A major new report into the causes of post-M&A disputes reveals four main reasons why deals end in legal acrimony. Financial advisory firm Accuracy reviewed over 900 claims over a ten year period across a breadth of sectors, to produce the most in-depth, data-driven research of its kind. The report, entitled ‘An Autopsy of cross border M&A disputes’, examines the leading causes of conflict and provides recommendations on how companies can avoid making similar mistakes in the future.
Four key triggers for disputes
All of the disputes covered by the Accuracy report – with values ranging from €5m to €10bn – contained one or more of the following four factors:
- Volatility in the target company’s markets finds its way into the transaction
- Ambiguity in the wording of the sale and purchase agreement (SPA)
- Pressure to acquire and the ‘thrill of the deal’
- Cases of fraud (around 10% of the post deal M&A disputes involve allegations of fraud that are central to the claim)
Volatility, caused for example by sharp movements in the target’s markets or regulatory changes, can lead to disputes because it affects how a final purchase price is determined. If volatility has not been managed effectively the purchaser may end up paying more, or less, than their expectation of value, with a dispute likely to result.
Another common factor in post deal M&A disputes is over ambiguity in the drafting of the SPA. Drafted by lawyers, SPAs contain sections that refer to technical accounting or financial reporting matters, including important representations and warranties. They also contain the accounting policies to be used in adjustments to the purchase price at closing. Ambiguity in drafting therefore often lies at the heart of post M&A disputes because of significant differences in price expectation on the part of seller or acquirer.
The use of a ‘locked boxed’ mechanism, where the price is fixed and the transaction is economically backdated, minimises the risk of a dispute. The research shows that a staggering 80% of disputes reviewed did not use this completion method.
External pressures or the ‘thrill of the deal’ effect also leads to post M&A disputes. This is where acquirers come under significant pressure to do deals, resulting in ‘red flags’ being ignored because it will interfere with the deal being done.
Additionally, around ten percent of the disputes reviewed by Accuracy were subject to fraudulent behaviour resulting from the manipulation, falsification or withholding of important data. Examples include distorted revenues and earnings, manipulation or concealment of liabilities and deliberate incomplete disclosure on financial statements.
Commenting on the research, Heiko Ziehms, a partner at Accuracy said:
“Disputes have many different causes. Each factor alone increases the probability of a dispute meaningfully, but two or more combined increase the risk of litigation or arbitration very substantially. Aspects of target companies’ financial reporting are also far more prone to disputes than others – revenue recognition on long-term contracts is a case in point.
“Some risk factors are comparatively easy to mitigate. For example, acquirers should ensure that the in-house deal-team, the various due diligence teams and the M&A lawyers work closely together at the intersection of their disciplines. Buyers should also consider very carefully where and how volatility could find its way into the purchase price formula and then address these areas for example by using fixed values in the final purchase price calculation.
“Avoiding a dispute is sometimes down to not getting a few words in the SPA wrong or ensuring a single conversation between the M&A lawyers and the financial due diligence team can take place.
“This can save years of litigation and a great deal of money and unnecessary stress.”
Other main findings from the report include:
Balance sheets and disputes
- Over half of disputes were based on working capital-related claims
- Within working capital the largest categories by size are disputes relating to trade debtors (71) and stocks (inventories) (57)
- A third (32%) of the working capital disputes arose due to short-term provision and accruals
Method of disputes
- 57% of disputes were arbitration tribunals
- Almost a quarter (23%) were heard through alternative forms of dispute resolution such as mediation
- And traditional litigation made up just 20% of the claims
Value and size of disputes
- Almost a third of claims is for less than 10 million euros
- 44% of disputes come in at between 10 million euros and 100 million euros
- 15% of claims were valued at more than one billion euros