluded.