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M&A transactions usually involve not only substantial sums of money but also complex legal and business procedures. Whereas the company seller wants to achieve a maximum possible purchase price and assume low liability risks, the company buyer strives to get a low purchase price and maximum protection against transaction-related risks. Therefore, it is not uncommon that successfully completed transactions are followed by disputes (so-called post M&A disputes).
A good tip for the parties to an M&A transaction is to consider already at the transaction negotiation stage how they can at least minimise the risk of a post M&A dispute if such a risk cannot be entirely eliminated, and how they want to appropriately conduct a dispute that cannot be avoided.
First of all, the contractual parties can reduce the risk of a post M&A dispute by structuring the typical points of dispute in a balanced manner and taking into account the parties’ interests in the company acquisition agreement.
This applies above all to the list of warranties to be granted by the seller, which is mostly at the heart of M&A negotiations. In business acquisition transactions, the statutory provisions regulating warranty for defects of purchased items are usually replaced by a self-contained system of warranties. The basic warranties of the seller include, for example, the legal existence of the target company, the lack of encumbrances in rem on the company's shares or the lack of circumstances indicating that the company is insolvent. Apart from those “standard warranties”, the buyer will strive to obtain warranties specific to the target company and covering the crucial factors creating value for the investment.
A frequent subject of controversy during M&A negotiations is the acceptance of obligations by the seller to indemnify the buyer in respect of identified risks, such as those arising from pending litigation, harmful soil contamination or tax risks related to past events. Finally, standard purchase price adjustment mechanisms or earn-out arrangements, which allow the seller to participate in the company’s profits also after the transaction has been completed, offer sufficient potential for dispute.
In the event of a post M&A dispute, the parties should make serious efforts to settle it through negotiations (out of court). Parties often overestimate their own chances of winning a legal dispute (litigation). A legal dispute not only costs money but also uses up staff and management capacities. Therefore, the option of a mediation procedure to be led by an experienced mediator should not be dismissed too early. If a post M&A dispute cannot be avoided, it can basically be conducted in two ways, namely before an arbitration court or before a common (state) court.
Arbitration tribunals offer the opportunity to settle the dispute without resorting to common (state) courts. Arbitration proceedings are offered, for example, by the German Arbitration Institute (Deutsche Institution für Schiedsgerichtsbarkeit e.V., DIS) or the International Chamber of Commerce (ICC). Advantages of arbitration proceedings are generally considered to include confidentiality and flexibility of procedure. Another advantage frequently mentioned in favour of arbitration proceedings is that the parties can choose the arbitrator as well as the language and place of proceedings. Arbitration proceedings are also a preferred option because they are considered to take less time. Arbitration clauses are popular especially in international transactions. Additionally, arbitration court rulings can in most cases be enforced without significant delay in all countries which signed the UN Convention on the Recognition and Enforcement of Foreign Arbitral Awards of 10 June 1958 (the so-called “New York Conven-tion”). Currently, over 160 states are bound by this international convention.
But also German common (state) courts should not be overlooked as a way to settle a dispute. German regional courts (Landgerichte), especially in the major cities, work mostly efficiently and professionally and have the expertise required to handle complex post M&A disputes. Additionally, Baden-Württemberg and North Rhine-Westphalia have introduced so-called Commercial Courts in which complex international business litigation can be conducted in English language. The fact that a party is entitled to appeal against the judgment issued by a first-instance common (state) court and have the decision examined by a court of appeals may drag out the proceedings, but it may reinforce the trust of the parties in the final decision. In this sense, this can be regarded as an argument in favour of courts of common jurisdiction.
Decisions of common (state) courts on cases involving post M&A disputes are published quite rarely. Recently, the Higher Regional Court (Oberlandesgericht, OLG) of Munich had to decide on a case which is an exemplary illustration of conflicts that may follow a company acquisition.
The plaintiff buyer acquired from the defendant franchise enterprise a company through which the buyer and the seller intended to run a restaurant based on a franchise agreement. In the company acquisition agreement, the seller accepted liability for a valid transfer of shares and for various circumstances (such as preparation of annual financial statements according to the principles of commercial law). However, any further liability, especially liability for the value and profitability as well as for defects in title and quality of the company, was excluded. The plaintiff raised claims for provision of untrue information before signing the agreement and for breach of duty, based on the argument that the defendant had promised daily sales of at least EUR 2,000 in a verbal conversation and had forecast annual sales of EUR 700,000 in an earnings outlook sent to the buyer. The actual sales figures were far below this level. The court dismissed the claim: The agreed quality of the acquired company did not include any specific level of sales or any specific financial position. This could not be changed by the declarations made before signing the agreement. Unless the information provided about the purchase object was mentioned in a (notarised) purchase agreement, such information was not covered by the contractual obligations. No intentional misstatements had been made.
It would have been unusual for the seller to provide warranty for the future development of the company’s business. This is because it is the buyer’s duty to determine the value of the target company as part of a (financial) due diligence audit and to decide on the transaction and, as the case may be, on the purchase price on this basis.
Despite all their confidence in the success of the transaction, the parties should bear in mind the risk of a post M&A dispute as early as in the M&A negotiation phase. The risk of typical controversies (for example, warranties, indemnity, purchase price adjustment) can be minimised by way of transparent and understandable contractual provisions. The seller can also protect himself through standard liability limitations or by taking out W&I insurance. The parties should choose a suitable mechanism depending on the size and structure of the deal (national/international). While arbitration clauses are mostly agreed for large or cross-border deals, courts of common (state) jurisdiction are a good option to choose for the settlement of disputes especially in the case of smaller transactions.
Kai Graf von der Recke, LL.M.
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Transaction advisory | Mergers & Acquisitions
