Gloves off: the M&A disputes landscape

May 2023 | FEATURE | LITIGATION & DISPUTE RESOLUTION

Financier Worldwide Magazine

May 2023 Issue

Despite all efforts to the contrary, global economic and geopolitical turbulence is continuing to have a colossal impact on a range of sectors and industries, with the upshot that corporations are having to navigate around a growing number of flashpoints.

And while 2023 is supposed by many observers to be a period of recovery from the increasingly forgotten but not entirely gone coronavirus (COVID-19) pandemic, this year has instead proved to be consistently gloomy – an uncertain landscape that is testing the resolve of corporations across the globe.

“It seems that uncertainty is the new certainty,” notes Baker McKenzie in its ‘The Year Ahead: Global Disputes Forecast 2023’ report. “As one threat recedes, others emerge. Supply chain disruption caused by the pandemic, along with Russia’s invasion of Ukraine and the energy crisis in Europe, have led to widespread global inflation.

“Central banks have reacted with interest rate rises, bringing to an end the era of cheap money which has existed in many economies since the financial crisis of 2008,” continues the report. “The Organisation for Economic Co-Operation and Development (OECD) predicts annual growth in the world economy of just 2.2 percent in 2023, well below historic trends.”

And with further economic, political and legal headwinds such as digital transformation, labour shortages and credible fears of global recession meaning that corporations do not have troubles to seek, the resulting environment is volatile and thus fertile ground for disputes.

“This is a time of great change, and this change has placed corporations under strain,” adds Baker McKenzie. “Many are renegotiating deals that no longer work in the current environment, forging new partnerships as they adjust operational and business structures, or divesting assets.”

Virtually inevitable

Many areas of business have of course been impacted by the aforementioned headwinds and the M&A environment is certainly no exception, with a rise in disputes among the most notable outcomes.

By way of explanation, following skyrocketing activity in 2021, M&A activity stalled in 2022 amid surging inflation, geopolitical tensions and energy insecurity. Add to this growing macroeconomic concerns combined with outsized valuations that characterised M&A deals, then an increase in M&A disputes was virtually inevitable.

“Prior to the pandemic, the advantages of arbitration had made themselves clear. However, with the number of M&A disputes set to rise, there is little doubt that this trend will gather further momentum.”

Testifying to this contention is Berkeley Research Group’s (BRG’s) ‘M&A Disputes Report 2022: Global Economic Headwinds Impact M&A Market and Drive Disputes’, which confirms that M&A disputes accelerated in 2022 even as deal activity slowed, with the darkening economic outlook expected to fuel a great many more disagreements between transacting parties throughout 2023.

Key takeaways from the BRG report include: (i) the pace of M&A disputes will likely pick up amid continued market volatility and concerns over inflation and a possible recession, as well as geopolitical uncertainty and lingering effects of the pandemic; (ii) financial technology (including cryptocurrency), energy & climate, and traditional financial services are the top-ranked sectors for increased dispute activity; (iii) environmental, social and governance (ESG) disputes are brewing as regulations take shape and businesses strive to meet evolving, multifaceted ESG criteria; and (iv) Europe, the Middle East and Africa (EMEA) is the region expected to drive dispute activity, with strict regulatory regimes and political strife seen as significant disruptive factors.

“Rising concerns around the volatility of markets and political upheaval are influencing M&A deals and dispute behaviour,” states the BRG report. “The dramatic events of the past year – including the energy crisis in Europe and elsewhere, falling stock prices, and real estate market disruptions – have shifted the sectors experiencing the most disputes compared to 2021, when the pandemic effects heavily impacted hospitality, life sciences and technology.”

The BRG report also confirms that macroeconomic concerns are surpassing residual pandemic disruptions as primary M&A dispute catalysts, a trend that dealmakers expect to extend across the majority of 2023, as well as beyond.

Grounds for disputes

Against a backdrop of ongoing global volatility, M&A disputes can emerge for a whole host of reasons and across a wide variety of sectors, with the financial, healthcare, education, energy and technology arenas among those seeing the lion’s share of dispute activity.

Upon inspection, M&A disputes may arise out of the main agreement itself or ancillary agreements – such as letters of intent, memorandums of understanding, confidentiality agreements and exclusivity agreements – and generally fall into two categories: pre-closing and post-closing.

“The signing of the transaction documentation is an important milestone, but it is not the end of the deal,” attests analysis by Aceris Law. “Pre-closing, and pre-signing, disputes may arise when one of the parties (often the buyer) determines that it cannot proceed with the transaction.”

In the estimation of Aceris Law, transacting parties may wish to withdraw from a deal for a variety of reasons, such as: (i) a precondition has not been met; (ii) the financing option for acquisition is no longer available; (iii) the financing option is less attractive; and (iv) the party concludes that prospects will not be met.

“Additionally, parties may breach pre-closing obligations or enter into agreements with third parties, breaching exclusivity undertakings,” suggests Aceris Law. “In such cases, the other party can litigate (or seek an injunction) to force the recalcitrant party to complete the transaction.

“As time is of the essence in pre-closing transactions, it is standard for parties to agree on injunctive relief as remedy for breach in a reasonably short time,” continues Aceris Law. “In this respect, fast-track arbitration or interim measures are commonly envisaged by sophisticated parties in M&A transactions.”

Mitigation

With the current economic and geopolitical landscape presenting a plethora of risk scenarios, it would no doubt be prudent for transacting parties to avail themselves of all available means of mitigation, and there are numerous steps that corporations can take to help reduce the likelihood of a dispute.

As identified in the BRG research report, there are key steps that dealmakers can take to mitigate the risk of a dispute. These include placing a greater emphasis on conducting enhanced due diligence while de-emphasising material adverse change and material adverse effect clauses for sellers, undergoing pre-litigation counselling and investing in litigation preparedness tools, such as establishing a document-retention policy.

“In 2022, more lawyers were counselling their clients to take such preventive actions,” states BRG. “Half of attorneys representing buyers and 62 percent of lawyers representing sellers advised their clients to conduct enhanced due diligence, up from 40 percent and 49 percent, respectively, in 2021.

“We are seeing a clear payoff for market participants that have taken a more tailored approach to their M&A processes and agreements – for instance, by incorporating deal-specific provisions while adhering to often tight transaction timelines,” continues BRG. “Although that does not necessarily eliminate disputes, we are seeing an important benefit materialise that counts in today’s environment: narrower and more defined disputes, despite the real issues faced by the target businesses.”

Arbitration

While the majority of M&A disputes are settled prior to trial – 73 percent in 2022 – those not subject to early resolution must be resolved by other means, with a number of mechanisms, such as expert determination, mediation and arbitration, available for parties to utilise.

It is arbitration, however, that is widely perceived to be the preferred method for resolving an M&A dispute. Indeed, this form of resolution has risen in popularity in parallel to the growth of M&A deals and can cover all the key moments of a transaction, with parties involved in higher value transactions often negotiating arbitration clauses into relevant documents.

According to Aceris Law, arbitration, in the context of an M&A dispute, has a number of major advantages when compared to other mechanisms, as outlined below.

First, flexibility of proceedings. Parties are allowed to organise their proceedings to suit their needs. This is particularly relevant if they wish to combine different methods of dispute resolution in addition to arbitration. Shorter timeframes may be envisaged, as well as the language and the law applicable to the proceedings.

Second, selection of arbitrators with the required expertise. Parties may choose their arbitrators and ensure that they have the necessary knowledge, for instance of M&A transactions, valuation, accounting and corporate law.

Third, a neutral forum for transnational disputes. In the context of cross-border disputes, arbitral tribunals are perceived as more neutral than domestic courts.

Fourth, confidentiality. Confidentiality is one of the most attractive characteristics of arbitration. This is highly important if parties are entering into disputes involving the disclosure of due diligence reports, business plans, tax and financial valuations and other sensitive issues.

Lastly, enforcement of arbitral awards. It is relatively easy to enforce arbitral awards across national borders under the Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention), which is in force in 168 states. This is not the case for most court judgments.

“Time is vitally important in some M&A disputes,” adds the Aceris Law analysis. “In this respect, fast-track arbitrations or expedited procedures are viable options to save time. These mechanisms offer shorter time limits for each procedural step.

“Many arbitral institutions provide for fast-track or expedited arbitrations, although reserved to small values,” continues the analysis. “Alternatively, parties may adopt an accelerated proceeding by simplifying the procedure and shortening the deadlines for submissions in their arbitration agreement itself.”

In addition to the attributes of arbitration, transacting parties also have the option to use the services of an expert witness in some cases. However, the mandate of any expert will depend on the wording of the parties’ agreement.

Future momentum

Without much fear of contradiction, the rise in popularity of M&A arbitration is likely to continue for the foreseeable future. Prior to the pandemic, the advantages of arbitration had made themselves clear. However, with the number of M&A disputes set to rise, there is little doubt that this trend will gather further momentum.

“As the economic effects of higher interest rates and increased energy costs feed through to the wider economy, we expect that buyer hesitancy will increase and performance of recent acquisitions may fall short of expectations,” states BRG.” This period of adjustment is likely to produce an upswing in M&A disputes over the coming years.”

Fraser Tennant