Legal remedies (or legal consequences) play a key role in M&A disputes. In many cases they are the most crucial and contentious element of the dispute. Whether in an asset- or share deal, disputes can arise in relation to several stages of an M&A transaction. There can be pre-signing issues, issues that are attributable to the period between signing and closing, and post-closing disputes. This chapter provides an overview of the most important legal remedies in M&A disputes.
Civil law or common law remedies versus contractual remedies
The core of every M&A transaction is nothing but a sales contract, albeit a fairly large and complex one – the sale and purchase agreement (SPA). Over recent decades, deals have become increasingly international or in many cases even truly global – a trend that is not only expected to continue, but also to grow. Against this background, any legal remedy under the applicable national sales law can apply to an M&A transaction in theory. Naturally, both the prerequisites and legal consequences of remedies will be defined under the applicable law, which – depending on the specific requirements of the transaction – is often not in the parties’ best interests. Transaction parties therefore usually aim to agree on an exclusive set of bespoke contractual legal remedies for their M&A contract (to the extent that this is possible under the applicable national law). Parties to complex M&A transactions, often coming from different jurisdictions and cultures, usually have a common interest in establishing a stand-alone regime with predictable conditions and outcomes. This has led to an international ‘best practice’ of legal remedies in M&A transactions. Therefore, this chapter does not provide a comparative analysis of civil law or common law remedies in specific jurisdictions, but rather gives an overview of the most important contractual legal remedies, which usually play a critical role in M&A contracts and disputes. Local differences between the most important jurisdictions are covered by the geographic survey in Part II of this Guide (see in particular the Sections on ‘Grounds for M&A arbitrations’ and ‘Remedies’.)
Overview of the most important contractual remedies in M&A disputes
The possibilities for agreeing on contractual legal remedies in an M&A contract are virtually endless, and there are a vast range of such remedies in practice.
In theory, unwinding of the contract or avoidance of the transaction are possible, for example on the grounds of intentional misinformation. In practice, however, these and all other remedies leading to rescission or reversal of the transaction are in most cases extremely difficult – or even impossible – and therefore only rarely requested (and in some jurisdictions even unknown). Hence, the most common remedies are (money) damages or indemnification.
The most common legal grounds for damages or indemnification in M&A disputes include the following:
Representations and warranties
One of the most common reasons why M&A transactions give rise to disputes are misrepresentations and breach of warranties. Representations and warranties are contractual promises by the seller that particular statements are true. M&A agreements usually contain statements on the details and characteristics as well as the economics of business and operations of the target company, expressed as a fact. A typical statement might be: ‘The target company is currently not engaged in any litigation.’ If this statement turns out to be false, the contract provides recourse against the seller – usually by facilitating the recovery of monetary damages, but possibly also by obliging the seller to provide compensation in kind for what has been warranted.
The contractual regime for misrepresentations and breach of warranties is usually intended to be exclusive, replacing the general law, and (unlike the law in many jurisdictions) often provides for the seller’s strict liability. Conversely, to satisfy the seller’s interests, M&A contracts often contain disclaimers or exclusions of liability, as well as limitations of liability and stricter limitation period regimes than set out in the law.
A typical clause dealing with breaches of representations and warranties could be:
If one or more representations or warranties are incorrect and/or incomplete, then the buyer is in each case entitled to demand, at its choice, from the seller that the warranted situation be restored or damages be paid. In the event of damages, the seller, at the buyer’s choice, must pay to the buyer or the company that is affected by the incorrect or incomplete warranty the amount that is needed for restoration of the warranted situation, and/or for compensation of other losses of the company.
While representations and warranties cover unknown risks with a view to establishing a specific risk-allocation between seller and buyer for the period until signing or closing, known risks – which the seller has disclosed or the buyer has identified in the course of its due diligence exercise – are typically covered by indemnities. On this basis, the seller must reimburse the buyer for any damages and costs in connection with a specific risk if such risk materialises in the aftermath of a transaction. A typical indemnity might read:
The seller must indemnify the buyer against all costs and liabilities in relation to the following litigation matters.
Given that these risks are already known, indemnities are typically not subject to the same limitations as representations or warranties. In particular, any limitation periods will differ and be tailored to the specific risks. At times, however, indemnities foresee specific risk (i.e., cost) sharing elements or a sliding scale for the seller’s indemnity obligations.
Purchase price adjustments
To prevent the actual cash or debt position of a company influencing the agreed enterprise value and to eliminate any deviations in the working capital levels because of the day-to-day operations of a target company, purchase price adjustment mechanisms are regularly agreed between the parties.
Typical post-closing adjustment provisions focus on liabilities and assets of the target company that fluctuate as a result of current business operations between the time the parties agree on a purchase price and the actual closing of the transaction, which can be months later (if no such fluctuation was likely to occur, the parties could agree on a fixed price in the first place without any need for an adjustment mechanism).
Disputes in this area can arise because the parties interpret valuation and calculation methods differently. The resolution of such disputes often requires external accountancy experts.
Earn-out clauses are a special way of adjusting the purchase price, in particular to close any valuation gaps. An earn-out is a contractual provision stating that the seller of a business is to obtain additional compensation in the future if the business achieves certain key performance targets, which may be defined as a fixed amount or a percentage of gross sales or earnings. They can come into play when valuation of the target according to standard valuation methods leads to a comparatively low purchase price (at least from the seller’s perspective), for example because the target does not have any material assets. Another reason for an earn-out clause can be to incentivise the seller to achieve a good management performance if selling the company but remaining in the operational business to provide know-how or management expertise.
Earn-out clauses also are one example where the typical roles in an M&A dispute of the buyer as claimant and the seller as respondent might be reversed. This is because earn-outs only have to be paid when certain conditions have been met. There are cases where the buyer argues that the seller’s conduct prevented the occurrence of an event or events giving rise to the earn-out claim. An example could be the (from the seller’s point of view) premature shutdown of a certain part of the business that makes it impossible to achieve certain goals that would trigger an (additional) payment under the earn-out clause.
Pre-contractual failure to disclose information
Another source of potential disputes can be pre-contractual failures to disclose relevant information to the buyer. Therefore, disclosure schedules form an integral part of many M&A transactions. Disclosure schedules contain material information relating to the SPA and typically list important contracts, intellectual property, employee information and other material matters as well as exceptions or qualifications to the detailed representations and warranties of the selling company contained in the acquisition agreement. An incorrect or incomplete disclosure schedule can result in a breach of the SPA and potentially significant liability of the seller.
In this context, information provided in letters of intent (LOI) or memoranda of understanding (MOU) can sometimes become relevant. Material differences between the LOI or MOU and the final SPA are, however, very common. This is because usually there will have been intense negotiations between the signing of the LOI or MOU and the SPA during which virtually every aspect of the transaction might have been discussed and therefore every aspect (including obligations to disclose information) might have changed significantly. Therefore, violations of obligations to disclose certain information arising from a LOI or MOU on the one hand and from the SPA on the other can have different prerequisites and legal consequences. Likewise, however, the LOI or MOU can be an important document in an M&A dispute in determining the correct interpretation of certain clauses in the SPA. In this context, the existence (or lack) of obligations to disclose information in the LOI or MOU might provide an indication of whether the respective obligation can be read into the SPA. In any event, and more generally, LOI and MOU are often very important documents when it comes to understanding and reconstructing the history of the transactions and consequently to interpreting the legal remedies clauses in the SPA.
Other disputes typically arise in connection with hidden – if not deliberately concealed – material information. Hidden material information is information that would be crucial when deciding to buy or at least when evaluating the target company, but that is not disclosed. If the seller conceals such information intentionally or fraudulently, particularly strict legal remedies can come into play. The scope of bona fide disclosure duties of the seller varies greatly among jurisdictions, and parties therefore need to pay particular attention to this aspect.
Another critical issue can be the attribution of knowledge: the question of which employee’s or director’s knowledge will be attributed to the seller. The parties often attempt to spell out this issue contractually in advance. However, mandatory law may limit the parties’ latitude to restrict the attribution of knowledge.
Material adverse change (MAC) clauses
Another common feature in M&A contracts are material adverse change (MAC) or material adverse effect (MAE) clauses. These are clauses aimed at giving the buyer the right to walk away from the acquisition before closing if events occur that are seriously detrimental to the target company. At the same time, MAC clauses prevent the seller from backing out. A typical MAC clause might define a MAC as:
any event, circumstance, fact, change, development, condition, or effect that, either individually or in the aggregate, has had or could reasonably be expected to have a material adverse effect on the business, financial condition, results of operations, or other aspects of the business of the target and its subsidiaries, taken as a whole.
Interestingly, MAC clauses are usually the subject of much negotiation in the course of an M&A transaction, but rarely end up in a legal dispute.
Fault and causation
Under civil and common law, legal remedies usually require fault and causation in addition to the other prerequisites of a legal remedy. Parties to M&A contracts often exclude fault as a condition and agree on strict liability instead (see above).
Causation, however, will always play an important role. As a breach of certain clauses of an SPA is never enough to trigger the seller’s liability, the buyer will always have to prove that this breach actually caused the alleged damage.
Burden of proof
Irrespective of the applicable law of the M&A transaction and the applicable procedural rules of a post-closing M&A dispute, the claimant will in most cases bear the burden of proof regarding both the existence of its claims and the concrete amount of damages it is claiming. In some situations the parties may have agreed contractual modifications.
Damages arising from M&A contracts can occur in many varieties. Typical damages issues include accounting, forensic or corporate finance aspects, sometimes in addition to valuation problems.In many cases the expertise of quantum or accounting experts is sought by the parties and the arbitral tribunal.
From a legal point of view, the basis of each and every damage assessment is to restore the situation that would have existed if the circumstance obliging the liable party to pay damages had not occurred. In other words, the aim is to determine what is necessary to put the other party into the position it would have been in without the loss. In some jurisdictions, such as Germany, there is a distinction between the recovery of positive and negative damages. Positive damages are intended to compensate for the contract not having been (properly) performed. Therefore, the aggrieved party is put in the position as if the contract had been properly performed. Negative damages are supposed to recover reliance damages. Therefore, the aggrieved party will be put in a position as if it had never entered the contract. In practice, most damages claims in M&A arbitration will seek to recover positive damages.
This basic principle can be put into practice in different ways. In many cases the aggrieved party has a choice. The injured party may either claim for specific performance, or cancellation or rescission of the transaction, for instance, or – last but not least – for monetary damages.
Liability can be limited by various contractual mechanisms, including de minimis clauses, baskets or caps.
De minimis clauses stipulate the minimum threshold amount claimable for a single instance of loss as a result of a breach of the SPA. An individual breach of the SPA causing a loss for the company of less than this amount will not be considered at all.
The basket refers to the total amount of the aggregate damages owing to all breaches of the SPA that must have been reached for the buyer to be entitled to compensation. A basket can be agreed as a tipping basket, in which all loss must be compensated once the relevant threshold is met, or a deductible basket, in which only losses that exceed the relevant threshold must be compensated.
A cap limits the maximum aggregate amount payable owing to breaches of the SPA. This may for example be the purchase price, or a certain percentage of it. Fundamental warranties in an SPA (that the seller is the legal owner of the shares and that these are all shares outstanding in the target company, for instance) are often excluded from the cap.
 Burkhard Schneider is a partner, and Paul Hauser is a senior associate, at Clifford Chance.
 For details see Kai F Schumacher and Michael Wabnitz, ‘M&A and Shareholder Arbitrations’, in John Trenor (ed), The Guide to Damages in International Arbitration (2nd edn.,Global Arbitration Review, 2018).