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.