Point de vue
Deloitte Forensic: Post-Closing M&A Disputes
Within Deloitte’s End-to-End M&A offering, our experienced dispute specialists can assist either buyers or sellers, as well as both parties jointly, with disputes that may arise during the “Post Close” stage of the transaction lifespan.
In the M&A process, buyers and sellers can spend significant amounts of effort and resources performing due diligence and negotiating a sale and purchase agreement (“SPA”) to reduce post-closing risk exposure. Even with the best of intentions, after the deal has closed, the parties may find themselves in disagreement over certain portions of the SPA.
In our experience, the most common types of Post-Closing M&A disputes arise in relation to the following:
(or Completion Accounts)
Breach of Representations
It is common for acquisitions of privately-held businesses to incorporate a purchase price adjustment following the deal closing to account for the target’s changes in net debt and working capital. Conceptually, these purchase price adjustments are made to compensate the parties for changes in the target’s balance sheet between the i) transaction closing date; and ii) the SPA-defined balance (simply referred to as a ‘peg’).
To calculate such an adjustment, the SPA typically requires the buyer to prepare and submit to the sellers, within a certain time limit post-closing, the target’s balance sheet as of the closing date. Frequently, the SPA will require that the closing balance sheet be prepared in compliance with an accounting ‘hierarchy’. For example, the completion accounts might firstly be required to follow specific accounting policies for certain balances, then be prepared in accordance with a defined accounting standard (e.g., the local generally-accepted accounting principles “GAAP”), and lastly, prepared in a consistent manner with the target’s prior accounting policies. These seemingly simple requirements can create disagreements between the parties. For example, the buyer may correct previously unidentified errors from the target’s prior accounting policies.
The common examples giving rise to a Closing Financial Statement dispute may include:
1. Corrections/changes to the target’s accounting policies
- Allowance for bad debt
- Classification of short-/long-term payables
- Inventory valuation methods
2. Timing of transaction closing date not aligned with typical month-/quarter-/year-end accounting entries
- Bonus compensation accruals
- Employee benefits
- Other missing accruals
3. Introduction of new provisions and reserves
Contingent payment, or ‘earn-out’, clauses can be part of the transaction consideration structure to compensate the seller based on the future performance of the target. Contingent payments are commonplace as they are utilized as a manner to i) bridge differences between the buyer’s and seller’s outlook of the target’s expected financial performance, and/or ii) create financial incentives for the target’s post-closing management team.
Such deal terms are referred to as “contingent payments” because the amount of the payment depends on the future performance of the target, which, as any executive knows, is subject to risks and uncertainties.
A portion of the deal consideration is placed in an escrow account, to be released to the seller if and when the target reaches certain milestones. If such stipulations are not met, then the funds are returned to the buyer.
However, in our experience, contingent payments can lead to disputes arising between the parties post-closing. In the first place, differences of interpretation of the relevant portions of the SPA is the likely starting ground for disputes. Next, similar to disputes involving closing accounts, changes/corrections to the target’s accounting policies can also lead to areas of disagreement. Lastly, and perhaps the most difficult to assess, changes in the direction and management of the target post-closing, which impact the contingent payment, can spawn heated disputes between the parties. Such complexities inherent in contingent payments require trust between the parties while drafting the terms of the SPA as unforeseen circumstances and unintended consequences may come to light post-closing (e.g., economic impacts from COVID-19 pandemic).
Breach of Representations & Warranties
The representations and warranties (R&W’s) embedded within an SPA provide disclosures, and thus risk protection, to both the buyer and the seller. Representations are statements of past and/ or existing facts surrounding the target, while warranties are promises that existing and/ or future facts are, or will be, true. One of the more routine sellers’ R&W’s might illustratively read as follows:
The target’s historical financial statements over the past N fiscal years, provided to the buyer, were prepared in accordance with the LOCAL GAAP, and the target’s books and records are fairly stated in all material respects, and all known material liabilities have been disclosed.
After closing, the buyer, with the rights of control and ownership of the target, along with full access to its books and records, may discover one (or more) of the seller’s R&W’s to be untrue. If this proves to be the case, the buyer may need to i) fully assess whether the seller’s R&W’s were in fact breached, ii) whether damages were incurred by the buyer due to the breach, and iii) if the SPA stipulates whether such damages are indemnifiable by the seller to the buyer (or, perhaps, indemnity is covered by a R&W’s insurance policy).
Such situations can be more complex as the buyer may have to determine whether the R&W’s were presented fraudulently, or merely drafted poorly, and assess which indemnity provisions in the SPA are relevant. Recourse to legal counsel should be considered.
Calculating damages due to the breach usually requires the assistance of forensic professionals who are well-versed in the proper methodologies required, always within consideration of the facts and circumstances. For example, if the breached R&W lead to a permanent impairment of the target’s value, a damages assessment may be more akin to a business valuation than a lost profits analysis.
Once damages have been assessed, the SPA’s indemnity limitations, if any, must be taken into consideration as well.
Key considerations for assessing Post-closing M&A Dispute Situations
Team of experienced experts
The Deloitte Forensic practice in Paris, France has professionals with deep experience assisting parties through post-closing M&A disputes. We are able to assist either party individually develop their stance in an advisory role, serve both sides as neutral financial and accounting experts, or as independent experts to offer an opinion in before a judge/tribunal.
With a team of experienced professionals dedicated to dispute resolution engagements, in addition to the support of our Deloitte network (encompassing transaction services professionals, industry experts, and accounting experts across the globe), we can meet your needs to resolve post-closing M&A dispute matters, in both English and French.