Forgot your password?
Please enter your email & we will send your password to you:
My Account:
Copyright © International Chamber of Commerce (ICC). All rights reserved. ( Source of the document: ICC Digital Library )
I. Introduction
Mergers and acquisitions (M&A) consist of two distinct kinds of transactions: a 'merger' combines two or more companies to form a new company, whereas an 'acquisition' (or 'takeover') does not lead to the formation of a new company but is simply the purchase of one company by another. Despite this difference in meaning, the two terms are often used together to refer collectively to all legal transactions leading to the consolidation of companies. The term mergers and acquisitions covers operations that may vary significantly in their nature, content and form, and relate to a company's assets or its shares. For present purposes, the term will be used generically to refer to all of the aforementioned transactions.
The use of arbitration to resolve M&A disputes is common and appears to be on the increase.1 Arbitrations relating to share purchase agreements, shareholders agreements and joint venture and cooperation agreements, which generally underlie M&A transactions, represent a significant portion of the caseload of the International Court of Arbitration of the International Chamber of Commerce (ICC Court). In 2012, they accounted for approximately 16% of the total caseload (121 cases), in 2011 17.7% (141 cases) and in 2010 13.6% (108 cases).
This article is based on a review of a selection of hitherto unpublished ICC arbitral awards rendered between 1995 and 2009 in 49 cases arising out of M&A-related contracts made between 1986 and 2006. Although the awards reviewed are only a part of all awards rendered in M&A disputes during the period in question, they can be considered to constitute a representative sample. They involved parties from 31 different countries. France was the most frequently represented (16.58% of all parties), followed by the USA (10.36%) and the Netherlands (9.84%). Approximately a third of the awards reviewed involved more than two parties (which is consistent with the general trend in ICC arbitration). They concerned a wide range of business sectors including energy, construction, telecommunication, general trade, finance, insurance, metallurgy and the food and pharmaceutical industries. Finally, they covered disputes of varying sizes, with amounts in dispute ranging from some US$ 2 million to more than US$ 400 billion.
This article considers the nature of those disputes and their subject matter with a view to identifying jurisdictional, procedural and substantive issues that typically arise in disputes relating to mergers and acquisitions and how they have been resolved in a selection of cases.
II. The time and nature of the dispute
M&A transactions are often complex and lengthy processes, which may give rise to disputes at all stages. Most of the effects of the transaction, including the transfer of property, are generally reserved until a later stage (the 'closing'), after the fulfilment of certain conditions previously agreed upon, such as the satisfactory completion of a due diligence process on the target company and its assets or the approval or authorization of the operation by a public or private body.
Disputes can arise in relation to the parties' conduct prior to the signing of the purchase agreement, between signing and closing, or in the post-closing phase. Disputes may occur not only between the buyer and the seller, but also, albeit less often, between two or more buyers or two or more sellers where they have regulated their relationship for the purpose of the operation through a contractual instrument such as a joint venture or a consortium agreement.
A. Pre-signing disputes
Disputes arising prior to the signing of the purchase agreement may relate to a preliminary instrument entered into by the parties at the start of their negotiations for the purpose of the main transaction. Examples of such preliminary instruments are letters of intent, memoranda of understanding, heads of agreement, terms sheets [Page21:] and invitations to submit an offer.2 Whether or not they are binding is not always clear and will need to be determined on a case-by-case basis having regard to their contents and to the parties' intentions.
Pre-signing disputes are rarely referred to arbitration due to the absence of a binding agreement and the extra-contractual (or pre-contractual) nature of most of the rules applicable to this phase. Hence, the most common issue to be decided at this stage is whether and to what extent the parties are under an obligation to negotiate in good faith before a binding instrument is executed. In the event of a dispute at the negotiating stage, parties have the option of calling off the deal or continuing negotiations in order to overcome the problems. Even when preliminary instruments do have binding effects, they often do not contain an arbitration agreement as parties may be reluctant to entertain the possibility of disputes when embarking upon negotiations.3
It has been suggested that an arbitration clause will not cover pre-signing disputes unless the clause appears in the relevant preliminary instrument.4 It is not uncommon for preliminary instruments to contain accessory binding obligations, or for parties to regulate their relations during the preparatory phase by entering into binding agreements on such matters as confidentiality or exclusivity, and for these binding instruments to contain arbitration agreements. Any disputes that may arise from the performance of such instruments may therefore be referred to arbitration on the basis of the arbitration agreement they contain. Failing a specific arbitration agreement in the preliminary instrument, it is also possible that an arbitration clause contained in the subsequent purchase agreement may be interpreted as covering pre-signing disputes sufficiently related to that contract.
B. Post-signing disputes
Regardless of the legal effects of the purchase agreement (which in many jurisdictions does not in itself cause the immediate transfer of ownership of the target company), its conclusion creates binding obligations which can be enforced in arbitration pursuant to an arbitration clause it contains.
The period between the signing of the contract and the closing may extend to many months, if not years. This is typically so in contracts whose effectiveness depends on the fulfilment of conditions precedent, such as the issuance of governmental or regulatory permits or authorizations, the delivery of financial statements by the seller, or the absence of 'material adverse changes'. The latter condition is embodied in a clause which usually provides the buyer with the right to rescind the contract if an event occurs that has a significant negative impact on the financial conditions, assets, liabilities or operational results of the target company. Its effect can be compared with that of force majeure and rebus sic stantibus clauses.5
If a controversy arises prior to closing, time is of the essence. The dispute must be resolved quickly to avoid jeopardizing the entire transaction. At this stage it may be uncertain which of the parties will be awarded ownership of the target company, so both parties may have an interest in a rapid resolution of the dispute to avoid the risk of a decrease in the target company's value. Also, to the extent that the proceedings monopolize the financial and human resources of those involved, they may affect the operational capacity of both parties and the target company for a long period of time. Furthermore, as time passes, there is an increasing risk that important documents may be lost and witnesses become unavailable.6 This explains why parties not infrequently opt for 'fact-track' or expedited arbitration, shortening the deadlines for constituting the arbitral tribunal or for completing other phases of the proceedings.
C. Post-closing disputes
Not surprisingly, most of the disputes arising from M&A transactions relate to the post-closing phase when the conditions precedent for the transfer of ownership of the target company are fulfilled, the impact of various circumstances influencing the purchase price becomes known and the buyer is in a position to assess whether the seller's representations and warranties at the closing date are true.
The most common disputes arising out of the post-closing phase are those relating to the determination or adjustment of the purchase price and those relating to the seller's breach of representations and warranties (e.g. with respect to the correctness of the target company's financial statements, the absence of liabilities other than those reflected in the balance sheet, or the seller's compliance with applicable laws and regulations).7 Disputes relating to specific performance of the parties' obligations, in particular the seller's obligation to transfer ownership of the target company, are also not uncommon. [Page22:]
III. Specific issues arising in M&A disputes
Owing to their lengthiness and complexity, disputes arising out of M&A transactions may vary in nature and subject matter, involve numerous claims and relate to obligations under several contractual instruments.
The characteristics of M&A disputes described above are well reflected in the awards reviewed for the purpose of this article. In most cases, the dispute related to the post-closing phase and concerned alleged breaches of representations and warranties (16 cases), price adjustment (15 cases) or specific performance of the parties' obligations under the purchase agreement (five cases). Four awards dealt with conditions precedent and three ruled on the parties' obligations under agreements regulating the framework of their negotiations, i.e. confidentiality and exclusivity agreements. The analysis of these awards has revealed a number of issues which, although not necessarily peculiar to M&A disputes, are relatively common in such disputes. Without claiming to be exhaustive, the following sections look at some of these issues as reflected in the awards examined.
A. Jurisdiction
The various instruments comprising an M&A transaction may contain different dispute resolution clauses, while a single instrument may combine different dispute resolution procedures (typically expert determination and arbitration), the respective scope of which is not always easy to determine. Further, questions may arise with respect to the extension of an arbitration agreement to disputes relating to the pre-contractual negotiation phase. These circumstances may raise jurisdictional issues for the arbitral tribunal to resolve.
Where M&A transactions are based on various instruments containing different dispute resolution clauses, it may be necessary to ascertain whether the clauses are compatible, allowing the claims made under different instruments to be determined in a single arbitration, as is explicitly foreseen in Article 6(4)(ii) of the 2012 ICC Rules of Arbitration:
In all cases referred to the Court under Article 6(3), the Court shall decide whether and to what extent the arbitration shall proceed. The arbitration shall proceed if and to the extent that the Court is prima facie satisfied that an arbitration agreement under the Rules may exist. In particular: […] (ii) where claims pursuant to Article 9 are made under more than one arbitration agreement, the arbitration shall proceed as to those claims with respect to which the Court is prima facie satisfied (a) that the arbitration agreements under which those claims are made may be compatible, and (b) that all parties to the arbitration may have agreed that those claims can be determined together in a single arbitration.
It is also not uncommon for the relevant instruments to contain provisions aimed at coordinating their respective regimes (including dispute resolution) such as an 'entire agreement' clause indicating that the instrument replaces and supersedes all previous stipulations.
M&A agreements frequently provide for expert determination to settle factual or technical issues arising out of the transaction, possibly followed by arbitration for any subsisting disputes.8 Various terms are used to refer to this type of dispute resolution mechanism: 'expert determination' in English law, 'Schiedsgutachten' in German or Swiss law, 'arbitraggio' in Italian law and 'bindend advies' in Dutch law. Expert determination is regarded as a rapid and cost-effective way of resolving technical issues without (or prior to) commencing a fully-fledged arbitration procedure. Even when expert determination does not resolve the dispute, it may be beneficial in clarifying certain factual or technical matters and thereby help to limit the scope of a dispute subsequently referred to arbitration. As it relates to the determination of the parties' contractual obligations, expert determination is often provided for in one of the substantive provisions of a contract rather than in the dispute resolution clause, although it is also found in dispute resolution clauses as a preliminary step in a complex dispute resolution mechanism.
An expert determination is in principle binding on the parties and any subsequent arbitral tribunal, unless the parties agree otherwise or the expert lacks the necessary independence and impartiality, the procedure leading to the expert determination breaches due process, or the expert's determination is manifestly wrong. However, unlike an arbitral award, the expert determination does not have res judicata effects and is not enforceable. [Page23:]
A distinction must be drawn between an expert provided for in the substantive provisions of the contract or in the dispute resolution clause it contains (the 'contractual expert') and an expert subsequently appointed by the arbitral tribunal or by the parties in the arbitral proceedings (the 'procedural expert').9 The task of the contractual expert may be to evaluate items that have an impact on the purchase price (such as the net equity of the target company, the value of its real estate or the amount of earnings for the purpose of price adjustment clauses) or the parties' representations and warranties claims.
Matters referred to expert determination may subsequently be referred to arbitration. This typically occurs if the expert determination is not voluntarily complied with or if the parties question the binding nature of the determination. The coexistence of a clause providing for expert determination and an arbitration clause can cause jurisdictional and procedural complications.
First, arbitration cannot usually be undertaken until the contractual expert has determined the technical or factual matter at issue. Yet, a party may need to seek a preliminary decision from the arbitral tribunal on an aspect of the dispute (e.g. the interpretation of a price adjustment formula contained in the contract, or applicable accounting principles) before commencing the expertise proceedings.10 Once the arbitration proceedings have started, the party may be tempted to sidestep the contractual expert by having the issue determined by a procedural expert.
Second, it is not always easy to demarcate the tasks of the expert from those of the arbitrators. One approach is to list in the clause relating to expert determination the tasks assigned to the expert, leaving the arbitral tribunal with jurisdiction over all other issues.11 However, doubts may remain as to whether the expert is competent to decide on preliminary legal issues such as the interpretation of the provisions relating to price determination in the contract, or the parties' obligations to provide the contractual expert with documents and information required for the expert determination.
Third, the legal effects of the expert determination necessarily affect the jurisdiction of the arbitral tribunal. If the tribunal finds the expert determination to be binding, it will normally confirm it in an award. If it finds otherwise, it will have to make its own determination. Whether and to what extent the expert's decision on legal, as opposed to factual or technical, issues is binding on the arbitral tribunal may be unclear. The arbitral tribunal is usually empowered to reopen legal preliminary issues decided by the expert if additional evidence emerges.
ICC Case 11587 is illustrative of the problems referred to above. The claimant agreed to sell to the respondents all the shares of several companies incorporated in various jurisdictions. The purchase contract provided for two different closing dates, at each of which 50% of the shares of the target companies were to be transferred against payment of 50% of the purchase price, which was subject to adjustment depending, amongst other things, on the determination of the consolidated net equity of the target business. A dispute arose between the parties over the method of determining the price adjustment. The buyers claimed that any dispute relating to the calculation of the price was to be settled by expert determination pursuant to the dispute settlement clause contained in the contract, and requested the appointment of a contractual expert. The seller objected, arguing that the dispute extended beyond mere price determination and covered the buyers' compliance with their contractual obligations with respect to the exchange of documents and information relating to price adjustment. The arbitral tribunal rendered three partial awards dealing with the preliminary issues.
In its first partial award, the tribunal 'postponed' the decision on whether to appoint a contractual expert to determine the matters in dispute relating to price adjustment, as requested by the respondents. It decided to appoint a procedural expert under Article 20(4) of the 1998 ICC Rules of Arbitration to assist it in assessing the parties' conduct with respect to the price adjustment mechanism provided in the contract. In the second partial award, the tribunal endorsed the conclusions of the expert it had appointed and decided that none of the parties had forfeited its rights with respect to price adjustment. Accordingly, the tribunal granted the respondents' claim for the appointment of a contractual expert to assess the accounting issues required for determining the final sale price. In the third partial award, the arbitral tribunal determined the cut-off dates on the basis of which the price adjustment should be assessed. [Page24:]
In ICC Case 11593, the contract provided that the price adjustment determined by the expert would be 'final and binding' save 'in the event of fraud or manifest error'. The buyer alleged that the expert had committed a 'manifest error' when applying the price adjustment formula. The tribunal found that an error had indeed been made and, to decide whether it was 'manifest' (failing a definition of this term in the contract), examined a series of precedents under the applicable (New York) law. It found that, according to the plain and ordinary meaning of the term, an error is 'manifest' if it is clear, obvious and material, i.e. affects the outcome of the relevant determination. The tribunal rejected the respondent's argument that to be 'manifest' the error must be obvious to the expert. In a majority decision, the tribunal concluded that the error in question was indeed 'manifest' insofar as the application of the price adjustment formula by the expert was contrary to the parties' likely intention in drafting the relevant contract provision.
The arbitral tribunal's jurisdiction may be questioned on the basis of a narrow reading of the arbitration agreement, interpreted as excluding disputes not sufficiently related to the contract containing the arbitration agreement.
In ICC Case 13430, a dispute arose over the validity of a 'purchase option' exercised by the buyer on 'option shares' representing 25% of the target company's capital and the determination of the purchase price. The sellers (respondents in the arbitration) counterclaimed for the purchase price on the basis of the contractual price determination formula, pursuant to which the price was to be determined on the basis of the target company's operating income during the three financial years immediately preceding the exercise of the option. The buyer (claimant in the arbitration) contested the tribunal's authority to determine the price, which had allegedly been 'manipulated' by the target company's management prior to the transfer. According to the buyer, the alleged 'manipulations' concerned the relationship between the company's shareholders and the management and, as such, were not covered by the arbitration agreement in the purchase contract. The tribunal decided otherwise, holding that the manipulations related to the purchase contract insofar as they had affected the determination of the purchase price. It therefore upheld its jurisdiction on the basis of a broad interpretation of the arbitration agreement.
If preliminary negotiations fail, a party may raise claims related to the other party's conduct during the pre-signing phase, alleging a breach of pre-contractual obligations or the general duty to negotiate in good faith (culpa in contrahendo) and relying on an arbitration agreement in the negotiated agreement (eventually unsigned) or in one of the preliminary agreements entered into during the negotiations. In this case, the arbitral tribunal's jurisdiction over the parties' pre-contractual liability could be questioned on the grounds of the limited scope of the arbitration agreement. To resolve such a controversy, regard would need to be given to the language of the arbitration clause.
In ICC Case 11789, the tribunal rejected the respondents' objections, and upheld its jurisdiction over the pre-contractual liability claims made by the claimant, finding that the arbitration clause was not limited to claims 'arising out of' the agreement, but extended to all disputes 'in connection with' the agreement. The tribunal rejected the respondents' additional argument that the agreement containing the arbitration clause had expired. Not only did the tribunal find that the agreement had been tacitly extended, but also referred to the principle of the autonomy of the arbitration agreement, as reflected in Article 6(4) of the 1998 ICC Rules of Arbitration:
Unless otherwise agreed, the Arbitral Tribunal shall not cease to have jurisdiction by reason of any claim that the contract is null and void or allegation that it is non-existent, provided that the Arbitral Tribunal upholds the validity of the arbitration agreement.
There may be occasions when parties try to join to the proceedings a party that has not signed the arbitration agreement. It may be the non-signatory target company, a company in the same group as one of the signatories, a signatory of an agreement related to the agreement containing the arbitration agreement, or a guarantor. Disputes may then arise with respect to the extension of the tribunal's jurisdiction to the non-signatory. Conversely, a signatory's status as a party may be questioned, for instance on the grounds that the contract was signed on behalf of another entity. [Page25:]
In ICC Case 10981, the arbitration was initiated by the seller and its parent company against the buyer under an arbitration clause contained in a share purchase agreement. The seller's parent company was a signatory to a related agreement and had guaranteed the seller's obligations under the share purchase agreement. The share purchase agreement referred to the buyer's undertaking 'to procure the release of [the guarantor] from the Guarantee'. The claimants requested that the parent company be released from the guarantee and claimed for damages. The tribunal dismissed the claimants' argument that the guarantor was a party to the share purchase agreement, and then examined the claimants' alternative argument that the guarantor was entitled to bring claims under the arbitration agreement as a third party beneficiary. The tribunal (by a majority) rejected this argument, finding that: 'Neither the wording of the Agreement nor the circumstances when the Agreement was negotiated and drafted clearly proves that the parties to the Agreement [i.e. the first claimant and the respondent] intended for [the second claimant] to obtain an independent right to rely on section 8 of the Agreement.'
In ICC Case 11724, objections were raised to the status as parties of the chairman (respondent 1) and of an entity (respondent 3) belonging to the same group as the seller (respondent 2). The claimant relied on the arbitration agreement contained in the letter of intent signed by respondent 1. In a first partial award, the tribunal decided that the fact that the letter of intent mentioned obligations imposed on respondent 3 was not sufficient to make respondent 3 a party to the letter of intent and to the arbitration agreement it contained, and decided that it did not have jurisdiction over respondent 3. The tribunal considered that a decision on its jurisdiction over respondent 1 required an examination of the merits of the dispute and reserved its determination for the final award. In its final award, the tribunal found that respondent 1 had signed the letter of intent only 'for agreement and acceptance in his capacity of chairman' of respondent 2. The tribunal also rejected the claimant's request to pierce the corporate veil on the basis of respondent 2's alleged abuse of the group's restructuring. It held that the claimant 'failed to establish that [respondent 1] abused the structure of Respondent 2 in the transaction in question' or that the restructuring was aimed at 'depriving Claimant of a realistic chance to enforce its alleged claims against Respondent 2'.
B. Procedure
The bifurcation of proceedings is quite common in M&A arbitrations, where arbitral tribunals often deal with preliminary issues by means of interim or partial awards.
Interim awards can resolve preliminary objections relating to the tribunal's jurisdiction or the line of demarcation between arbitration and expert determination. The arbitral tribunal may also issue a preliminary decision to order a party to comply with a condition precedent to closing, such as the submission of financial statements, notification to public authorities or the provision of a guarantee, or to grant declaratory relief affirming that a condition for the closing has been fulfilled or a preliminary instrument entered into by the parties during the negotiations is binding on them.
Interim or provisional measures can be particularly important in M&A arbitrations as a means of protecting the status quo and preventing a party from acting in a way that may endanger the successful outcome of the operation during its negotiation or implementation.
Conservatory measures can be used to prevent the seller from aggravating the financial situation of the target company before the closing, enforce confidentiality or exclusivity agreements pending finalization of the transaction, enjoin a party to abstain from disposing of the shares of the target, order a party to refrain from calling a bank guarantee issued to secure the parties' obligations under the contract, or require a party to place the purchase price or shares in escrow.12
Alternatively, the measures sought may be of an anticipatory nature and may be aimed at obtaining performance of the parties' contractual obligations, e.g. requiring payment of the contract price13 or taking steps to determine the purchase price.14 As is often the case with interim measures, the nature and purpose of the relief sought may be complex and varied, and may include both conservatory and anticipatory aspects.15[Page26:]
Under the 2012 ICC Rules of Arbitration, arbitrators are empowered to order provisional and conservatory measures pursuant to Article 28(1), which expressly authorizes the arbitral tribunal to issue such measures in the form of an award:16
Unless the parties have otherwise agreed, as soon as the file has been transmitted to it, the arbitral tribunal may, at the request of a party, order any interim or conservatory measure it deems appropriate. The arbitral tribunal may make the granting of any such measure subject to appropriate security being furnished by the requesting party. Any such measure shall take the form of an order, giving reasons, or of an award, as the arbitral tribunal considers appropriate.
In addition to confirming the power of ICC arbitrators to order interim measures on the basis of the above provision, the 2012 ICC Rules of Arbitration have introduced a new means of obtaining urgent relief before the arbitral tribunal has been constituted-the Emergency Arbitrator Provisions. Unlike the ICC Pre-Arbitral Referee Rules, introduced in 1990, which are a separate set of rules whose application requires a specific agreement between the parties, the Emergency Arbitrator Provisions are an integral part of the ICC Rules of Arbitration and are therefore automatically available as a consequence of the referral of a dispute to ICC arbitration. This new procedure is likely to prove particularly useful for M&A disputes, where the need for urgent relief often arises in the course of negotiating or implementing the transaction, prior to the constitution of the arbitral tribunal.17
If the ordering of an interim measure presupposes a finding on the parties' substantive obligations, arbitral tribunals appear reluctant to order the measure before having the opportunity to form at least a preliminary opinion on the merits of the case. In ICC Case 14785, the tribunal dismissed the buyer's request for immediate reimbursement of legal costs incurred to defend itself against third party claims in relation to an environmental warranty. Without even examining whether urgency justified the requested measure, the tribunal held that whether, and to what extent, the sellers were liable to indemnify the buyer for the costs incurred in proceedings triggered by third party claims was disputed, and that 'unless and until the Tribunal determines that, at least to some degree, those costs flow from a breach of the reps and warranties in the JVA', there was no basis for acceding to the applicant's request.
Confidentiality is frequently cited as one of the reasons for choosing arbitration rather than litigation. However, the existence and the scope of a confidentiality obligation binding the parties has become subject to some uncertainty, especially in the wake of several court decisions dating from the mid-1990s onwards that questioned the dogma of confidentiality and emphasized the need to identify the authority for any confidentiality obligation.18 The ICC Rules of Arbitration have never set out an absolute obligation of confidentiality binding on all the participants in the arbitral process. Despite amending the provision on confidentiality in the recent revision of the Rules,19 the new Rules have maintained this approach.
As stated earlier, parties often enter into a confidentiality agreement at an early stage of an M&A transaction or include a confidentiality clause in the preliminary instruments entered into during the negotiations. Any breach of these obligations may be pre-empted by means of interim measures, or may be subsequently sanctioned in an award on the merits. It is not always clear whether the parties' obligation of confidentiality extends to the arbitration proceedings. Considering the uncertainty that still surrounds this issue, parties should draft confidentiality provisions so as to clearly indicate whether, and to what extent, the arbitral proceedings are covered by the duty of confidentiality.
C. Merits
It is very common for parties, when starting to negotiate an M&A transaction, to set out exclusivity obligations, often as part of a broader contractual framework regulating the negotiations. Under an exclusivity arrangement, a seller may undertake to negotiate only with the buyer ('lock-in') or to refrain from negotiating with third parties ('lock-out') over a certain period of time.
Disputes relating to exclusivity provisions typically concern the precise scope of the obligations they create (e.g. whether the seller is prevented from negotiating with any other party, or only with specified parties, during the exclusivity period), the duration of the exclusivity period, the circumstances triggering the seller's liability (e.g. what constitutes 'negotiations' with third parties, or whether the seller's liability is dependent on additional conditions such as the conclusion of an [Page27:] agreement with the third party), or the potential buyer's entitlement to contractual penalties and/or compensation for damages.
In ICC Case 11724, the tribunal rejected the buyer's claim for payment of a penalty pursuant to the letter of intent for breach of the exclusivity obligation. It found that, although the seller had breached its obligation by conducting negotiations with a third party, the shares and assets of the target company were not transferred to the third party during the 'negotiating period', which was a requirement for triggering the seller's liability. The tribunal also rejected the buyer's claims for additional damages, since it found that the payment of a penalty was the only remedy provided in the letter of intent for a breach of the exclusivity commitment.
As stated earlier, the transfer of ownership of the target company may be subject to one or more conditions precedent, including approval by private, public or supranational bodies. When these conditions are not met, disputes may arise with respect to the allocation of responsibility for obtaining such approval and for the consequences of non-approval.
In ICC Case 11789, the parties had entered into negotiations for the purchase of a majority stake in an airline. The negotiations led to a promissory sale and purchase agreement, which was subject, among other things, to merger clearance by the EU authorities and to the target company's continuing eligibility to operate as an airline under EU legislation despite having part of its capital owned by a non-EU airline. As a consequence of the failure to meet the first of these conditions, the buyers withdrew from the transaction, arguing that the lack of EU merger clearance made the agreement inoperative. The sellers argued that responsibility for the failure to meet the condition precedent lay with the buyers, who had allegedly been insufficiently diligent in pursuing EU merger clearance, and requested that the buyers be ordered to perform the promissory agreement or, alternatively, to pay damages. The arbitral tribunal found that the buyers had provided evidence of their efforts to obtain merger clearance. It also found that the sellers had failed to demonstrate that any delay caused by the buyers had affected the EU Commission's decision. Consequently, the claim was rejected.
Claims relating to the alleged breach of the parties' representations and warranties under the purchase agreement are very common in M&A arbitrations. Representations and warranties are statements concerning the legal or factual status of the target company at the time of the signing or closing (or both). Although the expression 'representations' refers to past or existing circumstances, while the term 'warranties' refers to future circumstances, in practice the distinction is unimportant as the two concepts are rarely separated.
Representations and warranties are generally given by the seller, although agreements may provide for a limited number of statements by the buyer, too. Both the subject matter and the scope of representations and warranties vary depending on the characteristics of the target company and the law governing the contract. Parties to international M&A transactions tend to describe representations and warranties in a very detailed manner in an attempt to create an independent legal regime without relying (to the extent possible) on statutory provisions.20 A list of representations and warranties may be attached to the contract as an exhibit. The list of the seller's representations and warranties contained in M&A agreements generally includes: the seller's title to the shares or to the assets being sold; the absence of encumbrances attached to the shares or the assets; the accuracy and completeness of the target company's financial statements covering a specified number of financial years preceding the closing; the absence of undisclosed liabilities; the absence of material adverse changes (or changes specified in the contract); the accuracy and timely filing of tax returns and the timely payment of taxes due; the absence of pending proceedings initiated by tax authorities or threat of such proceedings; the compliance of the target company's activity and premises with applicable laws and regulations, including those relating to environmental protection; and the absence of pending proceedings other than those disclosed to the buyer. [Page28:]
In addition to specific representations and warranties, some M&A agreements also contain the seller's general warranty that it would disclose any circumstance that may have a material impact on the transaction or its terms (so-called 'material disclosure warranty'). In ICC Case 10977, relating to the sale of a cement business, the arbitral tribunal interpreted the provisions that 'all material facts relating to the Cement and Mining Assets have been disclosed to Purchaser in writing' as constituting a proper warranty giving rise to the sellers' liability in case of breach. Failing a definition of 'materiality' in the agreement, the tribunal relied on an applicable statutory provision on hidden defects and held that the provision in question required the sellers to advise the buyers in writing of any facts that would have an impact on the latter's decision to purchase the plant, the amount paid or the acceptance of specific terms of the contract. It concluded that the sellers had breached their obligation by failing to disclose the inadequacy of limestone reserves for supplying the plant.
The mere breach of a representation or warranty generally triggers the seller's liability regardless of its awareness or degree of negligence. The seller's liability is often excluded below a certain minimum amount, reduced by any deductible sum, or capped at a maximum amount. The applicability of such agreed restrictions of liability must be assessed on the basis of the applicable law, which often makes them unenforceable in case of fraud, gross negligence or wilful deceit. To overcome such contractual limitations, buyers bringing claims based on the seller's representations and warranties often try to demonstrate that the breach occurred intentionally or was committed with gross negligence. The relevant standards vary according to the applicable law, but are generally very high, and the burden of proof in this respect, which obviously lies on the buyer, is generally difficult to meet.
In ICC Case 14691, the buyer claimed that the sellers had intentionally breached various representations and warranties concerning, among other things, the accuracy of the target company's financial statements and the absence of undisclosed liabilities. The buyer alleged that, since these breaches were intentional, the sellers' liability was not subject to the cap provided by the share purchase agreement. Alternatively, in the event that the tribunal found that the respondent's breaches were not intentional, the claimant claimed indemnification subject to the aforementioned cap. The tribunal found that the claimant had not reiterated its claim based on intentional breach of representations and warranties against two of the three respondents in the post-hearing submission, and concluded that the claim against them had been withdrawn. With respect to the third respondent, against which the claimant had maintained the claim, the tribunal found that the notion of 'intentional breach' referred to conduct 'less egregious than fraud' but 'more egregious than negligence', which requires a showing that the failure to disclose information relevant to the breach of the representation or warranty was the result of a conscious choice. The tribunal concluded that the claimant had failed to meet the burden of proof in this respect.
In ICC Case 14235, the arbitral tribunal considered the issue of fraud from the perspective of the French legal notion of 'dol'. It distinguished fraud in the negotiation of the contract and fraud in the performance of the contract, and held that only the former was relevant in the context of the representations and warranties given by the seller in an M&A transaction. The tribunal observed that the inclusion of representations and warranties in the purchase agreement does not exclude the relevance of fraud in the negotiation of the contract. It referred to French case law which requires that two conditions must be met to conclude that the seller acted fraudulently, i.e. that it intentionally deceived the buyer and that the fraud concerns something crucial to the buyer's consent to enter into the agreement on the agreed conditions. The tribunal found that neither condition was met in the case and rejected the claim.
As stated earlier, a large number of the awards reviewed concern price adjustment. The disputes often concerned the interpretation of price adjustment provisions in the purchase agreement.
M&A transactions almost invariably set a provisional price, based on a defined method of valuation applied to the target company, which is then subject to adjustment at the closing pursuant to the provisions of the relevant contract. The need to adjust the purchase price arises from the sometimes lengthy interval between the date of signing and the date of closing, during which period the target company's financial conditions may change or new circumstances, unknown at the time of signing (e.g. resulting from the balance sheets), may become known. [Page29:]
The methods of valuation generally used to determine the purchase price can be divided into three broad categories: (i) market standards; (ii) asset-based methods; and (iii) earnings-based methods.21 Market or industry standards generally refer to the target company's capitalization as a basis for valuation. Asset-based valuation methods include various possible criteria for assessing the target company's value, the most common of which are based on the net asset value or other values (e.g. book value, replacement value or liquidation value). As for earnings-based methods, those that are particularly popular are the 'discounted cash flow' (DCF) method, which is based on an estimation of the future cash flows generated by the target company actualized by application of a discount rate, and methods based on EBIT ('Earnings before Interest and Taxes') or EBITDA ('Earnings before Interest, Taxes, Depreciation and Amortization').
The disputes that arise in connection with price determination are often due to a lack of clarity in defining the accounting elements to be factored into the price determination or uncertainty over the valuation standards and accounting principles to be applied in the price adjustment process (e.g. Generally Accepted Accounting Principles ('GAAP') or past practices). There may also be allegations of manipulation of accounts by one or other of the parties (e.g. by artificially increasing or decreasing receivables, liabilities or inventories). Also, the nature and extent of the cooperation expected of the parties during the price adjustment process may be a further source of dispute.
Price adjustment disputes are often complex and highly technical. As stated earlier, the relevant contractual provisions often refer them to expert determination in the first place. In this case, an arbitral tribunal subsequently seized of the dispute may be invited to decide, as a preliminary matter, whether the expert's conclusions are final and binding, and to rule on the merits of the dispute only if the answer is no.
In a partial award rendered in ICC Case 11786, the dispute concerned the validity of the put option exercised by the seller and the price of the shares that were the subject of the put option. Having found that the seller had validly exercised the put option, the tribunal examined the price determination. The relevant contractual provision referred to the 'fair market value of the shares' to be determined by an independent expert on the basis of several listed criteria, including, among others, 'the Company's existing and historical financial performance over the preceding three-year period', 'multiples of relevant financial indicators (i.e. turnover, net profits, cash-flow, net assets) paid for comparable companies in recent merger and acquisition transactions, in comparable countries and industries' and the DCF method. As a threshold matter, the arbitral tribunal noted that the parties were in agreement on the non-binding nature of the expert determination. In determining the price of the shares, the tribunal undertook a detailed analysis of no less than 27 valuation issues over which the parties disagreed, applying criteria listed in the purchase contract and discussed by the parties in their pleadings.
An earn-out is a specific kind of price adjustment based on earnings. Unlike a price adjustment based on net asset value, earn-outs are at least partly subject to the target company's future earning capacity. Earn-out clauses therefore usually contain an element of chance, since the results of the target company are influenced by a variety of factors, not all of which lie within the parties' control.
The rationale behind earn-out clauses is to encourage the seller to continue to contribute to the target's performance after the sale. An economic incentive is created that is directly linked to the achievement of specific targets defined in the agreement ('earn-out targets'). This objective explains why it is quite common for agreements containing earn-out clauses to provide for the involvement of the seller in the management of the target company in the post-acquisition phase. The seller's involvement also serves to protect it against unilateral decisions by the buyer that may affect the company's economic results in the earn-out period. Also, contracts containing earn-out clauses generally provide for the continuity of accounting principles and practices so as to prevent the buyer from manipulating the target company's post-closing results in the reference period (e.g. by increasing investments or adopting practices reducing profit in the short term).
Disputes relating to earn-out clauses often concern the criteria used to assess the target company's performance or the time of payment or currency in which payment is due. In ICC Case 14691, the share purchase agreement provided for an additional price to be paid by the buyer to the seller in the event that the target company met certain earn-out targets. The seller had received an advance on this earn-out portion of the price. [Page30:] In the arbitration initiated by the buyer, the seller raised several counterclaims with respect to the earn-out, in particular regarding: (i) the inclusion of certain recurring credits in the company's accounts; (ii) the time of payment of the earn-out sum; and (iii) the currency in which payment was to be made and the relevant exchange rate. The arbitral tribunal found that the expert determination, which had excluded the recurring credits for purposes of determining the earn-out, was final and binding. It further held that the buyer should have paid the earn-out amount immediately after sending the seller the notice containing its calculation of the amount due. Therefore, the seller was entitled to interest from such date until the date of actual payment. Finally, the advance on the earn-out had been paid in US dollars, while the earn-out was to be paid in Brazilian reais. The tribunal considered that the advance payment could only be credited at the time the main payment became due and payable, and based its decision on the exchange rate as of that date.
IV. Conclusions
The recent economic downturn and the consequent financial instability in which M&A transactions have been concluded are likely to have contributed to the upsurge in M&A arbitrations.
However, world economic conditions only partly explain the popularity of arbitration for resolving such disputes. It is fair to assume (as confirmed by observers and surveys)22 that some of the intrinsic advantages of international commercial arbitration-such as confidentiality, rapidity, the possibility of providing for a procedure tailored to the needs of the particular transaction (e.g. combining mediation, or expert determination, with arbitration, or defining the number and sequence of briefs and the corresponding time limits), as well as the possibility of appointing arbitrators with the required background and professional expertise-make arbitration well-suited to resolving such disputes, especially when they are of a transnational nature. Those advantages are particularly evident in institutional arbitration, which is often chosen for the resolution of M&A disputes.23
1 See G. Kaufmann-Kohler, 'Preface' in G. Kaufmann-Kohler & A. Johnson, eds., Arbitration of Merger and Acquisition Disputes, ASA Special Series No. 24 (2005) [hereinafter ASA Special Series No. 24] at v ('the volume of arbitrations involving disputes arising out of M&A transactions has exploded'). See also Schellenberg Wittmer, Dispute Resolution in M&A Transactions-Arbitration, Expert Determination, Mediation and Other Possibilities to Settle Disputes in M&A Transactions, Newsletter (November 2005) [hereinafter Schellenberg Wittmer Newsletter]; K. Sachs, 'Schiedsgerichtsverfahren über Unternehmenskaufverträge - unter besonderer Berücksichtigung kartellrechtlicher Aspekte' (2004) SchiedsVZ 123 at 124 ('Nowadays, arbitration agreements in international and national M&A transactions are rather the rule than the exception.').
2 See H. Peter & J.-C. Liebeskind, 'Letters of Intent in the M&A Context' in ASA Special Series No. 24, supra note 1, 265.
3 See G. von Segesser, 'Arbitrating Pre-Closing Disputes in Merger and Acquisition Transactions' in ASA Special Series No. 24, supra note 1, 17.
4 Ibid. at 35.
5 See P. Schleiffer, 'No Material Adverse Change' in R. Tschäni, ed., Mergers & Acquisitions (2004) at 54ff.
6 See A. Broichmann, 'Disputes in the Fast Lane: Fast-Track Arbitration in Merger and Acquisition Disputes' (2008) International Arbitration Law Review 143, especially 146. The author also discusses the disadvantages of including a fast-track clause in an M&A contract and concludes that, in pre-closing disputes, 'fast-track proceedings would be suitable, because they provide legal security quickly'.
7 See the General Report on the Survey on Dispute Resolution in International M&A Deals conducted by the Section of Business Law of the American Bar Association (2010) [hereinafter ABA General Report], which reveals that 'the two most commonly litigated issues revealed by the survey are (i) a breach of representations and warranties … and (ii) price mechanism/adjustment . . . The next most frequently litigated issue is earn out, followed by lack of performance by one of the parties, and finally, conditions precedent.' See also C. Borris, 'Streiterledigung beim Unternehmenskauf' in R. Briner, L.Y. Fortier, K.P. Berger, J. Bredow, eds., Law of International Business and Dispute Settlement in the 21st Century, Liber Amicorum Karl-Heinz Böckstiegel (Cologne, 2001) 75.
8 In general on this topic, see K.-H. Böckstiegel, K. P. Berger, J. Bredow, Schiedsgutachten versus Schiedsgerichtsbarkeit, DIS-Series (Schriftenreihe des Deutschen Institution für Schiedsgerichtsbarkeit) 21 (2007). See also B. Gross, 'M&A Disputes and Expert Determination: Getting to Grips with the Issues' in PLC Cross-border Arbitration Handbook (2010/2011).
9 K. Sachs, 'The Interaction between Expert Determination and Arbitration' in ASA Special Series No. 24, supra note 1, 235.
10 See W. Peter, 'Arbitration of Mergers and Acquisitions: Purchase Price Adjustment Disputes' (2003) Arbitration International at 491.
11 For examples of the problems that may arise from clauses which draw an unclear distinction between the respective roles of expert determination and arbitration, see B.D. Ehle, 'Arbitration as a Dispute Resolution Mechanism in Mergers and Acquisitions' (2005) Comparative Law Yearbook of International Business at 299-301.
12 See Final Award in ICC Case 9154 (2000) 11:1 ICC ICArb. Bull. 98; Final Award in ICC Case 14287 in Interim, Conservatory and Emergency Measures in ICC Arbitration, ICC ICArb. Bull., Special Supplement (2011) 74.
13 See the three Interim Awards in ICC Case 8670 (2000) 11:1 ICC ICArb. Bull. 77, where the claimants sought payment of the last three instalments provided for in the share transfer agreement.
14 See the Interim Award in ICC Case 13194 in Interim, Conservatory and Emergency Measures in ICC Arbitration, ICC ICArb. Bull., Special Supplement (2011) 72, where the respondent requested the tribunal to issue an interim award authorizing an independent analyst to issue a price determination and report.
15 See the measures sought by the claimant in ICC Case 8879 (2000) 11:1 ICC ICArb. Bull. 84.
16 The corresponding provision in the 1998 ICC Rules, applicable to most of the awards reviewed for the purpose of the present article, was Article 23(1).
17 See Article 29 and Appendix V to the Rules. See also N. Voser & C. Boog, 'ICC Emergency Arbitrator Proceedings: An Overview' in Interim, Conservatory and Emergency Measures in ICC Arbitration, ICC ICArb. Bull., Special Supplement (2011) 81; M.W. Bühler, 'ICC Pre-Arbitral Referee and Emergency Arbitrator Proceedings Compared' in Interim, Conservatory and Emergency Measures in ICC Arbitration, ICC ICArb. Bull., Special Supplement (2011) 93. For other examples of interim measures ordered in M&A arbitration proceedings, see ICC Case 8411 (2000) 11:1 ICC ICArb. Bull. 75; see also the UNCITRAL case reported in G. von Segesser, supra note 3 at 43.
18 See Esso Australia Resources Limited and Others v. The Honourable Sidney James Plowman (Minister for Energy and Minerals) and Others, High Court of Australia, 7 Apr. 1995 (1995) Arbitration International 235; Bulgarian Foreign Trade Bank Ltd. v. Al Trade Finance Inc. , Swedish Supreme Court, 27 Oct. 2000 (2001) XXVI Yearbook Commercial Arbitration 291.
19 See Article 22(3) of the 2012 ICC Rules of Arbitration.
20 See R. Tschäni, 'Post-Closing Disputes on Representations and Warranties' in ASA Special Series No. 24, supra note 1, 67.
21 H. Peter, 'Arbitration of Mergers and Acquisitions: Purchase Price Adjustment Arbitrations' in ASA Special Series No. 24, supra note 1, 55 at 56-57.
22 See ABA General Report, supra note 7. See also B.D. Ehle, supra note 11 at 288-290.
23 See Schellenberg Wittmer Newsletter, supra note 1. See also ABA General Report, supra note 7 at 8 ('When asked whether clients tend to favour institutionalized arbitration systems, such as ICC and LCIA, as opposed to ad hoc arbitration in international M&A, the response clearly favoured institutionalized arbitration.').