According to Cornerstone Research’s report of M&A litigationin 2014 (the “Cornerstone Report”), approximately 93 percent of M&A deals valued over US$100 million were litigated. This is a grim precedent to set, particularly as, within the first 3 months of 2015, the value of M&A deals has reached US$811 billion; a rise of 21% comparatively to the same period in 2014. This boom in M&A activity, particularly in the private equity sector, has not been seen since 2007 and it is critical that these deals are not jeopardised by the common and avoidable disclosure pitfalls, writes Georgina Squire, Head of Dispute Resolution at Rosling King.
The most typical disputes tend to involve disclosure that is carried out during an M&A transaction. As it was aptly phrased, “love may be blind, but marriage is a real eye-opener”. The process of disclosure is an integral part of the deal, providing not only information on value, but also allocating risk between the seller and the buyer. This is particularly true for distressed business or loan purchases. In these cases, a disclosure schedule (or disclosure letter) may be the best chance for a buyer to get visibility into key issues. For a seller, a comprehensive disclosure exercise can provide protection from criminal liability, allegations of fraud and actions for misrepresentation. It is therefore of utmost importance that the disclosure schedule and corresponding documents are reviewed critically.
Disclosures generally fall into two separate categories: ‘affirmative’ and ‘specific’. ‘Affirmative’ disclosures are positively required to be disclosed by a seller’s representations and warranties. Under English law, a representation is a statement of fact on which the recipient (buyer or seller)is entitled to rely, and which induced it to enter into, for M&A transactions, a sale and purchase agreement (“SPA”). A warranty, on the other hand, is a contractual promise which, if breached, gives rise to a claim for damages so as to put the innocent party in the position that it would have been in had the warranty been true.
There is usually a period of time between the signing of a SPAand the closing of the deal.Establishing and updating the disclosure schedule directly impacts the risk matrix between the buyer and the seller. Tailoring a disclosure schedule to ensure that a ‘fair’ disclosure is provided raises the difficult question of what information would be deemed material and therefore should be disclosed and what material can and should legitimately be withheld.
A way to avoid the pitfalls associated with disclosure is to involve litigators in an M&A deal. They will look at the issue through the eyes of someone challenging the disclosure at a later date and should be able to give a different perspective to a transaction lawyer.
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The Cornerstone Report clarified that in typical disclosure claimsthe general allegations madeby shareholders relate to material omissions within the deal process, fairness analysis and projections and conflict of interest with respect to directors and/or financial advisors. Many could be avoided if litigators were involved at the early stages of the transaction, rather than after the event, when the problem has surfaced.
Given the complexity and compressed timeframes of most M&A transactions, it is almost impossible to foresee and pre-empt all potential issues but companies who recognise the common sources of disputes and act on them will be more likely in a position to devote core energies to creating value rather than limiting loss.