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By Joe Liu
In recent years, the mergers and acquisitions (M&A) market has shown steady signs of recovery from the effects of the global financial crisis.
According to a survey of over 1,000 M&A professionals conducted by KPMG, 63% of the survey participants said they were planning acquisitions in 2014. Respondents cited large cash reserves, opportunities in emerging markets, and the availability of credit on favourable terms as the key drivers of deal activity.
Research conducted by Deloitte suggests that a surge in deal activity is set to continue into 2015. 84% of 2,500 corporate and private equity respondents anticipated a sustained pace of M&A activity over the next 24 months. This optimism has been shared by leading law firms, which have predicted significant M&A activity across a wide range of sectors, including financial services, energy, healthcare and TMT.
Arbitration clauses are now a regular feature of M&A contracts, particularly those of an international nature. A trend has emerged of subjecting M&A disputes to arbitration. For example, the EUR480 million dispute between Philips and Funai Electric over a failed sale of the former’s consumer multimedia entertainment business is among high-profile M&A cases where companies have turned to arbitration over a soured acquisition.
In Hong Kong, the number of M&A disputes administered by the Hong Kong International Arbitration Centre (HKIAC) rose by more than half from 2012 to 2013. The actual number of deals that have descended into arbitration disputes can be far higher, as many cases are resolved by ad hoc arbitrations in Hong Kong.
Common disputes in M&A transactions
M&A disputes can arise across the entire spectrum of a deal phase, from pre-closing disputes to post-closing disputes.
M&A disputes commonly arise at the post-closing stage. In this regard, contractual representations and warranties represent a major cause of dispute, as these statements have become increasingly far-reaching. M&A contracts often contain representations that the financial statements of the target company are accurate, complete and prepared pursuant to the applicable accounting standards, that the target has not concluded any non-disclosed material contracts, or that there have been no material adverse changes in the operation of the target.
Conflicts arise if these representations are breached, in which case claims for breach of contract, damages, indemnity and/or rescission are often raised against the seller. Sometimes fraudulent misrepresentation is alleged against the seller. The management of or exit from a investment vehicle (e.g. a joint venture), the competing exercise of put or call options, and shareholders’ claims against directors’ failure to conduct a competitive sale are other common causes of post-closing disputes.
Purchase price adjustment disputes are also a recurring theme. M&A agreements usually provide for post-closing price adjustment mechanisms, as completion can take a significant amount of time after the relevant agreement has been signed. It is common to base purchase price adjustments on future profits or turnover of the target (earn-out provisions). Such provisions, however carefully drafted, are a notorious source of dispute, as difficulties often arise over the interpretation of these provisions (e.g. the applicable accounting principles) and the quantum of the consideration. As substantial amounts of money are usually at stake, parties often try to influence the price adjustment mechanism in their favour.
Conflicts between the parties to an M&A transaction can also arise at any time before the acquisition actually takes place. For example, a dispute may result from one of the buyers’ decision to acquire the target company alone or to withdraw from the transaction. Pre-closing disputes may also relate to breach of the letter of intent, the confidentiality or exclusivity agreement. The non-fulfilment of conditions precedent, such as the failure to obtain necessary governmental permits or the confirmation of the board of directors, often leads to disputes between the parties at the pre-closing phase.
Arbitration as a preferred means of resolving M&A disputes
Arbitration is one of the most commercially effective and pragmatic means by which parties can resolve M&A disputes. It offers a number of significant advantages such as confidentiality, the ability to select a neutral seat of arbitration, to appoint arbitrators who are familiar with M&A transactions, to choose suitable and convenient languages, and to enforce arbitral awards worldwide.
Parties can further enhance the effectiveness of arbitration by selecting the suitable arbitration rules and seat of arbitration, for example choosing the 2013 HKIAC Administered Arbitration Rules (the HKIAC Rules) as the procedural rules and Hong Kong as the seat of arbitration. For the following reasons, HKIAC arbitration is among the most prevalent choices for resolving international M&A disputes concerning high-value and complex matters.
Parties can also choose other alternatives to resolve M&A disputes, such as mediation and expert determination, and these mechanisms can be combined with arbitration. Sufficient attention should be paid to drafting arbitration clauses in M&A contracts, particularly in multi-party and multi-contract situations.
Buyers and sellers should give serious considerations to the possible disputes that could conceivably arise, the choice of arbitration seat and rules, and the interplay between any arbitration clauses in all related agreements. Parties should ensure that their arbitration clauses are tailored to the needs of the underlying transaction(s) and will promote an efficient and cost-effective dispute resolution process.
(HKIAC and Bar & Bench have entered into an agreement to bring to you the latest analysis in the field of international arbitration)
(Joe Liu is the Deputy Managing Counsel at the Hong Kong International Arbitration Centre. As a member of the HKIAC Secretariat, Joe works closely with the team to develop the dispute resolution services provided by the HKIAC and to promote the use of Hong Kong/HKIAC arbitration worldwide.)