Introduction
M&A transactions are often at the center of business events. Both through success stories but also through recurring disputes. Now, all parties involved want the deal to work and no (legal) problems to arise, but M&A is nevertheless an area with the highest proportion of arbitration agreements.[1] This is not surprising, as transactions are already complex almost by definition. Very often, countless parties are involved, also from several countries. The importance of post-M&A arbitration was fueled by the Covid-19 crisis, as many contracting parties still tried to find a way out of deals or looked for a way to reopen negotiations.[2] But what disputes and problems arise, and why does arbitration enjoy such popularity, especially in the field of M&A?
Potential disputes in M&A
Representations and warranties
Representations and warranties are often at the heart of share purchase agreements (SPAs) and thus also the subject of arbitration proceedings.[3] These two kinds of clauses set the limits of the seller's liability, i.e. for what concrete condition (e.g. in which condition are the manufacturies) of the target company the seller is liable.
The biggest impact of the COVID-19 interruption has been on representations and warranties concerning business operations and continuity. This is because, for example, some business relationships were damaged (customer base as a motive for purchase), as well as third-party debts or the collectability of receivables. Such clauses will thus trigger some future arbitration proceedings.[4]
Fraud and pre-contractual failure to disclose
In arbitration proceedings following M&As, it is increasingly common for a buyer to bring a claim for fraud or similar conducts because the seller failed to disclose information. Such claims are usually based on the seller's intentional withholding of critical information from the buyer during pre-contractual negotiations that, if known, would have had a significant impact on the buyer's valuation of the target.[5]
Earn-out clause
Earn-out or other price adjustment demands have enjoyed increasing popularity in recent years.[6] What is an earn-out clause? An earn-out clause links the purchase price of a target company to its future performance. Thus, the final purchase price depends on how it is structured and on future performance. This is calculated based on previously agreed KPIs (Key Performance Indicators). The background of an earn-out clause is that it creates a common field of interest, whereby the seller is also interested in the company's success after the sale. In this way, he does not take actions that improve the balance sheet, for example, but damage its long-term.[7]
Without doubt, earn-out clauses through COVID-19 are a minefield for potential disputes. For instance, it will be disputed whether the thresholds have been met. Thus, the calculations underlying the sale will often be thwarted by earnings disruptions, which will also cause the business valuations of buyer and seller to diverge enormously, making disputes more likely.[8]
Procedural particularities of Mergers and Acquisitions-related arbitrations
In the context of M&A arbitrations, a variety of procedural issues have regularly emerged.
Multi-Party and Multi-Contract Disputes
Multi-party scenarios or multi-contract structures frequently result in M&A-related arbitrations, particularly on the buyer's side.[9] This raises concerns about the arbitral tribunal's composition, particularly considering equal participation, i.e. each party's power to nominate its "own" arbitrator.
In light of the well-known 1992 Dutco decision of the French Court of Cassation, which stated that "forcing multiple defendants to jointly appoint an arbitrator is against public policy," most modern arbitration institutions' rules, such as the ICC[10] and LCIA Rules[11], now provide adequate solutions to solve this practical problem, consistent with the principle of equal treatment of the parties. It may therefore be sufficient to insert model clauses of such institutions into agreements in transactions involving many parties and/or several contracts.
Another crucial consideration is if the parties agree to hold parallel proceedings to avoid contradicting decisions[12].
Extension of Arbitration Agreements to Third Parties
Lawyers who handle M&A arbitrations are regularly faced with the question of whether the procedures should be extended to third parties who have not signed the arbitration agreement. This is especially problematic when dealing with group company structures and transactions. Since there are so many different scenarios, unlike in multi-party conflicts, the rules of national and international arbitration tribunals rarely provide any direction. On the one hand, non-signatories can be added to a contract through a variety of legal theories, such as legal succession or letters of comfort. However, because many arbitral courts are hesitant to extend arbitration to third parties on these grounds, it is prudent to spell out exactly which parties are bound by the arbitration agreement and have them all sign it.
The question of whether an arbitration agreement can be extended to other companies in the same group is contentious.[13] The "corporate veil" can be "pierced" if the other group company:
(1) actively participated in the execution or termination of the agreement;
(2) can be regarded as the "actual" party to the agreement; and
(3) has its own peculiar economic interest in the contract, according to the "group of companies doctrine" developed in the famous French case Dow Chemical Firms et al. v. Isover Saint-Gobain.
In other European countries, such as Switzerland and Germany, however, both courts and doctrine rejected this notion as being incongruous with the parties' purpose and the principle of privity of contract.
Production of Documents
Given the complexities of the factual basis in M&A arbitrations, it may be beneficial to allow for substantial evidence gathering (e.g., witnesses and expert opinions). Document requests may generate confidentiality issues and necessitate specialized procedures, especially when the organizations involved are competitors, because much of the information involved is typically "sensitive".[14]
In any case, the role of discovery in international arbitration is largely determined by the rules of the arbitral institution chosen, as well as the domestic procedural rules of the arbitration venue or, in the case of ad hoc arbitrations, the provisions of the arbitration agreement as written by the parties. In recent years, the very divergent techniques in Civil and Common Law nations have been harmonized to the point where international arbitrators now employ a more limited type of discovery.
Remedies Awarded
Arbitrators in M&A disputes may be called upon not only to determine on the amount of a price adjustment or to award damages to the prevailing party, but also to modify the award to match the needs of the particular case, more so than in other arbitrations. If the applicable substantive law and the site of enforcement allow it, this may include performance awards or the formation of new arrangements between the parties, such as buy/sell options.[15] If a company's nature has changed since the arbitration proceedings began, the relief originally requested may become obsolete.
Drafting arbitration agreements in the Mergers and Acquisitions context
Given the variety of sources for M&A-related conflicts, as well as the procedural peculiarities discussed above, it takes some skills to create "water-tight" arbitration agreements that meet the standards required for an effective dispute resolution mechanism. In practice, an additional danger arises from the fact that transaction lawyers preparing M&A agreements may not always be sufficiently versed with arbitration law and/or may only deal with the arbitration clause as an "afterthought" just before closing, failing to give it the attention it deserves.[16]
Even though they rarely include a provision for multi-party conflicts, the court-tested model clauses of the more renowned arbitration organizations have proven themselves in the majority of cases[17]. Selecting such a clause will eliminate the need for lengthy provisions and provide the parties with some assurance. Once the procedure is underway, the parties and arbitrators can still customize it to their specific needs.[18]
Changes to the model clauses must be thoroughly thought out. They should be crafted in close collaboration between transactional and arbitration lawyers to ensure that they "fit" the unique dynamics of a particular transaction. As previously stated, the unambiguous delimitation of scope between expert determination and arbitration is a critical issue.
Conclusion
The conclusion drawn from the foregoing is that, despite some procedural peculiarities and pitfalls to avoid when drafting arbitration clauses, arbitration is an effective dispute resolution mechanism in mergers and acquisitions at every stage of the transaction, with features that make it an appealing alternative to court litigation. We have analysed the three most frequent cases that give rise to arbitration following an M&A transaction. in particular, guarantees given in the SPAs, earn-out clauses and pre-contractual omissions by the seller. To conclude, there are two keys to successful M&A arbitration, both in the domestic and international contexts: first, the careful drafting of an effective arbitration agreement, preferably done jointly by transactional and arbitration lawyers, or the considered selection of a model clause of a well-known arbitration institution; and second, the selection of the right experts, whose know-how and professional background can be crucial at the negotiating table.
[1] Drude, Post-M&A Arbitration and Joinder: Process and Drafting Considerations for M&A Transactions, SchiedsVZ 2017, 224; Sachs, Schiedsgerichtsverfahren über Unternehmenskaufverträge, SchiedsVZ 2004, 123. [2] Born/Angelini, Arbitrating post-M&A disputes: a look forward, Financier Worldwide Magazine, https://www.financierworldwide.com/arbitrating-post-ma-disputes-a-look-forward#.Ybxb8C9XaqC. [3] Drude, SchiedsVZ 2017, 224. [4] Vannieuwenhuyse, The Rise of M&A Arbitration, Kluwer Arbitration Blog, http://arbitrationblog.kluwerarbitration.com/2021/04/06/the-rise-of-ma-arbitration/. [5] Vannieuwenhuyse, The Rise of M&A Arbitration, Kluwer Arbitration Blog, http://arbitrationblog.kluwerarbitration.com/2021/04/06/the-rise-of-ma-arbitration/. [6] Ehle, Arbitration as a Dispute Resolution Mechanism in Mergers and Acquisitions, Comparative Law Yearbook of International Business, 295. [7] Born/Angelini, Arbitrating post-M&A disputes: a look forward, Financier Worldwide Magazine, https://www.financierworldwide.com/arbitrating-post-ma-disputes-a-look-forward#.Ybxb8C9XaqC. [8] Vannieuwenhuyse, The Rise of M&A Arbitration, Kluwer Arbitration Blog, http://arbitrationblog.kluwerarbitration.com/2021/04/06/the-rise-of-ma-arbitration/ [9] Bernard Hanotiau, Complex- Multicontract- Multiparty Arbitrations”, 1998 [10] Art. 10 of the ICC Rules [11] London Court of International Arbitration Rules, Article 8 ("Three or More Parties) [12] Klaus von Schlabrendorff, Arbitration in M&A - Multiparty Situations and Inter-Omnes Effect, 2001 [13] Otto Sandrock, The Extension of Arbitration Agreements to non-signatories: An Enigma Still Unresolved, in Corporations, Capital Markets and Business in the Law , 2000 [14] Axel Baum, "Drafting of Arbitration Clauses and Organization of the Arbitral Procedure in the Area of M&A", in Tagungsbeitrtige zur DIS-Vortragsveranstaltung "Schiedsgerichtsbarkeit bei M&A", 2001 [15] Wolfgang Peter, "Arbitration of Mergers and Acquisitions: Purchase Price Adjustment Disputes", Arbitration International, 2003 [16] Axel Baum, "Drafting of Arbitration Clauses and Organization of the Arbitral Procedure in the Area of M&A", in Tagungsbeitrtige zur DIS-Vortragsveranstaltung "Schiedsgerichtsbarkeit bei M&A", 2001 [17] See id [18] See id
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