Foreword by Andrew Chilvers
For ambitious companies eager to expand into overseas markets, often the
conventional route of organic business development is simply not fast enough. The other option to invest in or buy a business outright is far quicker but often fraught with unforeseen dangers. And even the biggest, most experienced players can get it badly wrong if they go into an M&A with their eyes wide shut.
If you search for good and bad M&As online the Daimler-Benz merger/acquisition with Chrysler back in 1998 is generally at the top of most search engines on how NOT to undertake a big international merger. Despite carrying out all the necessary financial and legal measures to ensure a relatively smooth deal, the merger quickly unravelled because of cultural and organisational differences. Something that neither side had foreseen when both parties had first sat down at the negotiating table.
These days the failed merger of the two car manufacturers is held up as a classic example of the failure of two distinctly different corporate cultures. Daimler-Benz was typically German; reliably conservative, efficient, and safe, while Chrysler was typically American; known to be daring, diverse and creative. Daimler-Benz was hierarchical and authoritarian with a distinct chain of command, while Chrysler was egalitarian and advocated a dynamic team approach. One company put its value in tradition and quality, while the other with innovative designs and competitive pricing.
Shilpen Savani discussed The Art of Deal Making: Using External Expertise Effectively as part of the Disputes chapter.
What are the most common post-closing disputes in your jurisdiction? (e.g. breaches of representations and warranties, price adjustment issues, tax covenants or fraud.) Do you have any relevant case law to highlight this?
In my experience it is the seller’s warranties within the purchase agreement that lead to most post-completion problems. These are often agreed by sellers in a rush of optimism to “get the deal done” and then later relied on by the purchaser as the basis of claims for breach of warranty and misrepresentation. If dealt with properly, warranties can be used to support a comprehensive due diligence exercise and provide a balanced allocation of risk between the parties. But they are sometimes used by sellers to conceal a problem that they hope will not be revealed until long after the deal is done. They can also be abused by a purchaser seeking to hold the seller accountable instead of undertaking a comprehensive due diligence exercise itself. This can be devastating for sellers if the warranties are backed by indemnities. There also tend to be recurring problems with earn-out provisions for key individuals after the transaction, which are often linked with performance over an extended period. It is normal for a purchaser to retain individuals as part of a deal in order to maintain consistency in the medium term, but the strings that are associated with this can become problematic for both sides. This has been very notable in the Covid-19 era, with economic conditions being disrupted beyond anyone’s projections.
Key individuals can be especially exposed when the same individuals are also outgoing shareholders and the sale value is linked to their performance after completion. This is not only because of the danger of not being able to meet targets (often due to unforeseen circumstances) but also because these individuals are invariably bound by wide-reaching contractual restrictions, which prevent them from leaving and taking up external opportunities in competition with the company. This can sometimes lead to senior executives and the highest performers of a business finding themselves “locked in” and yet unable to play to their strengths.
How would you help in-house counsel shape an M&A agreement to minimise any of the potential disputes mentioned above or aid enforcement proceedings?
It is important to bear in mind that the negotiation of an M&A agreement is essentially an exercise in bargaining power. There is usually one side that can flex financial muscle and it is this party that will start with an advantage. But that is not to say that the purchaser is always able to call the shots. Sometimes the seller is a company with unique assets that are very valuable – especially when the assets are in the form of intellectual property that has either realised its potential or is expected to do so in the future. If there are other buyers in the market, this can sometimes transfer power to the seller.
It is in both parties’ interests to undertake effective due diligence and in-house counsel should resist any temptation to compromise on this. No number of seller’s warranties is the same as knowing the best and worst things about a target business and making an early assessment of these things can be a priceless aid to getting the best deal done – with warranties that are likely to stick and be enforceable against sellers if breached.
Counsel acting for sellers should take care to ensure the purchaser has full access to the business, thus making it harder for post-completion claims to be made on the basis of misrepresentations and or breaches of warranty. As the Latin principle of “caveat emptor” states, the buyer must beware of what they are buying – and a seller should try to avoid accepting one-sided risk that extends beyond the sale of a business in the form of broad-brush contractual warranties and indemnities.
Those advising key individuals who will remain with the business after the sale should be wary of accepting too many strings – both in terms of unrealistic deliverables and post-termination restrictions which could prove very obstructive if things don’t work out as planned after the sale.
If a post-closing dispute does occur, what best practices should in-house counsel follow to minimise cost/reputational damage?
There is always a risk of disputes arising after completion and counsel should provide for this during the contractual negotiations. Agreeing the applicable law and which country’s courts will have jurisdiction for any disputes (preferably stated as exclusive jurisdiction to prevent parallel proceedings) is essential. Where possible, I recommend including a multi-tiered dispute resolution clause which provides a runway for dealing with disagreements and avoids disputes being litigated in open court and the reputational damage this can bring. This may begin with a requirement for the parties to engage in discussions in good faith, then escalating to a formal mediation if necessary. If even this fails, then a binding obligation to proceed to arbitration is worth considering because it offers the possibility of a confidential – and much quicker – resolution than going to court.
If these safeguards are put in place long before a problem arises it will make it much easier for counsel on both sides to navigate a path towards a resolution.
Top Tips – Top Ways To Fully Utilise A Disputes Lawyer During The Deal Process
- Ensure there is an effective dispute resolution mechanism in place.
- Check that any post-termination restrictions applicable to the outgoing shareholders are reasonable (and enforceable).
- If advising the purchaser, ensure that reasonable (and relevant) warranties are sought and backed up with personal indemnities from the seller in case breaches are later revealed.
- If advising key individuals who are going to remain with the business for an earn-out period, check that their deliverables are realistic and that their obligations on exit will not prevent them from thriving elsewhere if this happens sooner than planned.
- Where there are deliverables placed on the seller on an earn-out basis, these should be balanced against clear “earn out protections” requiring the purchaser to ensure the business is properly resourced and will be managed according to an agreed business plan.