Mergers and acquisitions (M&A) are complex transactions from both a business and regulatory perspective, and in many cases, they lead to legal action. The financial and reputational stakes are often high in M&A litigation, and the process often moves quickly. If you’re involved in a merger or acquisition, it is important to be aware of the legal implications.
How M&A deals can lead to litigation
Mergers and acquisitions include all transactions that consolidate two or more companies. Of course, not all mergers are created equal, and the legal implications differ depending on the size of the companies, how the companies are organized, whether either of the entities are public companies, whether the transaction is an entity purchase or an asset purchase, and whether the acquisition is pursued with or without the consent of the target company’s board (i.e., a hostile takeover).
There are two broad categories of mergers and acquisitions litigation. Pre-closing disputes happen before the transaction is complete, usually because one party to the transaction believes it has a basis to not proceed with the transaction. This may be the seller – particularly in a hostile takeover – but it may also be the buyer, if circumstances change such that the buyer no longer wants to proceed with a deal that has already been agreed to. In a pre-closing dispute, one party litigates to change the terms of the transaction or even to stop it altogether, while the other party litigates to force the transaction through. These proceedings are often expedited because there is pressure to close the deal quickly.
In contrast, post-closing disputes arise when at least one party to the merger or acquisition believes its expectations were not met. For instance, the seller might take issue with the buyer’s operation of the business during the earnout period, the buyer may allege that the seller breached a post-closing covenant, or the parties may disagree on who is responsible for a particular liability or exposure. Post-closing litigation is usually focused on monetary damages (financial compensation), although other forms of relief, including “unwinding” the acquisition entirely, may be possible in some circumstances.
Either type of M&A dispute may be heard in either federal or state court. Because most large corporations are incorporated in Delaware, a lot of M&A litigation matters are heard in the Delaware Court of Chancery.
Issues contested in pre-closing litigation
Litigation before closing is typically intended to either stop the transaction entirely or to change the terms of the transaction. For instance, stakeholders in the transaction might object to the price, flaws in the process, disclosures related to the transaction, or perceived violations of their rights.
A legal term that often comes up in M&A litigation is “material adverse change” (MAC), also known as a material adverse effect or event (MAE). Many acquisition agreements include a clause that allows the buyer to walk away from the purchase before closing if something happens that is detrimental to the value of the target company. However, there is no single set of circumstances that count as a material adverse change; rather, the definition of MAC is negotiated and defined within each contract. Litigation may be needed to resolve the dispute if one party claims a material adverse event has occurred and the other party disagrees.
M&A litigation may also involve contested acquisitions and “poison pill” provisions to avoid a hostile takeover. For instance, many boards of directors have a plan in place to allow other shareholders to buy corporate shares to stop one shareholder from acquiring a certain percentage of shares. Litigation may ensue if a shareholder believes their rights under these provisions have not been respected. Other types of M&A lawsuits may involve failure to disclose information related to the transaction or alleged violations of securities laws.
By definition, pre-closing litigation is time-sensitive because the claims need to be decided (or at least reach a preliminary resolution) before closing or a shareholder vote. These expedited proceedings require experienced and efficient counsel to divide the workload and handle all the details in a timely manner.
Issues contested in post-closing litigation
Post-closing disputes often involve claims related to balance-sheet adjustments, that is, discrepancies between the way the company or an asset is currently valued on the balance sheet versus how it was valued at closing; or claims related to earnout or purchase price adjustments, which are additional consideration from the buyer to the seller stipulated in the contract if the business meets certain benchmarks, or other adjustments to reflect changes in the target company’s financial condition that occur prior to the closing. What is at issue in these types of disputes is the amount of money one party owes the other.
Some of the issues that may come up in post-closing litigation include:
- Application of accounting methodologies to determine the value of a company or asset. If the buyer’s method is materially different from the seller’s, there may be a dispute over how much the purchased asset was actually worth.
- Which performance metrics are used to determine earnout and/or disputes about the buyer’s operation of the acquired business that might affect earnouts.
- Disputes over the buyer's and seller’s calculations of closing working capital.
- Breaches of post-closing covenants, such as agreements by the seller to not compete with the business or not solicit employees of the business.
- Breaches of representations and warranties (R&W) that set forth facts about the target company’s financial condition, assets, legal compliance, and so on. Usually, acquisition agreements stipulate that the seller must indemnify the buyer for losses suffered because of a breach (that is, the buyer lost money because the seller didn’t accurately represent some aspect of the business); there may be disputes as to whether a breach occurred or whether the breach caused the buyer’s losses.
- Disputes regarding responsibility for pre-existing liabilities or exposures, such as tax liabilities, tort claims for personal injuries, and environmental cleanup obligations.
- Disputes regarding the interpretation of contract terms, including mediation and arbitration agreements.
Resolving these post-closing disputes can be a time-consuming and costly process for both sides.
If you’re involved in a merger or acquisition, get experienced legal counsel
Buying or selling a business is never an easy process, but the right counsel can help you achieve your goals much more efficiently. Whether you are pursuing an acquisition that may involve conflict, contesting a hostile takeover, or seeking to enforce rights post-closing, you need a law firm that knows the applicable laws and has experience in high-stakes M&A litigation.
