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26 September 2019
Under the principle of caveat emptor (ie, 'buyer beware'), buyers alone are responsible for checking the quality and suitability of goods before purchasing them. Sophisticated M&A lawyers have long since mitigated this buyer risk through expansive due diligence exercises and tight contractual controls. In particular, M&A deals often feature heavily negotiated representations and warranties, which are designed to provide purchasers with a cause of action against sellers in case of skeletons in the closet. Post-acquisition price adjustment mechanisms are another means for parties to revisit the equilibrium of a transaction after it has closed. This article examines the growth of arbitration as a forum for resolving disputes that arise from these contractual mitigants of risk and the impact of legal technology in this area.
Representations and warranties are statements contained in contractual transaction documents in which the seller promises that certain facts, usually pertaining to the target business and, in particular, its financial and operational health, are true. A common example is: "The company is not involved in any litigation." Where, after closing, such statements turn out to be false, the buyer has a contractual cause of action, which is usually to recover monetary damages.
As corporate lawyers have sought to minimise buyer risk, representations and warranties have become increasingly expansive and are designed to provide belt-and-braces protection to buyers and plug gaps (known and unknown) in their due diligence.
Lawyers on the other side look to protect sellers by including in sale and purchase agreements terms designed to exclude, reduce or carefully delimit their liability, including, for example, through the use of:
Price adjustment mechanisms are another important means for buyers to ensure that they pay only for what they get and that sellers get a fair value for what they sell. Earn-out provisions, for example, subject the purchase price to adjustment post-closing based on some future metric – normally, turnover or profit performance.
Of course, disputes can arise at all stages of an M&A transaction, including before the deal is signed and between signing and closing. At the pre-signing stage, these disputes commonly relate to alleged breaches of the agreements put in place at the nascent stage of the deal – for example:
In between signing and closing, disputes often arise over the non-fulfilment of conditions precedent or other contingent obligations set out in the agreement, requiring procurement of certain outcomes (eg, relevant authority approvals for the deal or putting in place appropriate escrow arrangements).
However, post-closing disputes can often be the most difficult. Although designed to reduce and mitigate risk, representations and warranties and price adjustment mechanisms are themselves a common source of disputes, given that they essentially provide a means for one party to challenge the quantum of the transaction consideration after the event. This can result in a significant shift away from the deal that one party thought it had done, which is a recipe for a bitter fight.
Arbitration has become a prominent forum for the resolution of corporate disputes, including those arising from M&A deals. The London Court of International Arbitration's (LCIA's) 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 disputes arising from such agreements was 21% in 2018 compared with 15% in 2017. By contrast, over the same period there was a 3% fall in the number of disputes involving loan and other debt facility agreements.
One particular advantage of LCIA arbitration in the context of M&A disputes is that the LCIA Rules (unlike some other forms of arbitration) contain an express confidentiality obligation. As a rule, transaction parties often prefer to address disputes over the deal in private – particularly, for example, disputes relating to purchase prices which arise many months after the deal has become public knowledge or the target has been merged with the purchasing entity.
Another attraction of arbitration is the parties' ability to choose their arbitrator, thus tailoring the tribunal's expertise to suit the particular facts at issue. Post-closing disputes, in particular, often centre on factual, accounting or technical issues (establishing whether the warranty was true or whether the price should be adjusted) rather than purely legal issues.
For the same reason, it is also common in an M&A context for the parties to include a provision in their transaction documentation for expert determination, either as a preliminary or parallel step to pursuing claims in arbitration. Although an expert determiner's decision might be contractually binding, they are not enforceable in the way that judgments or arbitration awards are, and so must be the subject of a separate further court or arbitration action if not voluntarily complied with.
There is sometimes a sense that arbitration might have risked becoming a victim of its own success in 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 increasingly complex circumstances. Big-ticket arbitrations are now likely to involve at least the same time, costs and complexities as litigation.
Recent years have seen significant efforts by the leading arbitral institutions to ensure that arbitration remains a flexible and effective forum and to meet other challenges relating to complex corporate disputes.
In particular, M&A deals often do not involve a single bi-partisan agreement, but a suite of transaction documents between multiple parties. This might include the buyer, seller and target company, but also other shareholders, guarantors and even key suppliers, subsidiaries or other stakeholders. As most arbitral rules are written on a bi-partisan basis (ie, claimant versus respondent), arbitration does not appear to readily lend itself to disputes arising from such multi-party, multi-contract disputes, particularly where each transaction document might have its own arbitration agreement. Clearly, such an arrangement runs the risk of multiple parallel proceedings relating to the same set of facts.
Therefore, many institutions – including the International Chamber of Commerce (ICC) – have added clear provisions on consolidation and joinder into their procedural rules. By incorporating such rules into their arbitration agreements, 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.
What is a compatible arbitration agreement and whether there is clear consent from all parties for consolidation or joinder is not always straightforward. 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 the proceedings must be established following normal contractual principles. Therefore, arbitration clauses containing consolidation or joinder provisions are notoriously difficult to draft and generally require either something bespoke and specific or – at the opposite end of the spectrum – something light touch.
Addressing time and cost concerns, many institutions have introduced or clarified rules designed to provide for expedited arbitration, with simplified procedures and restrictive time limits. For example, the ICC expedited procedure rules remove the terms of reference stage and foresee that a tribunal will generally determine the case on paper, on the basis of limited documents and pleadings and without a final evidentiary hearing.
These elements can be tailored and there remains in Article 22 of the ICC Rules both a duty on the tribunal to manage cases effectively and also discretion over how the proceedings are carried out to discharge that duty. This is a duty that extends to the parties to ensure that the proceedings are carried out expeditiously but proportionately. As well as saving time in an appropriate case, the expedited procedure is cheaper. The ICC online costs calculator suggests anticipated arbitration costs are around 20% lower following the expedited procedure versus the standard ICC procedure.
Finally, M&A disputes may require interim measures on an urgent basis, particularly in cases arising between signing and closing (eg, to compel or prevent actions being taken by either party that might affect the target's value). 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 (eg, Article 28(2) of the ICC Rules), 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 such urgent relief in the agreed disputes forum (ie, in arbitration).
These trends underline that arbitration is a preferred forum for resolving corporate disputes.
Like many areas of legal practice, technology is changing the way in which parties approach M&A deals and disputes. For example, law firms are developing a number of legal processes that automate and add significant efficiencies to the management of satisfying conditions precedent, a key stage of completing any M&A deal. As such processes become more standardised in order to be capable of being better managed by computers, the data relating to such matters becomes more consistent. Consistent data sets and machine learning allow for more exciting uses of AI, including useful and error-free data analysis and outcome predictions.
Many M&A disputes turn on accountancy data and the purchase price ultimately paid (and any adjustment thereto) is often linked to the company's accounts or other financial reporting, which is carefully compared with contractual reference dates. At present, 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 on which the expert will be cross-examined in front of a tribunal.
Numerous legal technology tools are already available and used by the best legal and accountancy teams to assist and streamline this traditional approach – including e-disclosure tools that use predictive coding to sort data sets and data visualisation and analytics tools that sort and present such data to the tribunal in the most comprehensive and persuasive way.
However, as the objectivisation of data continues (and particularly as legal technology solutions are increasingly used at the front end of a transaction, as in the case of conditions precedent automation), innovative process-led solutions will increasingly be applied not merely as bolt-on tools that augment a traditional approach to the resolution of disputes arising from such transactions, but 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, increasingly become the product of a computer's reading of the consistent and objective data at the computer's disposal relating to those promises and less about human interpretations of that data.
For further information on this topic please contact James Rogers or Matthew Buckle at Norton Rose Fulbright LLP by telephone (+44 20 7283 6000) or email (email@example.com or firstname.lastname@example.org). The Norton Rose Fulbright website can be accessed at www.nortonrosefulbright.com.
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