(M)ergers & (A)rbitration: an increasingly popular choice for deal disputes?
International arbitration is frequently viewed as attractive for the resolution of corporate disputes. In this article, we examine the particular use of arbitration in mergers and acquisitions (M&A)-related disputes, summarise the key types of such disputes coming before arbitral tribunals, review some of the potential benefits of arbitration in the M&A context, and identify some trends in this space for 2023.
A rise of arbitration in M&A disputes?
M&A deal activity steadily increased after the Global Financial Crisis of 2008–2009. 2021 was a record year in terms of deal value1, and data shows that deal volumes for years after 2015 were on average roughly 80% higher than those of 2009.2
As we discuss below whether arbitration is chosen by the parties to those deals for the purpose of resolving any disputes will depend on a few factors. However, it would appear that the use of arbitration for the resolution of disputes arising from M&A agreements is on the rise:
- The Stockholm Chamber of Commerce Arbitration Institute (SCC) is one of the few institutions which specifically reports on the number of cases it administers which arise from M&A. Between 2009 and 2022 the number of proceedings commenced each year in the SCC that arose out of “share purchase agreements or company acquisitions” is reported to have trended upwards.3
- The Singapore International Arbitration Centre (SIAC) has reported annual figures for “Corporate” disputes since 2010. Corporate disputes are defined as including “disputes involving joint ventures, asset acquisitions, sale and purchase of shares, mergers and the constitution or dissolution of a company or partnership”. In 2010, 26 such disputes were commenced. In 2021, the figure stood at 66, again reflecting an upward trend in the use of arbitration.
- Further, the Hong Kong International Arbitration Centre (HKIAC) reports “Corporate”4 disputes as being a key and growing component of its caseload since 2011. During the period 2011-2015, an average of 37 Corporate arbitrations were commenced per year: by comparison in the period 2016-2021, this average rose to 55 Corporate arbitrations per year – an increase of 48%.5
- The London Court of International Arbitration (LCIA) only began reporting figures for share purchase agreement disputes from 2016 onwards, and even then, the figures are aggregated with shareholders’ and joint venture disputes. However, consistent with the statistics from other institutions, that metric shows an upwards trend which may in part relate to M&A disputes.6
Although not definitive, the available data seems to suggest an increase in the use of arbitration as a dispute resolution method for disputes arising from M&A. As we explore below, that likely reflects a growing appreciation of the suitability of arbitration for the issues which arise and recognition of the advantages which arbitration can offer.
What is being arbitrated?
M&A transactions give rise to disputes at all stages of the process, from negotiation of the deal to issues arising post-closing. The current geopolitical landscape, paired with recent market volatility, has created uncertainty for parties engaging in M&A activity. This has the potential to act as a catalyst for M&A-related disputes and – by extension – arbitration. Parties may, for example, be searching for ambiguities in the drafting of agreements in order to escape deals post-exchange, to renegotiate purchase price, or to improve their position in completion account disputes. The following are three examples of disputes which typically arise in the M&A context, and which are appropriate for resolution by arbitration.
Warranties, representations, and indemnities
Share purchase agreements and ancillary documentation will include various: (i) warranties (statements of fact as to the existing position of the target); (ii) representations (assertions of past or existing facts relating to the target that induce the other party to enter into the agreement); and (iii) indemnities (allocated risk for specific issues relating to the target identified during due diligence).7 Disputes arise if such statements are false, for example if company accounts have not been prepared accurately, the company has not met stated ESG targets, or fundamentally the target is not worth what the acquirer believed it to be. Failure to disclose such points may result in claims to recover the reduced value of the target. To protect against such risk, parties may take out warranty and indemnity insurance (W&I) and a purchaser may then bring a claim directly against the insurer(s), instead of the sellers. W&I continues to grow in popularity globally, especially in Europe and North America.
Material Adverse Change (MAC) clauses
Where a material adverse change occurs between signing and closing parties (typically the buyer) may rely on contractual provisions to walk away from the acquisition or look to renegotiate the purchase price. MAC clauses act to protect a party against the occurrence of risks in this interim period which are outside of its control. When operating in an uncertain economic environment, parties to M&A deals may be looking to improve their positions by seeking to rely on such a provision (the existence of which tends to be contentious and heavily negotiated). For example, parties may no longer be able to complete a deal, they may struggle to raise the required finance or higher interest rates may result in financing being more costly for purchasers to obtain. Further, if offering equity as consideration, the value of it may have diminished due to economic downturn. Proceedings may arise if the parties dispute whether a qualifying adverse event has in fact occurred. We have seen parties attempting to rely on events such as Covid-19, bank failures or Russia’s invasion of Ukraine as constituting material adverse change. This is increasing focus on the drafting of MAC clauses, with some parties seeking expressly to exclude pandemic, geopolitical conditions such as acts of war, or changes in macroeconomic conditions.
Purchase price disputes
In circumstances where there may well be fluctuations to the assets and liabilities of the target between signing and completion of the transaction, the parties may agree to an adjustment of the purchase price. Determining the calculation of the price adjustment naturally opens parties up to disputes such as how to calculate the adjustment, the categorisation of assets and liabilities and which accounting principles will apply. Alternatively, parties may agree an earn-out whereby, if the target meets certain requirements following a period after closing, the seller will receive additional consideration. Considering the current market volatility, parties may opt to use an earn-out mechanism to ensure that the purchase price is a true reflection of the target’s intended performance. However, sellers often view earn-outs as payments to which they are entitled, whilst buyers take the view that they are simply payments contingent upon certain triggers. Such tensions create an environment for dispute as to whether the agreed triggers have occurred or how the mechanism was intended to work. The determination of price adjustment and earn out related disputes may be complex and require specific knowledge of accounting principles. Expert determination is frequently used to determine values and prices, but the scope for proceedings (whether arbitration or litigation) remains. As explained further below, arbitration allows parties to tailor the tribunal to ensure that those determining the dispute have the requisite expertise.
Contrasting arbitration with litigation as a method of resolving M&A disputes
Various factors will influence commercial parties when considering whether to arbitrate M&A-related disputes. Much will depend on the nature of the asset being sold/acquired and the relative bargaining power (and depth of pockets) of the buyer and seller. The reality is that, like most other contractual provisions, the jurisdiction clause tends to reflect a compromise on the parties’ respective opening (and preferred) positions. Having said that, the following considerations are important.
Arguably the primary advantage of international arbitration is that arbitral awards can be easier to enforce than judgments obtained from national courts. That feature may be particularly attractive in cross-border transactions with multi-national counterparties.
Arbitral awards are generally regarded as easier to enforce globally by virtue of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards8 (the Convention). When an arbitration award is issued in an arbitration seated in a Convention signatory jurisdiction it is capable of being recognised and enforced in any other signatory jurisdiction (of which there are now over 170) in a straight-forward manner (subject to limited reservations/conditions and an exhaustive list of defences). By contrast, the cross-border recognition and enforcement of a national court judgment is, generally, subject to a more complex matrix of law and procedure under the applicable enforcement treaty between the country where the court judgment was issued and the country in which enforcement is sought; the coverage provided by such enforcement treaties is less comprehensive (there may be no reciprocal enforcement treaty in place between two countries) and can be challenging to navigate. In circumstances where it may not be known where enforcement will need to take place, arbitration can provide a degree of valuable security.
For example, if a buyer considers that it may find itself needing to take enforcement action against a seller in a jurisdiction where an English High Court judgment would be difficult (or even just more time-consuming) to enforce, it may prefer any dispute with the seller to be arbitrated rather than litigated before the English courts – provided of course that the prospective enforcement jurisdiction is a signatory to the New York Convention.
Privacy (and confidentiality)
Parties to an M&A transaction may prefer to resolve their disputes privately. Arbitration allows them to do this. Whether, and the extent to which, arbitration proceedings and arbitral awards are private and confidential will depend on the arbitration rules and law of the seat of the arbitration that the parties choose. However, with party agreement it is possible to achieve a high degree of privacy and confidentiality in arbitration (unlike in litigation, where confidentiality is typically granted in only very limited circumstances). Sensitive financial and commercial material may therefore be protected to a greater extent in arbitration.
Selection of the tribunal
In arbitration, the expertise of the tribunal appointed to hear the case can be tailored by the parties to the underlying dispute (unlike in courts, where a judge is simply assigned). An arbitrator with extensive experience of M&A transactions and disputes may more readily grasp the detailed and technical accounting issues which often arise, particularly in relation to completion accounts. The ability to nominate or appoint an appropriately qualified tribunal (which may extend to expertise in the subject matter or sector to which the transaction relates) may significantly limit the risk of an unexpected outcome or an incorrect result. The ability of the parties to provide for a 3-member tribunal with party nomination can also be attractive, affording each “side” of the dispute an opportunity to nominate a tribunal member who they regard as appropriately qualified to hear the matter.
Speed and flexibility
Although the speed of an arbitral process will differ from case to case, parties are typically able to shape and influence the procedure of the arbitration, the timetable for the proceedings and the approach to evidence in a way that they cannot before national courts. Parties can also enquire as to the capacity and future commitments of tribunal members before they are nominated/appointed, so as to ensure their availability will not operate as a barrier to efficient case management, whereas in the courts judges are typically selected without reference to the parties, with cases listed for trial on the first available date taking account of the court’s broader caseload, which can be heavy. In an M&A context, this can be important, even if funds are retained in an escrow account pending resolution of the issues. Parties do not want to wait for years to find out whether they can extract those funds and put them to work. To promote speed, parties may consider excluding from their contracts tiered dispute resolution mechanisms requiring mediation or similar ADR mechanisms which can negate this advantage to arbitration (noting of course that expert determination is a regular feature of M&A transactions, particularly for completion account disputes). Simply because such mechanisms are excluded from the contract that does not mean the parties cannot agree to mediate (even in parallel with an arbitration); and indeed, very often a mediation will have greater prospects of success if the parties come to it willingly at the time it is needed, rather than because of contractual obligation.
Finality of decision-making
A desire for finality of decision-making is closely aligned with that for speed. The prospect of (potentially multiple) appeals spanning years in proceedings before national courts can be very unattractive to commercial parties. The grounds upon which an arbitral award can be appealed will vary depending on the law of the seat of the arbitration in question. However, they are typically far more restricted than is the case with litigation and indeed certain grounds of appeal otherwise available under the law of the seat may be capable of being excluded by agreement of the parties (for example, under section 69 the English Arbitration Act 1996, the parties may agree to exclude the right to appeal an award on a point of law).
Other considerations may lead a buyer or seller to prefer litigation before national courts. Perhaps the most frequently cited are the need to consolidate separate proceedings or join third parties to existing proceedings; and the need to obtain urgent interim/injunctive relief. These considerations are perhaps no longer as determinative of a choice of litigation as they once were. While joinder in arbitration remains broadly a matter of all-party consent, many of the main arbitral institutions’ rules contain provisions permitting consolidation of proceedings, which may be useful for M&A deals involving numerous transaction documents (and it remains open to the parties specifically to agree consolidation provisions in their contracts).9 It is also now generally the case that arbitral tribunals have wide powers to grant interim measures (albeit not relief against third parties to the arbitration); most major arbitral institutions have also introduced emergency arbitrator provisions so that interim relief can be secured very quickly in an appropriate case. In other words, arbitration is increasingly able to provide a forum for the effective resolution of M&A disputes.
Trends for 2023
The current geopolitical landscape will continue to influence M&A-related disputes and permeate many of the trends for 2023.
In the UK and EU, clients have for some time been focused on the impact of Brexit, in particular querying the impact of the UK’s withdrawal from the EU so far as the legal and regulatory regime governing jurisdiction and enforcement of judgments is concerned. While English law will certainly remain a very popular choice for cross-border M&A transactions in 2023 and beyond, there may well be an increase in the use of arbitration as the preferred method of dispute resolution for M&A counterparties, given greater certainty around the enforcement regime that applies to arbitral awards.
As highlighted above, M&A volumes are intrinsically linked to the economy of the day. Economic conditions (e.g., interest rates, inflation, and exchange rates) in most major economies since Q2 2022 have been volatile. The risk of recession looms. In this environment, financial metrics may fluctuate materially during negotiation and between contract exchange and completion. In 2023 we expect to continue to see claims brought by parties looking to rescind or alter terms pre-completion or claims against parties who have failed to complete.
In addition, during the post-Covid M&A boom of 2021, many deals completed quickly, especially in relation to ‘hot’ assets, with less attention paid, in some instances, to due diligence and perhaps the overall disclosure exercise by some sellers. Parties may also have found that the business they acquired in 2021 has drastically altered prospects and may look to review the sale and purchase agreements they entered during the boom times. The prominence of the post-closing dispute – a reflection of buyer’s remorse – is likely to continue (or indeed, take centre-stage) in 2023, further fuelled by economic uncertainty. We expect these disputes will focus on breaches of representations and warranties, claims under indemnities, purchase price adjustments and post-completion mechanics.
1PwC Press Release, M&A reached record heights in 2021 and deal momentum is set to continue in 2022, 25 January 2022.
2Bain & Company M&A Report, Looking Back at M&A in 2022, 31 January 2023.
3SCC Annual Reports (2009-2022).
4HKIAC do not define what “Corporate” disputes include, and the terminology used varies depending on the year (corporate disputes, corporate, corporate/M&A, corporate and finance)..
5HKIAC, Annual Reports (2011-2021).
6LCIA, Annual Casework Reports (2018-2021), Facts and Figures - 2017 Casework Report, and Facts and Figures - 2016: A Robust Caseload.
7Representations are rarely included in English law M&A deals, but in the United States they operate effectively as warranties.
8The Convention on the Recognition and Enforcement of Foreign Arbitral Awards, done at New York on 10 June 1958.
9If the parties are concerned to provide for the ability to consolidate arbitration proceedings arising in connection with different but related contracts, it is advisable to ensure that the arbitration provisions in the relevant documents are consistent.