How often do disputes arise in M&A transactions, and when those disputes arise, how much is at issue? Liberty Global Transaction Solutions (GTS), one of the largest and most experienced merger and acquisition insurance teams in the market, addresses these questions and provides insight into the issues that underlie those disputes in its 2022 claims briefing.
Liberty GTS reported that, based on its historical claims data, about one in five M&A deals will result in a dispute, and about one in ten disputes will involve a claim that exceeds $10 million. Common issues and current trends in M&A disputes are discussed in more detail below.
With that dispute frequency and size in mind, buyers and sellers should consider how to best reduce their litigation risk. This article discusses two available options: strong dispute resolution provisions in deal documentation, and insurance.
How M&A Disputes Arise
In M&A transactions, disputes often arise from events that are either unanticipated or anticipated but considered unlikely to occur. Some common examples include a third-party claim received as the M&A transaction is closing, unexpected accounting, financial or tax-related issues, or unusual target company performance post-closing that affects the seller’s earnout. These unexpected or unlikely events lead to arguments over who should bear their impact.
Buyers and sellers should be aware of both common types of disputes, such as “buyer’s remorse” or deal valuation changes, and disputes that may arise more frequently in the turbulent post-COVID economy.
Accounting and financial-related issues account for nearly 30% of high and medium severity disputes that Liberty GTS has seen. Examples of the issues driving these disputes include revenue recognition, the capitalization of expenses and the failure to write off obsolete inventory.
Liberty GTS also expects to see an increase in certain types of claims in the current economy, including:
- undisclosed price increases as inflation remains high;
- undisclosed customer incentives used during the pandemic to retain customers;
- inventory issues and supply chain risks;
- errors in quantifying total accounts receivable;
- fraud claims due to economic pressures; and
- cyber activities.
How Buyers and Sellers Can Reduce their Litigation Risks
While there is no way to ensure that a dispute does not arise during the course of an M&A transaction, buyers and sellers can take steps to reduce the risk that a dispute will lead to protracted and expensive litigation and reduce the cost implications of any such litigation.
One example of an approach that reduces the risks of lengthy and costly litigation is including dispute resolution clauses in M&A transaction documentation. Properly crafted dispute resolution clauses provide opportunities for early business resolutions and require that unresolved issues be determined via private arbitration, avoiding the slow-moving and public court system. Learn more about the benefits of dispute resolution clauses in “Reduce Litigation Risk for Your M&A Deal with Dispute Resolution Clauses”.
Another example of an approach to reduce risk is insurance. There are several types of insurance that may be available for M&A transactions, including representation and warranties insurance (commonly referred to as “reps and warranties insurance”), tax indemnity insurance and contingent liability insurance. Reps and warranties insurance covers financial losses arising out of breaches of the reps and warranties in the purchase agreement (subject to standard exclusions). While reps and warranties insurance has historically only been economical in deals valued at $30 million or more, in the current market, insurers like Liberty may cover deals as small as $10 million subject to customary buy-side due diligence. BFL CANADA, a leading broker of transactional risk insurance products, also reports that the softening of the broader M&A market has compelled underwriters to target smaller deals. For example, underwriters are offering lower limit options, streamlined processes for smaller “tuck-in” acquisition strategies and providing sell-side policies for deals starting at $250K in enterprise value. Learn more about reps and warranties insurance in "A Case for Representations and Warranties Insurance in the Canadian Lower Mid-Market".
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