This article has been written by Ishika Vijay pursuing Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) and has been edited by Oishika Banerji (Team Lawsikho).
This article has been published by Sneha Mahawar.
Table of Contents
In today’s time, arbitration is sought by the parties as the most common mechanism for dispute resolution, in cases of mergers and acquisitions. Arbitration costs a lot of money but its benefits outweigh the cost, more and more parties are switching to the method of Arbitration has been a progressive contemporary mechanism of the court system as in the process of securing the privacy of the parties involved in the dispute, it provides for speedy disposal of matter thereby securing both time and resources. Alongside this, arbitration makes room for every company whether listed or non-listed, to choose its own arbitrator thereby being more in control, as compared to other methods of dispute resolution. International M&As have become increasingly complex, involving professionalised business transactions, typically consisting of numerous corporate entities and lengthy, multifaceted agreements. Mergers and acquisitions transactions increased in 2018 globally, with announced transaction volumes reaching $4.1 trillion, with growth expected to continue in 2023. This article aims to provide insight on the role of arbitration in managing smooth M&A at an international background.
Why is arbitration chosen as a dispute resolution mechanism in M&A transactions
The increase in the number of mergers and acquisitions taking place also has led to the increase in disputes, whether it was during Pre-closing or at later stages of an M&A deal. Disputes are part of any deal and can take place at any stage,to safeguard the members of the organisation from loss due to undisclosed information, parties reside in arbitration as a dispute resolution method. Some of the prime reasons as to why arbitration is chosen over other dispute resolution mechanisms in case of M&A transactions have been listed hereunder:-
- Firstly it is very convenient for the parties to choose who they want as an arbitrator, someone who specialises in the field. The freedom to choose from both ends makes it a very lucrative option as well.
- Secondly, the court proceedings are usually public and confidentiality is difficult to maintain, arbitration provides the freedom to maintain confidentiality.
- Thirdly in the cases of cross-border transactions, where both countries speak different languages, it is easier to make contracts in their native language and one pre-decided language, for example, English, can be used for conducting proceedings, which is not possible in the court of law.
- Lastly, it provides an amicable and business-like environment than litigation and it also helps in fostering relationships among the enterprises.
Arbitration in cases of international M&A
The importance of arbitration in the M&A sector globally was better felt following the pandemic. Several M&A transactions have been affected by the COVID-19 pandemic with the major sectors experiencing the same being aviation, tourism, retail & clothing and food & beverage. Further, it was in the year 2020 that several transactions failed to see the light of day such as the acquisition of Sycamore by Victoria Secret and the acquisition of Tiffany by LVMH. The latter was on the verge of nearly breaking down and could only be completed after the parties had agreed on a discount of the price per share. Arbitration remains the most preferred dispute resolution means as the complexity in M&A transactions increases.
What type of disputes take place in M&A
Pre-closing disputes, post-closing disputes (including purchase price adjustments), claims over indemnification rights, disputes over representations, warranties, and indemnifications, and shareholder rights are majorly issues that arise in cross-border M&A transactions. Other issues include whether to use international arbitration or expert determination, fraud claims, and disagreements over clauses such as buy-out clauses, call-and-put options, and pre-emption rights. A discussion concerning the same has been provided in the latter part of the article.
An idea about the Reliance, Future Group & Amazon dispute
The dispute which took place between these three groups was amicably solved by the Arbitration centre in Singapore. In August 2020, the Future Group agreed to sell its retail, wholesale and logistics business to Reliance Industries Limited (RIL) for 3.4 billion dollars but it was in 2019 when Amazon had acquired some stake in one of the subsidiaries of Future Group and stated in one of the clause to not sell its assets to the listed companies which were mentioned in the contract to avoid competition.
Amazon argued that this deal violated its right as a shareholder and was to be considered a breach of contract hence the deal could not be done and thereafter took the matter to arbitration in Singapore. In October 2020, Singaporean arbitration ruled in the favour of Amazon, blocking the deal between Future group and RIL. Both RIL and The Future Group brought the matter to the Indian Supreme Court which favoured Amazon and enforced the Singaporean arbitral award. The enforcement of arbitral awards reflects the significance attached to the same and the recognition by India’s Apex Court that has followed. The discussed dispute is an ideal interpretation of the usage of arbitration as a convenient method of dispute resolution in cases of international M&A transactions.
An overview of the dispute between Twitter and Elon Musk
In December 2021, Twitter filed a lawsuit against Elon Musk, CEO of Tesla and SpaceX alleging that he has violated the terms by posting the content on Twitter without taking advice from Twitter’s legal representatives. Musk and Twitter eventually agreed to arbitration to resolve the dispute. The arbitrator selected for the case was JAMS, a leading provider of alternative dispute resolution services.
M&A are considered as strategic business collaborations that form an indispensable part of the corporate world. In the same, it is necessary for the parties involved to have mutually consented upon fundamental terms and considerations in regards to the target’s business before closing the deal. Legally speaking, the dispute between Twitter and Elon Musk which appeared before the Delaware Chancery Court, has given prominence to the contractual nitty gritty that are prevalent in M&A deals with a special focus resting on the Material Adverse Effect (MAE) clause. Speaking categorically, acquisition agreements include clauses that protect the contractual parties’ interests. MAE is such a clause that serves as a ground for the acquirer to end a transaction as a consequence of a materially adverse event as in such case, the acquirer’s commercial interest is said to be in jeopardy.
Musk had further terminated the merger agreement to acquire Twitter by claiming that the latter has made inaccurate representations (especially in relation to fake Twitter accounts), which allegedly resulted in adverse events thereby triggering the MAE clause. Twitter had denied the claims that were raised by Musk thereby challenging the termination. Twitter on its part had contended that Musk’s intentions to walk away from the transaction was because of the market downturn as well as the subsequent fall in the stock price. The present scenario concerning this dispute is known to all of us.
Stages of M&A transactions involving arbitration
Various stages of merger and acquisition transactions where disputes can arise and arbitration can be involved is discussed below.
Due to the pandemic, there have been numerous cases where the agreement has been rescinded due to a violation of this specific clause. Pre-closing covenants basically define how the seller must conduct business between the signing and closing of the deal. For example, suppose company A (seller) enters into a slump sale agreement with company B. (buyer), and it is explicitly stated in the agreement that during the time between the execution and closing of the agreement, Company A must continue to conduct business as usual. Now, if company A transacts differently than before, company B has the right to terminate the contract.
In the recent past, the seller has repeatedly used the pandemic as an excuse to violate the preceding clause. Whereas the buyers regard the seller’s action as a violation of the preceding clause, resulting in a breach.
As a result, there have been a plethora of deals in which the buyers chose the exit route due to such violations on the seller’s end. On the contrary, the sellers make every effort to complete the transaction. In order to settle the dispute, the parties may choose between emergency arbitration and arbitration.
Representation and warranty clauses
These clauses are essentially promises made by both parties to each other regarding past and present facts. And if there is any misrepresentation or breach of the same, indemnification is sought for such breach or misrepresentation. In most cases, misrepresentation allows the buyer to rescind the contract, whereas breach of warranty allows the party to seek damages but does not allow the party to rescind the agreement.
For example, if a seller represents that there is no ongoing litigation involving the land subject to the agreement. However, it is later discovered that the land is in dispute and is on trial. In such cases, the buyer has the option to cancel the contract. In such cases, the buyer may either repudiate the contract or seek indemnification from the seller.
Disputes can also arise between the time of signing and the time of closing the deal, in which case the representation and warranty clause can serve as a closing mechanism through which parties can seek damages for breach of the same.
Clause of indemnity insurance
This clause follows on from the representations and warranties clause. Such insurance has become popular. To summarise, the buyer seeks indemnity from the insurer in the event of a breach of the seller’s representations and warranties. Now, using the same example from the representation and warranties clause, a seller represents that there is no ongoing litigation involving the land subject to the agreement. However, it is later discovered that the land is in dispute and is on trial. The buyer may now seek compensation from the seller.
In such cases, the insurer would obviously prefer to have full access to all available information in order to fully comprehend the risk of indemnifying the buyer. Given the current pandemic situation, insurers will need to be extremely cautious when drafting the agreement. The insurer would prefer to absolve itself of all risks directly related to COVID-19. However, it should be noted that in the event of a default, the request for arbitration will be made to the insurers rather than the defaulting party.
In these cases, the arguments made in the arbitration session are primarily about the technicalities of the insurance policy, which must be determined.
Earn-Out clauses – price adjustment
Purchase agreements frequently state only a provisional price and include open-ended adjustment mechanisms and procedures. Earn-out provisions and purchase price adjustment calculations are by far the most common post-M&A disputes. Earn-out clauses provide for an additional purchase price paid to the seller based on the target’s future earnings over a specified period (earn-out period). When future performance must be evaluated objectively, such clauses may cause disagreement between the parties.
Typical issues include the type of performance indicator to be considered or the seller’s contention that the buyer attempted to “manipulate” earnings, for example, by changing accounting policies or changing the operations of the business after the purchase, making accurate earn-out calculations consistent with the terms of the agreement difficult. The parties’ different cultural backgrounds and accounting or reporting practices may cause additional complications in an international setting.
Based on the foregoing, it is possible to conclude that, despite certain procedural peculiarities and pitfalls to avoid when drafting arbitration clauses, arbitration is an effective dispute resolution mechanism in mergers and acquisitions at all stages of a transaction, with features that make it an appealing alternative to court litigation. Two keys to successful M&A arbitration, both in the domestic and international context. 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 impression they can make on the parties, arbitrators may be decisive in determining the outcome of a case.
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