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.

Read the Full Merger and Acquisition Forecast

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