2020 M&A Forecast - Buyer remorse: Are the gloves coming off?

We all aim to live without regrets. However,
the last few years have been characterised by
strong competition for assets, high prices, quick
processes and vendor-friendly terms.

As we predicted in our forecast for 2019, this buying
bonanza has led to some buyer’s remorse. Our litigators
were involved in a number of post-acquisition disputes in
2019, an increase on previous years.

We see that trend continuing in 2020, with the following
coming to the fore in particular:

• Warranty claims on the increase: We expect to see
  more warranty claims in 2020. In particular, we expect
  to see claims relating to financial and operational
  performance, contractual breaches, regulatory
  compliance and employee claims (in particular in
  connection with holiday pay). We therefore expect
  purchasers to be much more aware of the warranty
  protection they have, be actively on the lookout for
  potential warranty breaches, and to be much more
  aware of time limits and thresholds.
• More disputes over adjustment mechanisms:
  There will be more attention paid to price adjustment
  mechanisms that are designed to normalise the price
  between signing and completion of the transaction.
  We have already seen attempts to use adjustments
  in much broader ways than the parties may have
  intended. For example, sellers have attempted to use
  the broad catch-all adjustments designed to remove
  the impact of one-off, non-recurring, abnormal,
  seasonal or extraordinary items for a range of items
  which are not truly one-off. We expect this trend will
  continue.
• ‘Sour Grapes’ claims: We expect to see disgruntled
  buyers use warranty and adjustment mechanism claims
  to try and re-value bad deals.

As we predicted in 2019, many buyers have simply
overpaid for assets in recent years and we have seen
buyers try to shoe-horn claims to try and address what
are simply bad purchases. Often this involves holding an
escrow or a deferred payment to ransom, i.e. submitting
claims in an attempt to stop further funds going out the
door on a deal gone wrong. We expect that most of these
claims will ultimately fail, but not before they cause
significant cost, time and stress for sellers.

In all cases, we believe that clear and detailed drafting of
warranties, adjustment mechanisms and earn outs is one
of the best ways to avoid disputes. The more detail that
can be provided in the sale agreement, the less there will
be to fight about.

We were involved in the recent case of Malthouse v
Rangatira [2018] NZCA 621 where the parties disputed
whether an earn out had a particular end date or was
indefinite. The plain wording of the Investment Agreement
had no end date for the earn out and the Court of Appeal
found that the commercial background and context was
insufficient to outweigh the plain wording.

Protecting yourself from buyer’s remorse:

• The first line of defence for buyers and sellers is a
  thorough due diligence process. Legal and financial
  due diligence is important, but we often see that other
  areas get less attention. For example, our view is that
  operational DD is vital but often receives less focus.
• More broadly, there is always greater risk of buyer’s
  remorse if you do not do a full DD process. If you are
  going to pick and choose areas, the most important
  thing is to have a very clear understanding of where
  the risk lies in the target.
• Warranty and Indemnity (W&I) insurance is very useful
  to ensure the buyer has recourse against a dependable
  insurer who can pay out. Sellers can also exit cleanly
  and use funds made from the sale. However, the
  counter-argument is that W&I insurance creates a
  certain level of moral hazard as the sellers effectively
  have no ‘skin in the game’ to do disclosure properly.
• Another option is the use of escrow or hold-backs,
  where funds are set aside to cover claims. If you’re a
  seller you should favour escrow over hold-backs to
  avoid the ‘guilty until proven innocent’ conundrum. For
  sellers, we recommend that there be a clear deadline to
  force buyers to make a claim or lose the escrow.
• Earnouts are useful mechanisms to defer payment
  until certain financial goals are met within a particular
  timeframe. However, earn outs in themselves can be a
  source of litigation if not drafted clearly.