Frequency of M&A disputes
Mergers and acquisitions (M&A) disputes arise frequently in the United States. This is not wholly surprising as the US accounts for a large percentage of global M&A deals – nearly 60 per cent of all global deals (in announced value) occurred in the United States in 2021.
In the wake of record-breaking M&A activity in 2021 and early 2022, there has been a marked increase in M&A-related disputes in 2022. Besides the sheer increase in deal volume, thereby increasing the statistical probability of disputes, this increase in the number of disputes has also been attributed to high company valuations during the covid-19 pandemic and an increasingly dark economic outlook. High valuations increase the likelihood of disappointment; the failure to live up to anticipated performance can also lead to lower earn-out payments. Often these circumstances give rise to earn-out disputes and related accounting disputes, as well as indemnity claims.
Although M&A activity in the second half of 2022 has generally cooled as compared with 2021, healthy M&A activity is still predicted in 2023. Venture capital and private equity firms currently hold large supplies of dry powder and the macroeconomic conditions have resulted in attractive opportunities thanks to lower company valuations. This sustained deal activity is expected to lead to a continuing pipeline of M&A disputes. Further, more M&A-related disputes are anticipated going forward into 2023 given increasing fears of recession coupled with stunning inflation numbers, high interest rates, and unprecedented energy costs and geopolitical threats.
Form of dispute resolution
M&A disputes in the United States are commonly resolved in arbitration or court litigation. Although it is difficult to quantify with precise certainty the percentage of disputes being resolved in arbitration (as opposed to court litigation) owing to the lack of publicly available arbitration records, data suggests that arbitration is becoming a less popular form of dispute resolution in private company M&A transactions in the United States.
This conclusion can be drawn from the American Bar Association’s (ABA) Private Target Mergers and Acquisitions Deal Points Studies, which are released every other year. In the late 2000s, the ABA studies showed that arbitration provisions were included in around 35 per cent of transactions, while in 2021, they showed that arbitration provisions were included in only around 7 per cent of transactions. However, according to SRS Acquiom’s MarketStandard database, 15 per cent of all transactions globally included an arbitration provision, and where a US public buyer was involved, arbitration provisions were used in 18 per cent of transactions. That said, it should be noted that where US financial buyers are involved, no transactions contain arbitration provisions in SRS Acquiom’s MarketStandard database. This could reflect a preference by US banking institutions for New York courts.
Whatever the exact percentage of M&A deals in the United States that include arbitration provisions, this apparent downward trend appears to be contrary to the rise in M&A arbitration at arbitration institutions around the world (including in Europe and Asia). For example, reports from the London Court of International Arbitration and the Singapore International Arbitration Centre appear to suggest an increase in the number of M&A or related disputes. Time will tell whether the US trends back towards more arbitration for resolving M&A disputes.
Finally, other methods of alternative dispute resolution are sometimes included in M&A deals, such as expert determination and mediation provisions. For instance, expert determination is most commonly used for addressing accounting disputes.
Grounds for M&A arbitrations
Most M&A arbitrations involve post-acquisition claims that arise under the terms of a purchase and sale agreement (PSA) relating to a transaction. The PSA typically includes provisions setting out the purchase price and earn-outs (if any), representations and warranties, and indemnification obligations. Arbitration will only be the method of dispute resolution if the PSA contains an arbitration clause. The governing law chosen in the PSA will be the substantive law applied in an arbitration, and New York and Delaware law are the two governing laws most commonly selected. New York and Delaware law are generally considered ‘contractarian’, that is to say the plain meaning of agreements will generally be enforced according to their terms. New York and Delaware law are also commonly selected because of their well-developed body of case law deciding commercial and corporate disputes.
Post-closing disputes regarding the purchase price often focus on post-closing adjustments to the purchase price. For example, often a PSA will provide for adjustments to the purchase price based on the actual working capital held by the target at closing to ensure that the final purchase price corresponds to the financial condition of the target at the time of closing. These provisions take into account that the financial condition of a company can change between the date when the PSA is executed and when the closing takes place. It can take months for parties to close under a fully executed PSA if the parties need to obtain regulatory approvals or financing, or conduct any additional due diligence. Disputes regarding working capital adjustments may arise because of disagreements on the applicability of certain accounting principles or policies, as well as disputes regarding the target’s accounts receivable, inventory, accounts payable, and accruals and contingencies.
The calculation of earn-out payments is another common source of disagreement between parties. An earn-out is additional consideration that can be earned by a seller if the target meets certain financial milestones in the months or years after the closing. The buyer in an M&A deal will typically engage in extensive due diligence regarding the condition of the target prior to entering into a binding PSA to identify the strengths and weaknesses of the target, as well as any synergies. Whether synergies are achieved post-closing can have a big impact on whether earn-out milestones are triggered. These disputes thus focus on the calculation of the financial performance of a company, and since that is generally based on a company’s EBITDA (earnings before interest, tax, depreciation and amortisation), the treatment of certain costs and expenses in that calculation can be a source of contention. Earn-outs can also be contingent on or subordinated to other company debt, which can also lead to disputes. Further, the operation of a business itself can be the basis for an M&A arbitration over an earn-out. For example, the timing of certain expenditures, failing to operate the company in the ordinary course, or general mismanagement by the acquiring company can prevent the target from meeting certain earn-out milestones required by the PSA.
Indemnification provisions may be another source of dispute. Indemnity obligations generally require a seller to defend, hold harmless and indemnify a buyer from various claims, including claims arising from the seller’s breaches of its representations and warranties. However, indemnity obligations may be limited by caps on liability as well as by certain threshold amounts required to be met (called baskets) in order for claims to be brought and such claims are also often constrained by survival periods.
In Berkeley Research Group’s 2022 M&A Disputes Report, North American stakeholders identified sellers’ breaches of representations and warranties as a key factor giving rise to M&A disputes. Some of the most common representations and warranties assure the accuracy of the target’s financial statements. According to the ABA Private Target Mergers and Acquisitions Deal Point Studies, financial statement representations are required by buyers in virtually all transactions, although the language of the representations and warranties are generally heavily negotiated. Other common representations and warranties include assurances about the accuracy of certain regulatory or environmental disclosures.
It is worth noting, however, that the use of representations and warranties insurance (R&W insurance) has become a mainstay in M&A transactions in the United States, providing insurance coverage for breaches of representations and warranties in the PSA. R&W insurance is most often purchased by the buyer and enables a seller to exit the deal with greater certainty by limiting or eliminating the need for seller indemnity. By eliminating the escrow holdback, R&W insurance can make a deal look more attractive, extending the time given to the buyer to discover problems with the transaction and allowing the parties to more efficiently negotiate the transaction agreement. In the event of a breach of the representations and warranties, policyholders may look to their R&W insurance for recovery.
Breaches of representations and warranties
As noted above, a buyer will typically engage in extensive due diligence before entering into a binding PSA. That being said, there generally is no affirmative duty to disclose facts between a buyer and a seller. This is one of the reasons why representations and warranties are included in a PSA. Common representations and warranties from a seller are that material information with respect to the business (for example, litigation or claims, environmental issues and status of key customer relationships) has been disclosed. The parties may negotiate about knowledge qualifiers with respect to the representations and warranties, with the seller often seeking to limit its liability for representations or warranties that may not be accurate. For instance, parties may negotiate whether the knowledge qualifiers comprise only actual knowledge of the target or also include the knowledge that officers and directors should have had in their official capacity when acting diligently.
Fraud and failure to disclose
In general, the legal elements of fraud under New York and Delaware law are:
- a false representation;
- the respondent’s knowledge or belief that the representation was false or a reckless indifference to its truthfulness;
- an intent to induce the claimant to act or refrain from acting;
- justifiable reliance on the representation by the claimant; and
- damage caused by the reliance.
Although there is some variance from state to state, at least under New York and Delaware law, a claim for fraud may be brought with respect to a false representation of fact in a PSA, provided the above elements are satisfied. In other words, the inclusion of the representation of fact in the PSA does not limit a buyer to a claim for breach of contract by law.
Contractual disclaimers or limitations may be utilised. As to extracontractual misrepresentations, a contract may disclaim reliance on any extracontractual representation. However, Delaware courts will not permit contracting parties to bar or limit fraud claims against parties that make deliberately false representations in the agreement itself.
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. If a claim of fraud in the inducement is brought, however, an officer could be held liable if that officer had actual knowledge of the fraud. 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.
Burden of proof
A claimant must prove its claim, including for fraud or breach of contract, by a preponderance of the evidence standard (i.e., that it is more likely than not that each element of the claim existed at the required time).
A parent corporation is typically not imputed with the knowledge of its subsidiaries. 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, this knowledge could be imputed to the parent.
The main implications from an arbitration standpoint are evident: the greater the pool of persons whose knowledge triggers liability, the greater the chances of proving a violation of contractual representations and warranties. Moreover, if not only actual knowledge but also knowledge that a reasonably prudent or diligent person should have had were to lead to contractual liability, the greater the potential for liability against the seller.
Practical difficulties can arise when officers and directors of the target company who certified the accuracy of representations in the PSA remain employed by the buyer after closing, as it becomes difficult for the buyer to allege that the seller knew, or should have known, the representations were not correct. Another aspect to consider is that knowledge within a target company may be subject to special confidentiality restrictions and thereby not accessible or usable by either sellers or buyers in an M&A deal. This holds especially true for supervised entities, such as banks or other financial institutions, that are subject to statutory (banking) secrecy, but also companies with strict business and trade secrets or severe contractual confidentiality obligations.
New York law recognises the broad authority of arbitrators with respect to remedies. Remedies for breach of contract typically include monetary damages, though attorneys’ fees and consequential damages may be awarded as well if the PSA allows it. Punitive damages are typically unavailable in a breach of contract action. Although punitive damages may be obtained as a remedy in cases of fraud, the bar to recover punitive damages is typically extremely high and requires extremely egregious or ‘morally culpable’ conduct.
For breach of contract claims, ‘the ordinary rule is that it is impractical to unwind a consummated merger’ and compensatory money damages will be the typical remedy in an arbitration. Parties may obtain specific performance, including forcing a party to close or to unwind a transaction, subject to the terms of the PSA.
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 the 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. In the context of fraudulent inducement, the law puts the parties back in the position they were in before the contract.
Availability of tort claims
A party may be held liable to a contractual counterparty for tortious conduct where the tort involves a breach of ‘a duty of reasonable care distinct from its contractual obligations, or when it has engaged in tortious conduct separate and apart from its failure to fulfil its contractual obligations’. In addition, where a party has fraudulently induced a party to enter into a contract, or where a party engaged in extracontractual conduct intended to defeat the contract, a plaintiff may also assert a tort claim. Conversely, a party seeking merely to enforce contractual rights may not also bring a tort claim.
Law applicable to tort claims
While contractual choice of law provisions are generally applied to breach of contract claims, some states will not expand the scope of a choice of law provision to encompass tort claims. New York courts will typically apply choice of law provisions very narrowly, and will not interpret a choice of law provision to encompass tort claims unless the contract explicitly provides that such tort claims are covered. Other states, however, will interpret a choice of law provision more broadly to cover tort claims arising out of a contractual relationship.
Special substantive issues
The US Arbitration Act evinces a federal policy favouring arbitration. The law provides for strong, uniform and broad enforcement of arbitration agreements.
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 or bankruptcy proceedings (voluntary or involuntary), this may affect 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’. The standard of review of such determinations is broader than that applied to arbitral awards: that is, in order to set aside the decision, a party must show ‘palpable error’ or a failure to follow accepted procedures.
 Matthew J Weldon is a partner and Thomas A Warns is an associate at K&L Gates LLP.
 KPMG International Limited, Survey (November-December 2021), available at https://home.kpmg/dp/en/home/insights/2021/12/blowout-year-global-ma.html (last accessed 24 November 2022).
 Berkeley Research Group (BRG), ‘M&A Disputes Report 2022’, available at https://www.thinkbrg.com/insights/publications/ma-disputes-report-2022/ (last accessed 24 November 2022).
 See Grant Thornton, ‘M&A in a post-COVID world’ (19 May 2022), available at https://www.grantthornton.com/insights/articles/advisory/2022/ma-in-a-post-covid-world (last accessed 24 November 2022).
 The amount of committed but unallocated capital held by a firm.
 Prairie Cap. 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), 2015 WL 1209358 (N.Y. Sup. 2015) (same).
 Abry Partners V, L.P. v. F & W Acquisition LLC, 891 A.2s 1032, 1036 (Del. Ch. 2006).
 In Express Scripts, Inc., v. Bracket Holdings Corp., 248 A.3d 824 (Del. 2021), the Delaware Supreme Court held that, although parties cannot contractually disclaim liability for deliberate fraud, it is possible to disclaim liability for false statements made while in a grossly negligent or reckless state of mind.
 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).
 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).
 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).
 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” imputed to its corporate parent . . . 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).
 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).
 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.
 Seynaeve v. Hudson Moving & Storage, Inc., 261 A.D.2d 168, 169 (1st Dept. 1999).
 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.’).
 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’).
 Note that, in some states, courts will decline to enforce contractual caps on liability if it violates public policy, such as provisions that purport to immunise a party from liability for fraudulent misstatements. See, e.g., Abry Partners V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032, 1035–36 (Del. Ch. 2006).
 Cont’l Cas. Co. v. PricewaterhouseCoopers, LLP, 15 N.Y.3d 264, 271, 933 N.E.2d 738, 742 (2010); LCT Cap., LLC v. NGL Energy Partners LP, 249 A.3d 77, 90 (Del. 2021) (Under Delaware law, ‘[t]he damages available for deceit or fraudulent misrepresentation are generally limited to those which are the direct and proximate result of the false representation’).
 New York University v. Continental Ins. Co., 87 N.Y.2d 308, 216 (1995).
 Krock v. Lipsay, 97 F.3d 640, 645 (2d Cir. 1996) (‘Under New York law, in order for a choice-of-law provision to apply to claims for tort arising incident to the contract, the express language of the provision must be “sufficiently broad” as to encompass the entire relationship between the contracting parties.’); see also Audax Credit Opportunities Offshore Ltd. v. TMK Hawk Parent, Corp., 72 Misc. 3d 1218(A), 150 N.Y.S.3d 894 (N.Y. Sup. Ct. 2021).
 See Abry Partners V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032, 1047–48 (Del. Ch. 2006) (stating choice of law provision will be enforced so long as the law selected ‘has a material relationship to the transaction’ and extending scope to tort claims).
 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/
ProblemsSuggestedImprovements.pdf (last accessed 24 November 2022).
 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.