Few Latin phrases are remembered better by law graduates than “caveat emptor”, meaning “buyer beware”. It is the principle that the buyer alone is responsible for checking the quality and suitability of goods before a purchase is made. Sophisticated M&A lawyers have long since mitigated this buyer risk through expansive due diligence exercises and tight contractual controls. In particular, M&A deals feature often heavily negotiated representations (“reps”) and warranties, designed to provide a purchaser with a cause of action against the seller in case of skeletons in the closet. Post-acquisition price adjustment mechanisms are another means for the parties to revisit the equilibrium of the transaction, after the deal has closed.
In this article we examine the growth of arbitration as a forum for resolving disputes that arise from these contractual mitigants of risk, before considering the impact of legal technology in this area.
Getting what you pay for and paying for what you get
Reps and warranties are simply statements contained in the contractual transaction documents and made by the seller to promise that certain facts are true, usually pertaining to the target business and in particular its financial and operational health. A common example is that: “The company is not involved in any litigation”. Where after closing, the statement turns out to be false, the buyer has a contractual cause of action, usually to recover monetary damages.
As corporate lawyers have sought to minimise buyer risk, so reps and warranties have become increasingly expansive, designed to provide belt and braces protection to a buyer, and plug gaps (known and unknown) in the buyer’s due diligence exercise.
Lawyers on the other side look to protect the seller by including within sale and purchase agreements terms designed to exclude, reduce or carefully delimit the seller’s liability, including for example through the use of disclaimers or exclusions, contractual limitation periods and de minimis and de maximis thresholds for claims.
Price adjustment mechanisms are another important means for the buyer to ensure that it only pays for what it gets and that the seller gets fair value for what it sells. Earn-out provisions, for example, subject the purchase price to adjustment post-closing based on some future metric, normally turnover or profit performance.
Risk mitigation means disputes
Of course disputes can arise at all stages of an M&A transaction, including before the deal is signed and between signing and closing. At the pre-signing stage, these disputes commonly relate to alleged breaches of whatever agreements have been put in place at the nascent stage of the deal: memoranda of understanding, letters of intent and confidentiality agreements, for example.
In between signing and closing, it is common for disputes to arise over the non-fulfilment of conditions precedent (CPs) or other contingent obligations set out in the agreement, requiring procurement of certain outcomes, including relevant authority approvals for the deal or putting in place appropriate escrow arrangements, for example.
But post-closing disputes can often be the most difficult. Although designed to reduce and mitigate risk, reps, warranties and price adjustment mechanisms are a common source of disputes, given that in essence they each provide a means for one party to challenge the quantum of the transaction consideration after the event. This can result for the other party in a significant shift away from the deal that it thought it had done, which is a recipe for a bitter fight.
Arbitration has become the prominent forum for the resolution of corporate disputes, including those arising from M&A deals. The LCIA’s 2020 Annual Casework Report records a continuation of the trend towards increasing numbers of shareholder, share purchase and joint venture agreements being referred to LCIA arbitration. The proportion of total LCIA cases involving disputes arising from such agreements was 20% in 2020, up from 14% in 2019. By contrast there was over the same period a 14% fall in the number disputes involving loan and other debt facility agreements.
One particular advantage of LCIA arbitration in the context of an M&A dispute is that the LCIA rules (unlike some other forms of arbitration) contain an express confidentiality obligation. As a general rule, transaction parties will generally prefer to address disputes over the deal in private. Particularly disputes in relation to purchase price arising potentially many months after the deal has become public knowledge or the target has been merged into the purchasing entity, for example.
Another attraction of arbitration is the parties’ ability to choose their arbitrator, thus tailoring the expertise of the Tribunal to suit the particular facts at issue. Post-closing disputes in particular often centre on factual, accounting or technical issues (establishing whether the warranty was true or whether the price should be adjusted) rather than purely legal issues.
For the same reason, it is also common in an M&A context for the parties to include provision in their transaction documentation for expert determination, either as a preliminary or parallel step to pursuing the claims in arbitration. Although decisions of an expert determiner might be contractually binding, they are not enforceable like a judgment or arbitration award, and so must be the subject of a separate further action in court or arbitration if not voluntarily complied with.
There is sometimes a sense that arbitration might have risked becoming a bit of a victim of its own success in resolving commercial disputes. Having begun life as a shorter, cheaper, alternative process for resolving disputes privately on a bi-partisan basis, its huge growth to become the predominant forum for commercial cases has meant that it has had to evolve to meet the needs of more and more complex circumstances. Big-ticket arbitrations are now likely to involve at least the same time, costs and complexities as an equivalent litigation. Recent years have seen significant efforts by the leading arbitral institutions to ensure that arbitration remains a flexible and effective forum and to meet other challenges in relation to complex corporate disputes.
In particular, M&A deals often involve not a single bi-partisan agreement, but a suite of transaction documents between multiple parties. This might include the buyer, seller and the target company but also other shareholders, any guarantors and even any key suppliers, subsidiaries or other stakeholders. As most arbitral rules are written on a bi-partisan basis (i.e. claimant versus respondent), arbitration does not at first sight readily lend itself to disputes arising from such multi-party, multi-contract disputes, particularly where each transaction document might have its own arbitration agreement. Clearly such an arrangement runs the risk of multiple parallel proceedings relating to the same set of facts.
Many institutions, including the ICC, have therefore added clear provisions on consolidation and joinder into their procedural rules and by incorporating such rules into their arbitration agreement, parties will normally have consented in advance to the possibility of the consolidation of proceedings and the joinder of third parties in disputes arising under compatible arbitration agreements. What is a compatible arbitration agreement and whether there is clear consent from all parties for consolidation or joinder is not always straightforward of course. Although the institutional rules provide a clear procedure for consolidating proceedings or adding parties, including the possibility of joining parties to the arbitration without the need for all parties to consent under the new Article 7(5) of the ICC Rules introduced in 2021, arbitration is still fundamentally a consensual process. This means that despite the procedural tools for consolidation and joinder under the institutional rules, there will still fundamentally need to be an agreement to arbitrate in place between all of the parties to the proceedings. Given the abovementioned considerations, arbitration clauses containing consolidation or joinder provisions are notoriously difficult to draft, generally requiring either something entirely bespoke and very specific, or else, at the complete opposite end of the spectrum, something very light touch.
Addressing time and cost concerns, many institutions have introduced or clarified rules designed to provide for expedited arbitration, with simplified procedures and restrictive time limits. The ICC expedited procedure rules for example does away with the Terms of Reference stage and foresees that a Tribunal will generally determine the case on paper, on the basis of limited documents and pleadings and without a final evidentiary hearing. These elements can be tailored of course, and there remains in Article 22 of the ICC Rules both the duty on the Tribunal to manage the case effectively and also the discretion over how the proceedings are carried out to discharge that duty. This is a duty that extends to the parties to ensure that the proceedings are carried out expeditiously but proportionately. As well as saving time in an appropriate case, the expedited procedure is cheaper. The ICC online costs calculator suggests anticipated arbitration costs are around 20% lower following the expedited procedure versus the standard ICC procedure.
Finally, M&A disputes may require interim measures on an urgent basis, in particular in those cases arising between signing and closing, for example to compel or prevent actions being taken by either party that might affect the value of the target. Although arbitral rules have long since recognised the right of parties to go to a competent local court to obtain such relief on an urgent interim basis (see for example Article 28(2) of the ICC Rules), the introduction of emergency arbitrator provisions to provide interim relief from a promptly appointed sole arbitrator (who is thereafter prevented from acting in the main dispute on the merits), has reinforced the ability of parties to obtain such urgent relief within the agreed disputes forum, that is to say within the arbitration.
The decision of the English High Court in Gerald Metals SA v Timis  EWHC 2327 (Ch) further underlines the shift. The effect of the decision in that case was that by opting the availability of emergency arbitrator relief into the scope of their arbitration agreement (by incorporating by reference institutional rules containing emergency arbitrator provisions), parties are likely to have limited the jurisdiction of the Court to grant that interim relief.
These trends underline that arbitration is the preferred forum for resolving corporate disputes.
Like many areas of legal practice, technology is changing the way that parties approach M&A deals and disputes. For example, Norton Rose Fulbright is developing a number of legal processes that automate and add significant efficiencies to the management of satisfying conditions precedent (“CP”), a key stage of completing any M&A deal. As such processes become more and more standardised in order to be capable of being better and better managed by computers, so the data relating to such matters becomes more consistent.
Consistent data sets and machine learning then allow for more exciting uses of artificial intelligence, including useful and error-free data analysis and, with that, outcomes prediction.
Many M&A disputes turn on accountancy data and the purchase price ultimately paid (and any adjustment to it) is often linked to the company’s accounts or other financial reporting, carefully compared to contractual reference dates. Presently this typically requires an accountancy or valuation expert witness to undertake a forensic exercise, reviewing relevant data and documents, before filtering and analysing the information revealed in order to opine on the outcome of those data and documents in a written report upon which the expert will be cross-examined in front of a tribunal.
Numerous legal technology tools are already available and utilised by the best legal and accountancy teams to assist and streamline this traditional approach – including e-disclosure tools that utilise predictive coding to sort data sets and data visualisation and analytics tools that sort and present such data to the Tribunal in the most comprehensible and persuasive way. This is the advocacy of the now, rather than the advocacy of the future.
However, as the objectivisation of data continues (and particularly as legal technology solutions are increasingly used at the front end of a transaction, as in the case of CP automation), so we will increasingly see innovative process-led solutions being applied not merely as bolt-on tools that augment a traditional approach to the resolution of disputes arising from such transactions, but as genuine alternatives to those traditional approaches. A dispute over whether a condition precedent has been complied with, a representation was true, or a price adjustment is required will, for example, become increasingly the product of a computer’s reading of the consistent and objective data at the computer’s disposal in relation to those promises, and less and less about human interpretations of that data.