The Hindu Business Line : Delay and dispute in M&A deals

Mergers and acquisitions (M&As) are slowly turning out to be painfully long, and most of the times burdened with disputes in one form or the other. Let's first take a local example: After negotiations stretching over 50 days, Reliance Communications and South Africa's MTN Group ended talks that could have seen a potential telecom powerhouse emerge. Even as the media and analysts try and discover the corporate `whodunit' behind it all, many are left to wonder what happened to the times of deals such as Ranbaxy-Daiichi or even Hindalco-Novelis, which sailed through in comparison.

Internationally, the hoopla over who will acquire Yahoo! saw a new `window' open, as on the eve of a release of its latest earning figures the Internet company gave corporate raider Carl Icahn three seats on its board of directors. This happened after Microsoft pulled out its offer on May 3, saying Yahoo! refused to budge despite a bid sweetened to $50 billion!

What seems to be the problem in these potential deals? "Recent experiences in more mature M&A markets (mainly continental Europe and the US) show that transactions concluded in these geographies either go through a lengthy negotiation process or a formal dispute resolution process with respect to purchase price after the deal has been signed," says Mr Srikant Krishnan, Partner, Ernst & Young.

Disputes are on the rise - especially when one of the parties to a transaction is not well-advised or does not have prior experience of dealing with sophisticated M&A players, adds Srikant who has about 13 years of M&A transaction experience.

While 2007 was a great year for M&A chroniclers, this year has seen far too many failures.

"Given the increasing number of overseas acquisitions by Indian companies, the risk of running into `bad deals' cannot be ignored from a contractual perspective. This risk is greater when dealing with sophisticated sellers, especially financial sellers," Mr Krishnan told Business Line over an email interaction.

If you haven't disputed the purchase price and tried to extract the maximum out of the deal you haven't done your job, is what bosses direct their M&A heads.

To find out why deals fail, why disputes arise and why M&A bosses lose hair faster, read on.

Edited excerpts from the interview:

Many a time, we see headlines announcing that M&A parties don't agree to an earlier decided price. Isn't that unfair? One side must be taking advantage of the other.

Disputes can be of various types and can arise at various stages of the transaction. Disputes can be relating to purchase price adjustments. A price adjustment may be needed for various reasons, such as difference in value due to passage of time between signing and closing a deal, price adjustment for change in assumed fundamentals of the business, debt-free cash-free price and/or sellers' restrictions.

Passage of time, how does it change a deal?

A transaction usually goes through several phases from the initial contact between the buyer and the seller till the time the deal is closed. The delay could be for various reasons, for example, regulatory approvals, putting transition agreements in place, etc.

Till the actual exchange of consideration and title takes place the seller is in a position to influence the value change, while the price agreed to by the buyer at the time of signing the agreement is usually adjusted for any change in value of the business. Change in value is commonly measured on the net assets or variables thereof which form part of financial statements.

Can a target company say that fundamentals have changed and consequentially demand an upward revision in the acquisition price?

Price adjustment for change in assumed fundamentals of the business is a common reason for disputes during M&A. The basic theory discussed above remains the same. However, instead of using financial statements as a reference to net assets, the adjustment may be based on certain key value drivers of the business. For example, value drivers can be the customer base, assets under management (for banks), etc.

Tell us about the `debt-free cash-free price' angle that you said is one of the reasons for M&A disputes.

Assuming a `no cash and no debt' scenario on acquisition, the buyer offers a price to the seller, which is termed as a `cash-free debt-free' purchase price. If the seller leaves any debt or cash in the business on date of acquisition, the purchase price is accordingly adjusted.

Can sellers impose or have restrictions?

Usually, parties agree that there will be no material changes to the business from the signing date to the closing date (when the consideration and title are exchanged). If this practice is to be believed then price adjustments should be restricted to known, immaterial changes that are customary in the normal course of business. However, in reality, price adjustments are still significant.

What happens when the premium is locked in?

A price adjustment mechanism is commonly found in contracts to adjust a given basic price based on the seller's representation of the business and buyer's understanding of the business based thereon. The underlying principle being the amount of premium (or discount) that the parties have agreed to has been agreed and `locked in'.

Any change in value between signing and closing should in theory be mirrored by change in price; or in other words the change in value of business (between signing and closing) should not change the premium that has been agreed upon.

It only sounds natural that any price adjustment mechanics must be tuned to the aforementioned rationale; that is, it should not disturb the agreed premium between the parties.

However, in practice, aggressive/professional sellers or buyers may use contractual terms to define purchase price adjustments to actually claw into the premium or discount that has been originally agreed with.

Recently we saw an instance where the acquirer and target company disagreed on facts. The target company was accused of asset-stripping when it wanted to sell a `less-profitable' business. Are such disputes on facts common?

Disputes relating to facts are settled upon establishment of facts and it may be a matter of time before this can be established.

For example, if a customer files for bankruptcy, it needs to be determined if he pays his dues. The contract between the parties may have a clause that a bankrupt customer's receivable will be adjusted from the price. In this situation a factual determination needs to be made whether the customer is indeed bankrupt at the date of closing. What about disputes relating to agreed terms? Is there a problem in understanding?

Disputes arising from ambiguity while drafting contracts may lead to different interpretations and are often subject to a time consuming resolution process. In such situations even a formal resolution process may not be able to reach proper conclusion.

Example: A contract contains a clause that the value of assets at the date of acquisition (closing date) will be determined in accordance with the generally accepted accounting principles (GAAP). There is no clarity in the contract on the GAAP (US GAAP or the Indian GAAP, for instance) and hence both parties dispute the basis on which the value of net assets should be determined at closing and, accordingly, the amount of price adjustment to be settled.

What are the steps that could be taken to ensure deals are sealed much faster and smoother?

Certain steps need to be undertaken to ensure a smooth and speedier deal closure. One needs to carry out a background check on the party you are dealing with and understand if they have a litigious past/are they known to haggle over purchase price adjustments; many global companies have developed a negative list of sellers.

We need to ensure shorter time lines for deal closure, outline the objective of purchase price, lock in premium assumed on the deal - include no double-dip clauses and last, but not the least, word the contract carefully leaving no room for ambiguity between the parties.

D. MURALI

KUMAR SHANKAR ROY

(Illustration by R. Rajesh)

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