Author: Layan Al Fatayri*
| Jurisdictions: | Topics: |
I. Introduction
Merger & Acquisition (M&A) are considered challenging commercial transactions, particularly when they occur across borders and include several corporate entities and lengthy detailed agreements.
From a corporate perspective, M&A transactions are defined as the merging of two companies in a given business field, which results in the development of the market economy. All M&A transactions involve several stages and methods that may result in disputes between the parties, especially when such transactions take place cross-border. For example, a company in a given country can be acquired by another company from another country, known as a foreign investor, which will result in the combination of the assists and liabilities of both companies into one legal new entity.
These high-volume cross-border transactions may raise disputes between parties from a legal aspect including the issues related to due diligence, parties’ contractual obligations, breach of pre-closing obligations, breach of post-closing stage concerning representations and warranties, and adjustments to the purchase price, in addition to several other possible issues.
Due to the effect these high-volume cross-border transactions have on the economy, international arbitration emerges as the most preferable method to regulate these transactions and solve the disputes that arise from them in a quick, efficient, and confidential manner. In today’s society, with the increasing number of M&A transactions worldwide, arbitration is the most popular alternative dispute resolution method used by the parties to resolve their disputes arising from M&A.[1] Arbitration provisions are now considered essential in M&A agreements. For instance, there have been a number of well-known M&A disputes in which businesses have gone to arbitration over a bad acquisition, such as the €480 million lawsuit between Philips and Funai Electric over a botched sale of the former’s consumer multimedia entertainment division.[2]
Despite other forms of alternative dispute resolution mechanisms or the possibility of resorting to litigation, studies have shown that parties prefer arbitration to solve their disputes arising from M&A transactions. According to the CMS European M&A Study 2022, which provides information about the M&A market and the use of arbitration to settle conflicts arising from M&A transactions. This study, which includes more than 400 share and asset transactions throughout Europe for which CMS offered advice, has demonstrated the most recent developments in M&A dispute arbitration. It shows that, despite a minor decrease of 1% in 2021 (33% of the transactions contained such clauses in 2021 and 32% in 2020), previous years have shown a continuous rise in the number of arbitration clauses. In the past eleven years (2010 – 2020), when arbitration use averaged 33%, its present popularity as a dispute settlement method is still very close to that of its long-term popularity.[3]
This increase in cross-border M&A transactions and the increased use of arbitration as a mechanism for solving disputes arising from these transactions highlights the importance to understand the role of International Arbitration as a chosen dispute resolution mechanism in M&A transactions and its use in the Pre-closing and Post-closing stages of M&A transactions as an alternative to litigation.
II. Arbitration as a Chosen Dispute Resolution Mechanism in M&A Transactions
Arbitration is one of the most practical and economically efficient ways for parties to settle M&A issues. With the increased number of M&A conflicts, and in order to protect parties from loss due to withheld information, parties use arbitration as a dispute resolution process. The practice has also shown that most M&A parties prefer and agree to use arbitration as the chosen dispute resolution mechanism and as an alternative and more preferred mechanism when compared to litigation. Klaus Sachs, a well-known German arbitration specialist, wrote that “nowadays, arbitration agreements in international and national M&A transactions are rather the rule than the exception.”[4] Therefore, the advantages that arbitration provides to parties and the important role it plays in M&A transactions compared to litigation should be addressed and highlighted.
First, arbitration offers parties an impartial and efficient dispute settlement tool. This is especially useful in cross-border M&A deals because parties may be from different legal systems with varying laws and regulations. In other words, arbitration provides a neutral forum for resolving disputes to parties from different legal systems who are hesitant to litigate in a foreign court system, which can be especially useful in international M&A transactions where parties can choose the location of the arbitration and the applicable law, thereby avoiding potential bias.
Second, arbitration can also provide greater privacy and anonymity than court-centric litigation processes. It is therefore particularly useful in M&A deals involving sensitive information and trade secrets. This advantage can help protect the reputation of the parties and companies involved in the dispute and avoid public scrutiny of their disputes.
Third, arbitration can be more flexible and adapted to the individual interests of the parties than court processes, providing for more efficient and cost-effective dispute settlement. Arbitration allows parties to tailor the process to their specific needs, including selecting arbitrators with expertise in M&A transactions or a specific industry. This can help ensure that the dispute resolution process is efficient and relevant to the issues at hand, especially when dealing with a dispute arising from a high-volume M&A transaction that includes complicated business issues.
Fourth, the enforceability of arbitration awards is generally stronger than litigation court judgments. Under the authority of the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, arbitration facilitates the recognition and enforcement of arbitration awards across international borders. It can thus provide parties with greater certainty and predictability when entering into cross-border M&A transactions.
Fifth, arbitration affords the parties in cross-border M&A significant autonomy. In contrast with litigation, where judges are appointed by the state, in arbitration parties benefit from the ability and opportunity to choose and select arbitrators that have the experience and knowledge in the raised dispute to issue a fair and impartial decision based on the facts and evidence presented. Not only do parties benefit from the ability to appoint arbitrators but also to choose the language in which the proceedings will be conducted. This advantage is especially significant in international cross-border disputes, since the language in litigation would be determined by the jurisdiction.
Sixth, in arbitration, parties have the ability to choose the scope of document production, which increases efficiency by limiting time and expenses. By contrast, in litigation, the scope of documents is in the hand of the court, which can lead to a more expensive and time-consuming process for parties.
Seventh, in arbitration, the rules of evidence and the extent to which witnesses and experts can be cross-examined can be negotiated by the parties. This permits parties to put the evidence offered by the other party for evaluation, potentially leading to a more accurate and fair decision. On the other hand, the standards of evidence are frequently decided by the court in litigation, and cross-examination may be limited or forbidden.
Finally, arbitration gives parties additional procedure freedom and the chance to seek innovative approaches. The terms of the arbitration, including the locations, duration, and use of technology, can be agreed upon by the parties. This can result in a more efficient procedure since parties and witnesses will spend less time and money on travel. While in litigation, courts have their norms and regulations which parties don’t have the full authority to modify them.
Notwithstanding the benefits that arbitration offers to parties, there are several factors that parties should cautiously consider when selecting arbitration as a dispute resolution process in M&A transactions.
The wording of the arbitration provision is the most significant factor that parties should consider. A clear arbitration clause in the M&A agreements is required for parties to benefit from the advantages of arbitration and to use arbitration as the method for resolving disputes arising from high-volume cross-border M&A transactions. Arbitration provisions should be prepared in a clear and straightforward manner, indicating the scope of disputes subject to arbitration, the choice of arbitration rules, the applicable laws, and the language of the processes. Since the arbitral rules selected create the normative basis for the arbitration process, it is critical for parties to choose arbitration rules which are established, recognized, and regularly used in cross-border transactions. The parties should also carefully evaluate the choice of law that will govern the contract and any complications that may emerge. This is especially important in international transactions, where different legal systems and cultural norms may apply. The choice of law will have an influence on the contract’s interpretation and enforceability, as well as any substantive legal issues that may emerge in any dispute.
Additionally, the selection of arbitrators, enforcement of arbitral awards, and the costs arising from such proceedings are also considerations that parties should examine. Parties should carefully assess possible arbitrators’ qualifications and previous experience, especially in cross-border M&A transactions. The arbitrators must be knowledgeable in the relevant legal and commercial issues, as well as any cultural differences that may occur during the arbitration process. Parties should also examine the expense of arbitration in comparison to other dispute resolution mechanisms, including litigation. While arbitration can be less expensive than litigation in some situations, there are costs connected with the selection of arbitrators, the administration of the arbitration, and the preparation of evidence and arguments that should be considered by parties.
To sum up, arbitration enjoys several advantages that parties benefit from when choosing arbitration as a dispute resolution mechanism in M&A transactions, while at the same time requiring parties to carefully evaluate the above-mentioned considerations. But what are the uses of arbitration in the Pre-Closing and Post-Closing Stages of an M&A Transaction?
III. Arbitration In the Pre-Closing and Post-Closing Stages of M&A Transaction
As laid out above, in M&A transactions disputes, especially cross-border ones, arbitration is usually the most preferred dispute resolution mechanism parties can refer to. Yet its use may differ whether it is applied at the pre-closing or the post-closing stage of the transactions.
A. Pre-Closing Stage
At the pre-closing stage, the use of arbitration in solving disputes may arise from the due diligence phase, the negotiation phase of the purchase price, and the representations and warranties.
- Due diligence Disputes:
Due diligence is the process of conducting a high-level examination and investigation of the company, its assets, and financials before proceeding with the business transactions.[5] M&A transactions usually start with due diligence investigation aimed at assessing the target company’s business, along with its legal and operational aspects. Following this evaluation, parties may sometimes break the deal and decide not to continue with the acquisition process based on the unexpected results of this evaluation, and disputes may therefore arise. Arbitration as a chosen dispute resolution mechanism can provide the parties with the opportunity to solve their dispute in a faster, more flexible, and more confidential manner than litigation, protecting their sensitive information and allowing the parties to modify the procedure to their particular needs.
- Purchase Price Dispute:
Even after parties agree on a purchase price in the purchase agreement, sometimes due to the results of the due diligence evaluation and the legal, financial, and operational aspects of the target company, parties may adjust the purchase price resulting in disputes between them. Disputes at this phase may arise over the calculation of the adjusted purchase price. Arbitration at this stage of the M&A transactions can be an advantage for parties since it provides an opportunity for parties to determine a suitable solution more quickly than litigation without risking the transaction.
- Representations and Warranties Disputes:
These disputes may arise as a result of one party’s breach of the fundamental representations and warranties made and declared by them concerning various aspects of the target company and the transaction. For such disputes, arbitration may be the advantageous mechanism that parties can use in order to help them solve their disputes to be able to continue further with the transaction.
Overall, arbitration at the pre-closing stage can assist preserve the deal by offering a faster and more effective way of resolving disputes than litigation. This allows the parties to maintain their business relationship and proceed further with the transaction.
B. Post-Closing Stage
At the post-closing stage, we will address the use of arbitration in solving disputes that arise from the Earnout and the adjustments in the purchase price, and integration and synergy disputes.
- Earnouts Disputes:
Earnouts are the mechanism that parties use in order to calculate the price payable by the buyer with respect to the assets and shares under acquisition along with the performance of the target company business after the acquisition date. The purpose of the Earnout provision is to bind the sellers to the target company for a certain period and encourage them to continue driving the organization’s success after the sale. However, if parties could not decide on the calculation of the Earnout amounts and in order to avoid any delay in completing the transaction, using arbitration as a dispute resolution mechanism will provide the parties with the opportunity to solve their dispute in a more efficient manner than litigation that might resort parties to a more lengthy and costly judicial process.
- Purchase Price Disputes:
Purchase price disputes are common in the post-closing phase of M&A transactions. The adjustment of the purchase price provisions is highly seen during this stage, especially in high-volume cross-border transactions. Disagreements on the purchase price at the post-closing stage affect the time and could affect the attention of the owners whom the buyers are relying on to operate the company. Therefore, arbitration provides parties with a more effective and efficient dispute resolution mechanism than litigation, which often entails a more lengthy and costly judicial process.
- Integration and Synergy Disputes:
Post-closing disputes may also arise over issues related to the integration of the target company into the acquiring company or the realization of synergies. Arbitration can help resolve these disputes, allowing the parties to focus on realizing the full value of the transaction.
We can deduce, arbitration can be useful in settling disputes in both the pre-and post-closing stages of M&A deals. It may enhance the parties’ working relationship, assure adherence to the agreed-upon conditions, and ease the transaction’s balance conclusion.
IV. Conclusion
Based on the above-mentioned, we may conclude that arbitration is seen as an efficient dispute resolution mechanism in M&A transactions, with advantages that make it a more desirable and preferable process to M&A parties than litigation. The arbitration mechanism may be an efficient dispute resolution tool in M&A agreements, providing benefits such as confidentiality, efficiency, and flexibility. Therefore, while structuring M&A agreements, parties should carefully analyze the consequences and requirements of arbitration and customize the procedure to their individual needs. While arbitration may be beneficial in cross-border M&A transactions, parties must carefully consider the effects and use of arbitration at the pre-closing and post-closing stages of M&A transactions when disputes may arise.
* Layan Al Fatayri holds an LL.B. from the Université La Sagesse with honors and further acquired her master’s degree (LL.M.) from the Université La Sagesse with honors. Layan is completing her Ph.D. studies in International and European Law focusing on International Commercial Arbitration and Cross-border Commercial matters at the University of Debrecen, Hungary, Europe. Layan worked at several professional institutions including the UNHCR and participated in several international legal conferences. Layan is also a member of Young ICCA, an organization functioning under the International Council for Commercial Arbitration, the Hungarian Arbitration Association, and the Australian Center for International Commercial Arbitration.
[1] Öcal, Zeynep, (2019), Arbitration of Mergers And Acquisitions Problem Of Consent In Parallel Proceedings And Consolidation Of Parallel Proceedings.
[2] Liu, Joe, et al. “Arbitration of Cross-Border M&A Disputes.” Kluwer Arbitration Blog, 20 Apr. 2015.
[3] “The Rise of Arbitration in Post M&A Disputes.” NOW.
[4] Sandeep K Bohra, “Role of ADR in Merger and Acquisition.” Share and Discover Knowledge on SlideShare, https://www.slideshare.net/lucent51/role-of-adr-in-merger-and-acquisition.
[5] LexisNexis. “Due Diligence: What You Need to Know?”