Managing Expert Determinations
It is reported that the global deal value for merger and acquisition (M&A) transactions reached US$5.9 trillion in 2021, driven by a number of factors, including the lower cost of debt and higher deal multiples driving up deal values. The combined effect of high deal values and the market disruption caused in 2022, with events such as the war in Ukraine, means that there are likely to be many acquired businesses struggling to achieve the performance underpinning those deal values. As such, the number of M&A disputes in 2022 is expected to increase.
This Guide focuses on how to deal practically with M&A disputes primarily through arbitration. However, a substantial proportion of M&A disputes are resolved through expert determination proceedings. The growing number of M&A disputes is expected to be echoed by an increase in the number of disputes that are referred to expert determination.
An expert determination is a form of alternative dispute resolution whereby a third-party subject-matter expert is appointed to act as an expert to determine how the issues in dispute should be resolved, rather than issue legal proceedings where a judge or arbitrator will determine the dispute. Typically, the expert’s determination is final and binding in the absence of fraud or error (depending on the contractual terms agreed by the parties).
As such, although during any negotiations the parties to an expert determination may have assessed the relative strength of their position for each issue, either internally or with the assistance of external legal counsel and (accounting) experts, to assess whether it is worthwhile proceeding with an expert determination, the exercise must be used with a hint of caution as there is no guarantee as to what the expert determination will be on each issue in dispute and there is very little recourse to challenge the determination.
Expert determinations can be used for a variety of disputes, particularly where the determination is in respect of a valuation or technical matter. This chapter discusses a number of topics relevant to expert determinations in the context of M&A disputes, namely:
- types of M&A disputes best resolved through expert determinations;
- typical matters of dispute within completion accounts and earn-outs;
- the importance of the share purchase agreement (SPA) drafting process;
- a typical determination process, including the use of external experts;
- preparation of submissions to an expert determiner;
- preventing a potential dispute; and
- sources of assistance for expert determinations.
This chapter gives the authors’ views on the above, but it is important to note that the determination process is entirely bespoke for each transaction, which lends itself to a unique approach for each determination. The areas discussed below should provide guidance on the stages that can be worked through to ensure that the process runs as smoothly as possible.
Types of M&A disputes best resolved through expert determinations
There are many different types of disputes arising from M&A transactions, including warranty claims, indemnity claims, misrepresentation claims, completion accounts disputes, earn-out disputes and locked box leakage claims. This chapter is only concerned with those disputes that, in the authors’ opinion, are best resolved through an expert determination (i.e., disputes in respect of completion accounts and amounts due under earn-out arrangements).
Expert determinations are predominantly provided for in SPAs in the event that a dispute arises during the post-transaction process, that is during the completion accounts process or in the calculation of earn-outs.
Completion accounts mechanisms
Completion accounts mechanisms are one of the two traditional completion mechanisms for calculating the final consideration due upon the acquisition of an entity, the other being that of locked box accounts.
With a completion accounts mechanism, the final adjustments to consideration are based on the actual balance sheet of the target entity prepared after the transaction as at completion. The SPA will set out the consideration payable at completion, which is then subject to a ‘true-up’ adjustment post-transaction once the completion accounts have been reviewed and agreed. It is only after the true-up adjustment is calculated that the final equity value of the transaction is agreed. It is also during the process to agree the components of the true-up adjustment that disputes typically arise and are then referred to expert determination.
With a locked box mechanism, the final equity value adjustments are applied to a balance sheet prepared at a date prior to completion, termed the ‘locked box balance sheet’, which forms part of the locked box accounts. Locked box mechanisms avoid time being spent post-transaction on agreeing completion accounts and bring certainty for both parties on the final equity value and consideration due at completion. The certainty of the final equity value reduces the potential for disputes and, as such, very few locked box deals are referred to expert determinations.
Amounts due under earn-out arrangements
Consideration payable by way of earn-out is a common feature of M&A transactions, particularly at the current time, considering the effects of current geopolitical and economic volatility on company valuations. Simply put, earn-outs can be used to bridge the gap between the seller’s and the buyer’s opinions on the value of a company at completion by calculating at least part of the consideration with reference to the performance of the target business post-transaction. With the majority of earn-out arrangements being based on specified financial metrics, if there is no or insufficient drafting in the SPA setting out how the earn-out amount is to be calculated, the arrangements can, and often do, give rise to disputes.
Typical matters of dispute within completion accounts and earn-outs
Typical matters of disputes within completion accounts include:
- accounting treatment of individual items, for example, the calculation of deferred income;
- provisions, for example, for expected future liabilities, bad debts or obsolete stock that are estimated based on assumptions;
- the release of provisions from prior periods;
- balances not included in previous financial statements;
- changes in accounting standards from prior periods;
- classifying leases as operating leases or finance leases;
- interpretation of generally accepted accounting principles (GAAP); and
- the effect and treatment of any post-balance sheet events.
Areas of disputes within earn-outs are similar to those in completion accounts and will typically arise where the threshold to trigger an earn-out payment has just been missed or where there are allegations of non-adherence to the terms of the SPA by one party or the other.
As mentioned above, the amount payable under an earn-out arrangement is usually dependent on the achievement of a financial target. This is likely to be performance related and based on a figure included within a company’s profit and loss account or income statement, such as revenue, gross profit, pre-tax or post-tax profit or earnings before interest, tax, depreciation and amortisation (EBITDA).
From a seller’s perspective, the further up the profit and loss account the figure on which the earn-out is to be based (i.e., revenue is the highest item), the less likelihood of any manipulation and the simpler it is to calculate and review, because the figure is comprised of fewer components. However, the metric chosen is more likely to concern a company’s profitability.
In particular, EBITDA is a commonly used measure of earn-out performance, as it removes the effects of interest, tax, depreciation and amortisation, which are not considered to be part of operational performance and may be outside the seller’s control.
The difficulty arising from the selection of EBITDA as the relevant metric is that it is not defined in accounting standards and is often not presented in the historical financial statements of a company. The definition of EBITDA in the SPA, therefore, needs to be drafted as clearly and unambiguously as possible, in particular what is to be included and excluded from EBITDA (for example, how to treat one-off or exceptional revenues or costs), to avoid differing interpretations that may lead to a dispute.
The importance of the SPA drafting process
This Guide reflects on the influence of the drafting of the arbitration clause on any M&A dispute. In the same way, the drafting of the schedules detailing the completion accounts mechanism and earn-out arrangements, and the clauses governing the appointment of an expert determiner, will have a significant effect on whether the M&A transaction will end up in a dispute, and how any dispute will proceed.
This section briefly discusses the standard approaches to drafting completion accounts mechanisms and earn-out arrangements, and also how the expert determination process may be structured within the SPA.
Typically, the completion accounts will consist of a closing balance sheet, and may also include a profit and loss account, the preparation of which should be prescribed in the SPA by a bespoke set of accounting policies and procedures drafted specifically for the transaction in hand.
There is a standard approach used in SPAs to determine the order of priority of the accounting policies and procedures to be applied in the preparation of the closing balance sheet. This is known as the accounting hierarchy and is as follows:
- Specific accounting policies: The parties agree specific accounting treatment of certain items to be adopted in the completion accounts, which will take precedence over the most recent set of financial statements. Specific accounting policies are often included for items that are measured using accounting estimates and that therefore involve judgement (for example, provisions).
- Consistency with the most recent set of financial statements: The most recent set of financial statements can be a convenient reference point as to the accounting treatment applied to certain balances within the completion accounts.
- GAAP: Specify the relevant GAAP to apply, whether that is the GAAP of the target entity or of the acquiring entity.
Careful drafting of the hierarchy and any specific policies is key to avoiding a dispute. The policies should be as clear as possible, removing the need for judgement or alternative interpretation.
It can also be useful to include a proforma template within the SPA for the balance sheet and the schedule to determine equity value. This could be a detailed schedule based on the company’s latest management accounts, which should mean the treatment (and potentially quantum) of certain items can be agreed in advance of completion.
With regard to preparation of the completion accounts, various procedural points should be included within the SPA, including:
- responsibility for the initial preparation of the completion accounts;
- timing for the preparation and review of the completion accounts;
- cut-off date for the information to be taken into account in the preparation, review and determination of the completion accounts; and
- importantly for our purposes, the approach to resolving any disagreements.
Typically, the completion accounts become final and agreed upon expiry of the stated review period unless the reviewer has raised any objections regarding any specific items. If the reviewer raises any objections, the SPA should allocate a amount of time for the parties to settle the objections. If the parties are unable to settle all disputed items, the parties will then either jointly or individually be able to refer the disputed items to an expert determiner.
The process and approach for preparing the earn-out schedule is similar to that of the completion accounts, the difference being the earn-out metric and how that should be calculated, which is often the significant area of dispute.
As explained above, the metric can be financial (such as achieving a certain pre-tax or post-tax profit, EBITDA or revenue target) but could also be non-financial (such as securing regulatory approval, the completion of a specific project, or the award – or non-termination – of certain key contracts).
Whatever metric is chosen, ensuring it is clearly defined in the SPA and how any amounts due are to be calculated is of utmost importance in reducing the potential for disputes. Other important considerations in drafting the SPA include specifying the time frame of the earn-out (typically earn-outs are for one to three years) and detailing suitable protections for both parties, particularly the sellers, as the earn-out will be generated by the performance of a company that is no longer under their control, although sellers will often choose, or are required, to remain with the company in some capacity during the earn-out period.
Expert determination clauses
The expert determination clauses in the SPA will usually include the following provisions:
- the process for selecting an expert to resolve the dispute. Typically, an SPA will require that the expert is from an accounting firm of international repute with a minimum number of years’ experience, although in some cases a named firm or expert will be nominated to prevent further delays in the case of a dispute. The key requirement is to choose an expert who has experience and an understanding of the expert determination or M&A dispute process as well as the subject matter. In the United Kingdom, if the parties cannot agree on an expert, the parties can jointly approach and use the Institute of Chartered Accountants of England and Wales Nomination Scheme to nominate an independent expert;
- confirmation that the expert determiner will be appointed as an expert, not an arbitrator;
- the procedure that the expert determiner will follow. It is advisable that the expert determiner is given leeway to establish their own procedure for their determination (we typically see clauses such as the expert determiner has 30 days to deliver their determination, which does not give any consideration to the complexity of the dispute), albeit the SPA may require the expert determiner to include various steps in the determination process including:
- written submissions;
- response submissions;
- information requests; and
- oral hearings;
- the areas that the expert determiner will be responsible for determining. For example, it is advisable to limit the role of the expert determiner to determine only the items in dispute, rather than to determine whether the completion accounts are correct in their entirety. The extent of the expert determiner’s jurisdiction may be limited to the values put forward by either party or a range of values, rather than the expert determiner being required to calculate the correct value of an item;
- confirmation that the determination will be final and binding in the absence of fraud or manifest error; and
- confirmation of whether the determination will be provided with reasons (speaking) or without reasons (non-speaking). A reasoned determination will provide brief reasons as to how the expert determiner arrived at their conclusion on each issue.
Typical expert determination process
Once the parties have selected and agreed an expert determiner, an engagement letter, drafted by the expert determiner and addressed to both parties, should be agreed.
The engagement letter should contain the issues in dispute that the expert determiner is being appointed to determine. This may require some negotiation between the parties, or a court decision if the parties cannot agree, before the engagement letter can be completed, but the determination cannot start until agreement has been reached.
The engagement letter should also set out the process or timetable that the parties and the expert determiner intend to follow (in more detail than that contained within the SPA). A suggested timetable would be as follows:
- both parties to prepare and submit to the expert determiner their own analysis with supporting papers, and to present their written viewpoint within an agreed number of business days of the signing of the engagement letter (‘initial submissions’). Submissions are typically provided simultaneously but can be provided sequentially. The expert determiner will typically be responsible for sharing the initial submissions with the other party;
- following receipt of the initial submissions, both parties may prepare and submit to the expert determiner a written response, with supporting papers, to the other party’s initial submissions within an agreed number of business days of receipt (‘response submissions’);
- the expert determiner may circulate written questions to the parties within an agreed number of business days of receipt of the parties’ initial or response submissions;
- the parties will prepare and submit their written responses to the expert determiner’s questions within an agreed number of business days;
- each party will comment on the other party’s written responses to the expert determiner’s questions within an agreed number of business days (if the parties and the expert determiner consider such a step is necessary); and
- the expert determiner will make all endeavours to provide the parties with their determination within an agreed number of business days of receipt of the final submissions from the parties.
It could be stated that the procedure and timetable outlined above may be changed by mutual agreement of the parties in the light of changing circumstances; for example, if the expert determiner requires further information from the parties in order to come to a determination. In the absence of agreement between the parties, the expert determiner may have discretion to make such alterations to the procedure as they reasonably consider appropriate.
Further, the parties and the expert determiner may consider it necessary to introduce the option for an oral hearing, which can be enacted by the expert determiner, and each party may request an oral hearing to be decided by the expert determiner. Oral hearings in expert determinations are rare, but useful on occasion.
The expert determiner may seek assistance, at any time, from an expert (or experts) in the field appropriate to the matter being addressed, including independent legal advice, provided that the expert determiner first informs the parties of their intention to seek such advice, and of the likely reasonable cost of the assistance. The expert determiner shall have discretion to order that either party should pay the cost of the assistance; in the absence of such an order, the cost would be borne equally by the parties.
Finally, in respect of the costs of the determination itself, the expert determiner is usually given the ability to direct how their costs are borne by the parties, and if there is no direction, the costs are split equally between the parties. An alternative approach could be where the success, or lack thereof, regarding each disputed item is to be taken into account when assessing costs. The expert determiner will require both parties to pay their share of the costs before releasing the final determination to either party.
Preparation of submissions to an expert determiner
The majority of expert determinations are conducted solely in writing and thus the determination will be based on the information provided to the expert determiner in submissions and the expert’s own expertise.
The content of submissions will differ from case to case. It may be helpful to advise the expert determiner of the background of the transaction, including the parties, the target and the chronology of the transaction and dispute, but the majority of a party’s submissions should be focused on the matters in dispute, clearly setting out its position, reasons why it disagrees with the other party and the evidence supporting its position.
With regard to each disputed item, a suggested approach is to provide:
- sufficient background to the item in dispute, including quantum, so that the expert determiner understands the context in which the item is being disputed;
- reference to the particular clauses and schedules of the SPA under which the item in dispute should be considered. This is an area that may or may not be agreed by the parties. Where it is not agreed, a party should provide details of its interpretation of each referenced clause or schedule and provide reasoning as to why the particular clauses and schedules are or are not relevant;
- details of the approach applied to calculating quantum, typically with reference to the accounting hierarchy set out in the SPA, whether the issue should be determined with reference to specific policies, the historical approach taken by the business or GAAP, with all available supporting information to justify the position taken; and
- as much supporting information as possible. The expert determiner will be engaged to determine the issues based on the information provided to them. Delays may result from a failure to provide all information relevant to the items in dispute, as the expert determiner will need to make requests for further information and so prolong the process. Further, there is a risk that information supportive to a party’s case is not considered by the expert determiner as they are not aware of such information being available, which may lead to an adverse determination for the party concerned.
The initial submission may be the first time each party is provided with the other party’s reasoning (depending on the detail provided in the dispute notice and during negotiations) and the response submissions provide each party with the opportunity to respond to and robustly challenge the other party’s arguments. However, if following the provision of evidence not previously provided, one party understands and accepts the other party’s treatment of a particular issue, it will be appreciated by the expert determiner if concessions are made where appropriate. Response submissions should address the other party’s initial submission, not introduce new material.
Preventing a potential dispute
The use of an SPA advisory specialist – an accountancy firm that will work alongside the legal advisers to provide guidance in respect of the financial and accounting aspects of the SPA – can help to minimise the likelihood of a dispute, as the specialist can identify areas where the drafting has left matters open to judgement or where the drafting is not as clear as it could be before the SPA is finalised.
Areas covered by a review by an SPA advisory specialist will include:
- financial definitions linking into warranties and completion schedules;
- completion accounts, including the financial hierarchy of preparation and specific accounting policies;
- deferred or earn-out consideration clauses; and
- the accounting warranties (year-end and management accounts).
Sources of assistance for expert determinations
When contemplating an expert determination process, there are a number of sources of assistance and guidance that provide information such as standard rules to apply in expert determinations, appointing an expert or handling expert determination arrangements. Some of the sources of assistance to consider are:
- Institute of Chartered Accountants in England and Wales;
- The Academy of Experts;
- Centre for Effective Dispute Resolution; and
- International Chamber of Commerce.
This chapter gives an overview of the expert determination process as a whole, discusses some of the areas that frequently give rise to disputes and provides a suggested approach for providing submissions to the expert determiner.
It remains the view of the authors that the most efficient method of managing expert determinations is to take action to avoid a dispute arising. We believe this begins with ensuring that the drafting of the SPA, and in particular the drafting of the financial and accounting clauses, is in terms that are as clear as possible, to reduce the number of clauses that could be considered ambiguous or requiring judgement.
 Sandy Cowan is a partner, Fiona Frith is a director and Alexandra Kingston is an associate director at Mazars LLP.
 Refinitiv, ‘Global Mergers & Acquisitions Review – Full year 2021.
 Also known as the purchase agreement.
 Also known as post-closing purchase price adjustment disputes.
 See Institute of Chartered Accountants in England and Wales, Corporate Finance Faculty, ‘Completion mechanisms: Determining the final equity value in transactions’ (October 2016, Issue 64).
 https://www.icaew.com/about-icaew/find-a-chartered-accountant/appoint-an-expert-mediator-or-arbitrator-to-assist-in-a-dispute (last accessed 24 October 2022).
 https://academyofexperts.org/alternative-dispute-resolution/expert-determination/#page_content (last accessed 24 October 2022).
 https://www.cedr.com/alternative-dispute-resolution-processes/expertdetermination/ (last accessed 24 October 2022).
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