United States

Introduction

As at June 2020, the International Monetary Fund was already forecasting an 8 per cent decline in GDP for the United States.[2] But the ultimate effect of the coronavirus pandemic on the US economy may only be assessable in hindsight.

M&A activity in the second quarter continued to decline as covid-19 remained an unrelenting problem. North American M&A activity reached US$336.8 billion over 2,025 transactions in the second quarter of 2020, showing year-on-year declines of 26.7 per cent and 33.1 per cent, respectively,[3] and substantial declines from the record activity seen in recent years. The 2020 M&A dealmaking decline is of course a necessary consequence of the increasing difficulty for economic predictability resulting in the lack of accuracy of earnings forecasts.

Transactions continue in technology and healthcare, as many companies in these sectors have benefited from covid-19 side effects and have opportunistically sought out M&A transactions in times of volatility. However, in less robust areas such as oil and gas, dealmaking is best characterised as one way to survive.

Especially with respect to transactions closed prior to the pandemic, the rippling effects on disputes are beginning to trickle, often directing the disputants’ attention to the underlying force majeure clause, while, importantly, material adverse effect clauses are much more common in M&A transactions.

Grounds for M&A arbitrations

Failure to complete the transaction

To the extent market conditions allow a buyer of a unique asset to do so, disputes arising from the failure to complete a transaction are closely tied to the ability of one party to a merger or acquisition agreement to force a closing of the transaction. While parties often include specific performance clauses in their M&A contracts (i.e., the parties agree that irreparable harm will occur if there is a breach of the agreement and that monetary damages will not suffice to compensate for the breach), such clause is not sufficient by itself to guarantee an award of specific performance. Certainly historically established and still true today, New York and Delaware law place a primacy on damages as a remedy when guiding arbitral tribunals’ discretion on the issue. This may hold especially true when the parties had agreed on termination fees. In fact, even absent termination fee agreements, efforts to enforce specific performance arbitral awards have been met with the argument that under New York public policy, the arbitration tribunal was not permitted to award it.[4]

Price adjustment

Internationally less likely to be immediately enforceable than arbitral awards, the most common kinds of disputes that are submitted to expert determination in the M&A context are purchase price adjustments and post-closing balance sheet adjustments.[5] A high degree of expertise requiring technical answers to a question an expert can determine from the material submitted merit the often lesser degree of due process mandatorily applied by an expert. Disputes that require the exercise of business judgement, such as disagreements over business plans in a joint venture, are less suited to expert determination. Under New York law, a party can bring a special proceeding in state court to enforce such determination.[6]

Earn-out

Future asset performance dependent, earn-out provisions are a frequent subject matter of post-M&A arbitration. Empirical data suggests this may be one of the reasons they are used less frequently. In the US, the parties often find other, less dispute-prone, mechanisms to close a deal.

Failure to disclose or fraud

Failure to disclose or fraud claims are commonly addressed in the underlying M&A agreement by means of contractual language disclaiming reliance on any representations that are not expressly set out in the contract. These clauses often bar claims based on allegations of pre-contractual fraud. As is true for every dispute, careful analysis will also have to be placed on the question of whether the potential recovery of sufficient damages merits the effort of litigation or arbitration, or both.

Misrepresentations and breach of warranties

Larger dollar-value claims for misrepresentation and breach of warranties are increasingly the subject of warranty and indemnity insurance claims.[7]

Contractual provisions often set a damages cap or a deductible that must be met before the seller becomes liable. A key question for claims based on misrepresentation or breach of representations and warranties is whether they can establish a sufficient amount in dispute. Especially in the de minimis setting, whether small claims can be aggregated and whether there is a requirement that materiality be demonstrated can become determinative. Whether the reduction in value on an asset on the books is indemnifiable as a ‘diminution in value’ claim will often be addressed by the language of the underlying contract. Establishing actual or constructive knowledge (‘should have known’) for designated seller representatives may also become outcome determinative.

In a 2017 decision, the Delaware Supreme Court applied a post-closing bar on liability for breach, holding that where the agreement barred post-closing liability for misrepresentation and breach of warranty but allowed for a post-closing adjustment based on the target’s net working capital, the buyer could not seek a post-closing adjustment that could have been brought as a breach claim.[8]

Fraud and failure to disclose

Buyers and sellers may attempt to pursue fraud claims in a variety of situations, including where a final agreement was not reached,[9] where contractual remedies are unsatisfactory[10] or where the alleged fraud does not correspond to contractually stipulated representations.[11] Unless the contract contains an enforceable clause disclaiming reliance on any extracontractual representation, a defrauded party may pursue a claim for fraud or fraudulent inducement.[12] In Delaware, while provisions barring extracontractual fraud claims will be enforced, courts will not permit contracting parties to bar or limit fraud claims against parties that make deliberately false representations in the agreement itself.[13]

Where the claimant’s fraud claims are not prohibited by an enforceable non-reliance provision, such claims will be judged according to the general standards for analysing common law fraud. Under both New York and Delaware law, a claimant seeking to establish fraud or fraudulent inducement[14] must plead: (1) a false representation; (2) the respondent’s knowledge or belief that the representation was false or a reckless indifference to its truthfulness; (3) an intent to induce the claimant to act or refrain from acting; (4) justifiable reliable on the representation by the claimant; and (5) damage caused by the reliance.[15] Actionable misrepresentations include both untrue factual statements and statements of opinion that are not honestly held.[16]

Under both federal and New York state law, if a contract contains an arbitration clause, unless the arbitration clause in a (container) contract was itself specifically induced by fraud, all fraud claims relating to the contract, including fraudulent inducement to contract, must be arbitrated and cannot be brought in court.[17]

Burden of proof

Principally, the claimant must prove its claim, including claims for fraud or breach of contract, by preponderance of the evidence. The same holds true for the respondent and its defences or counterclaims. Arbitrators have broad discretion to weigh the evidence and may have the authority to adjust the burden to reflect their understandings of what outcome would be fundamentally fair under the circumstances, but in practice, arbitrators who are required by the contract to apply the law, whether New York or Delaware law, or otherwise, will typically apply the same preponderance standard that would apply in US federal civil court.

While pleading standards may be addressed in the applicable arbitration rules and the applicable pleading standards known from US laws may not be directly applicable, especially in an international arbitration, some US arbitrators may be guided by fraud having to be pleaded with particularity in US federal civil courts,[18] whereas in asserting most other causes of action, the claimant must plead its claim under the less rigorous plausibility standard.[19]

Knowledge sharing

A parent corporation is typically not imputed with the knowledge of its subsidiaries.[20] For this reason, the parent of a target will generally not be liable for misstatements or omissions by the target. However, if the subsidiary is acting as an agent or alter ego of its parent, or under other special factual circumstances, such knowledge could be imputed to the parent.[21]

A corporation’s officers will generally not be held individually liable for contractual claims brought against the corporation, unless the contract expressly calls for it.[22] If a claim of fraud in the inducement is brought, however, an officer could be held liable if he or she had actual knowledge of the fraud.[23] Delaware courts have held that this liability can potentially extend to a key institutional shareholder (e.g., a private equity sponsor) whose designated directors knew of the fraud, even if the shareholder itself did not.[24]

Remedies

New York law recognises the broad authority of arbitrators with respect to remedies.[25] For contractual claims, ‘the ordinary rule is that it is impractical to unwind a consummated merger’,[26] and compensatory money damages will be the typical remedy in an arbitration.

Equitable relief may be available subject to the arbitration agreement and any applicable institutional rules. Parties may obtain injunctive relief, including forcing a party to close or to unwind a transaction.[27] In the interest of confidentiality, emergency arbitration may be of special interest in this context.[28]

In addition, the type of award available to a claimant in arbitration is often expressly limited by the arbitration agreement. For example, an agreement on the International Centre for Dispute Resolution Rules forecloses the possibility of punitive damages, even where such damages may otherwise be available. Where fraud or other tort claims are subject to arbitration, and they commonly are, those claims may also be governed by the contract’s provision addressing damages, if the provision is sufficiently broad to include those claims.[29]

Measure of damages

M&A agreements often provide for capped or liquidated damages, as long as the provision is intended to be compensatory rather than punitive. The general rule, under New York law, is that claimants bringing fraud claims may recover for the pecuniary loss sustained as a result of the fraud. These damages can be measured by (1) the difference between value of the asset bought, sold or exchanged and its purchase price, or the value of the asset exchanged for it; and (2) pecuniary loss suffered otherwise as a consequence of the recipient’s reliance on the truth of the representation.[30] In the context of fraudulent inducement, the law puts the parties back in the position they were in before the contract.

Special substantive issues

The US Federal Arbitration Act evinces a national policy favouring arbitration. The law provides for strong, uniform and broad enforcement of arbitration agreements. Starting with statutory claims arising under antitrust laws, those based on most types of employment contracts, and a wide array of consumer disputes – they are all arbitrable in the US.[31] To the extent that these matters arise as ancillary to an M&A arbitration, they are likely to be resolved as part of the arbitration process.

Other US legal regimes may come into play depending on the nature of the transaction, such as the review process under the Committee on Foreign Investment in the United States. In addition, if any of the parties are nearing insolvency, bankruptcy proceedings (voluntary or involuntary) may have an impact on pending arbitral proceedings.

Special procedural issues

New York law contains a special provision for court enforcement of expert determinations. In the M&A context, specific factual or technical issues such as purchase price adjustments are often determined by expert independent accountants rather than by arbitration. Under Article 76 of the New York Civil Practice Law and Rules, a party may bring a proceeding to ‘specifically enforce an agreement that a question of valuation, appraisal or controversy be determined by a person named or to be selected’.[32] The standard of review of such determinations is more searching than that applied to arbitral awards: a party must show ‘palpable error’ or a failure to follow accepted procedures.[33]


Notes

[1] Martin F Gusy is a partner at K&L Gates LLP. Parts of this chapter build on Frances E Bivens and E Alexandra Dosman’s excellent work in the first edition of The Guide to M&A Arbitration.

[2] ‘A Crisis Like No Other, An Uncertain Recovery’, International Monetary Fund, June 2020, available at www.imf.org/en/Publications/WEO/Issues/2020/06/24/WEOUpdateJune2020.

[3] The second quarter of 2019 was a relatively weak M&A quarter for North America. See PitchBook, North American M&A Report: Q2 2020, available at https://pitchbook.com/news/reports/q2-2020-north-american-ma-report.

[4] New York and Delaware law are by far the most used United States laws in the context of M&A. Corporate law is regulated differently in each US state.

[5] Related disputes commonly addressed by an expert include fair market valuations, earn-out disputes and allocation of tax benefits.

[6] See New York Civil Practice Law and Rules, Section 7601 (‘A special proceeding may be commenced to specifically enforce an agreement that a question of valuation, or other issue or controversy be determined by a person named or to be selected. The court may enforce such an agreement as if it were an arbitration agreement [.]’). See also Alstom v. General Electric Co., 228 F. Supp. 3d 244 (S.D.N.Y. 2017) (addressing the scope of cumulative expert determination and ICC arbitration clauses).

[7] See ‘M&A: A rising tide of large claims – Representations and Warranties Insurance Global Claims Study’, available at www.aig.com/business/insurance/mergers-and-acquisitions/mergers-acquisitions-claims-reports.

[8] Chicago Bridge & Iron Co. N.V. v. Westinghouse Elec. Co., 166 A.3d 912, 936 (Del. 2017).

[9] RAA Mgmt., LLC v. Savage Sports Holdings, Inc., 45 A.3d 107, 109 (Del. 2012) (seeking to recover diligence costs where the party ‘never would have proceeded to consider purchasing’ if it had not been defrauded).

[10] FdG Logistics LLC v. A&R Logistics Holdings, Inc., 131 A.3d 842, 864 (Del. Ch. 2016) aff’d sub nom. A&R Logistics Holdings, Inc. v. FdG Logistics LLC, 148 A.3d 1171 (Del. 2016) (rejecting the plaintiff’s claim to unwind an allegedly fraudulent transaction as ‘unfeasible’ but noting that, if the fraud claims are successful, the plaintiff’s recovery will not be limited by the merger agreement).

[11] Norcast S.ar.l. v. Castle Harlan, Inc., 147 A.D.3d 666, 667 (N.Y. App. Div. 2017) (alleging a fraudulent scheme to ‘conceal’ the buyer’s identity despite the plaintiff not obtaining ‘a contractual warranty regarding the purchaser’s identity’).

[12] Kronenberg v. Katz, 872 A.2d 568, 593 (Del. Ch. 2004) (an effective ‘anti-reliance’ clause must amount to a ‘contractual promis[e]’ by the plaintiff that it did not ‘rely upon statements outside the contract’s four corners in deciding to sign the contract’); PetEdge, Inc. v. Garg, 234 F. Supp. 3d 477, 488 (S.D.N.Y. 2017) (similar).

[13] Abry Partners V, L.P. v. F & W Acquisition LLC, 891 A.2s 1032, 1036 (Del. Ch. 2006) (‘[W]hen a seller intentionally misrepresents a fact embodied in a contract – that is, when a seller lies – public policy will not permit a contractual provision to limit the remedy of the buyer to a capped damage claim. Rather, the buyer is free to press a claim for rescission or for full compensatory damages’).

[14] See LVI Grp. Inv. LLC v. NCM Grp. Holdings, LLC, No. CV 12067-VCG, 2018 WL 1559936, at *11 (Del. Ch. 28 March 2018); Powell v. Adler, 128 A.D.3d 1039, 1040 (N.Y. App. Div. 2015).

[15] Prairie Capital III, L.P. v. Double E. Holding Corp., 132 A.3d 35, 61 (Del. Ch. 2015) (stating elements of fraud claim in the context of a merger agreement); S’holder Representative Servs. LLC v. Sandoz Inc., 46 Misc. 3d 1228(A) (N.Y. Sup. 2015) (same).

[16] Appel v. Berkman, No. 316, 2017, 2018 WL 947893, at *4 (Del. 20 February 2018); Laura Dietz, 60 N.Y. Jur. 2d Fraud and Deceit § 116 (2018).

[17] Prima Paint Corp. v. Flood & Conklin Mfg. Co., U.S. 395, 403–04 (1967).

[18] See, e.g., Del. Super. Ct. Civ. R. 9 (stating requirement to plead fraud with particularity); N.Y. C.P.L.R. 3016 (same).

[19] Campaign for Fiscal Equity, Inc. v. State, 86 N.Y.2d 307, 3018 (N.Y. Ct. App. 1995); Desimone v. Barrows, 924 A.2d 908, 929 (Del. Ch. 2007).

[20] See In re Am. Bank Note Holographics, Inc. Sec. Litig., 93 F. Supp. 2d 424, 443–44 (S.D.N.Y. 2000) (‘While it is true that a subsidiary’s fraud cannot be “automatically” . . . where factual allegations are sufficient to make a claim for participation of a subsidiary in the fraudulent scheme, a corporate parent may be liable’); see also Chill v. Gen. Elec. Co., 101 F.3d 263, 268 (2d Cir. 1996).

[21] Fireman’s Fund Ins. Companies v. Meenan Oil Co., 755 F. Supp. 547, 556 (E.D.N.Y. 1991) (‘The concept of piercing the corporate veil is properly invoked to extend the reach of liability and, perhaps, imputed knowledge to a controlling corporation or individual.’); Reiss v. Societe Centrale du Groupes des Assurances Nationale, 246 F. Supp. 2d 273, 281 (S.D.N.Y.) (discussing imputation of knowledge based on agency); Simon v. Philip Morris, Inc., 86 F. Supp. 2d 95, 109–10 (E.D.N.Y. 2000) (discussing imputation of knowledge based on special factual circumstances).

[22] Salzman Sign Co. v. Beck, 10 N.Y.2s 63, 67 (N.Y. App. Ct. 1961); Wallace ex rel. Cencome Cable Income Partners II, Inc., L.P. v. Wood, 752 A.2d 1175, 1180 (Del. Ch. 1999).

[23] People by Abrams v. Apple Health & Sports Clubs, Ltd., 80 N.Y.2d 803, 807 (N.Y. Ct. App. 1992); Prairie Capital III, L.P. v. Double E. Holding Corp., 132 A.3d 35, 60 (Del. Ch. 2015).

[24] Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I LLP, No. CV 7906-VCG, 2014 WL 6703980, at *21 (Del. Ch. 26 November 2014).

[25] Frederick R Fucci, ‘Arbitration of M&A Transactions: Laws of New York and Delaware – Part III’, 72(3) Dispute Resolution Journal (Juris 2016), at *20–22.

[26] Fdg Logistics LLC v. A&R Logistics Holdings, Inc., 131 A.3d 842, 863 (Del. Ch.), aff’d sub nom. A & R Logistics Holdings, Inc. v. FdG Logistics LLC, 148 A.3d 1171 (Del. 2016); Bank of N.Y. Co. v. N.E. Bancorp, Inc., 9 F.3d 1065, 1067 (2d Cir. 1993) (‘[W]here a merger has been consummated, restoration of the status quo may be impossible’).

[27] Staklinski v. Pyramid Elec. Co.,6 N.Y.2d 159, 163 (N.Y. Ct. App. 1959) (the parties ‘in so many words authorized an arbitrator to grant equitable relief . . . Whether a court of equity could issue a specific performance decree in a case like this . . . is beside the point’); Ruppert v. Egelhofer, 3 N.Y.2d 576, 581 (N.Y. App. Ct. 1958) (‘The whole question is as to the intent of the parties’); Drake Bakeries, Inc. v. Local 50, Am. Bakery & Confectionary Workers Int’l, AFL-CIO, 370 U.S. 254, 260 n.5 (1962) (stating the ‘New York rule . . . that an arbitrator may award relief in the nature of an injunction’).

[28] See commentary to Article 6 of the ICDR Rules in Gusy and Hosking, A Guide to the ICDR International Arbitration Rules, Second edition (OUP, 2019).

[29] See Mayaguez S.A. v. Citigroup, Inc., 16 Civ. 6788 (PGG), 2018 WL 1587597, at *8 (S.D.N.Y 28 March 2018).

[30] Cont’l Cas. Co. v. PricewaterhouseCoopers, LLP, 15 N.Y.3d 264, 271, 933 N.E.2d 738, 742 (2010).

[31] Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614 (1985) (US antitrust claims); Perry v. Thomas, 482 U.S. 483 (1987) (wage collection); Shearson/American Express, Inc. v. McMahon, 482 U.S. 2020 (1987) (Racketeer Influenced and Corrupt Organizations Act claims); the US Supreme Court has upheld the use of mandatory arbitration in consumer contracts as well as ‘class action waiver’ clauses in those contracts. DirecTV, Inc. v. Imburgia, 136 S. Ct. 463 (2015).

[32] New York Civil Practice Law and Rules, Section 7601. See generally New York City Bar Association Committee on International Commercial Disputes, ‘Purchase Price Adjustment Clauses And Expert Determinations: Legal Issues, Practical Problems And Suggested Improvements’ (June 2013), available at www2.nycbar.org/pdf/report/uploads/20072551-PurchasePriceAdjustmentClausesExpertDeterminations--LegalIssuesPracticalProblemsSuggestedImprovements.pdf.

[33] Frederick R Fucci, ‘Arbitration of M&A Transactions: Laws of New York and Delaware – Part I’, 71(2) Dispute Resolution Journal (Juris 2016), at *35–36.

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