Unlike in litigation, most parties to an M&A transaction are actively working towards a shared, overarching goal. Namely, they both want to get the deal done expeditiously. However, it would be a mistake to assume that the interests of buyers and sellers are aligned in all respects.
There are many potential points of friction and dispute in an M&A transaction, including issues that arise after closing. This article highlights dispute resolution mechanisms available to resolve transaction-related disputes, along with points to consider when selecting a dispute resolution mechanism for your transaction.
Dispute Resolution – An Overview
"Dispute resolution" is the overarching term for how legal disputes related to a transaction can be resolved. There are three primary dispute resolution options, which we will address in turn:
- 1. Mediation (non-binding; outside of court);
- 2. Arbitration (binding or non-binding; outside of court); and
- 3. Litigation (binding, but subject to appeal; before a judge or a jury in court).
Many buyers and sellers who hope to take a more collaborative approach to the transaction initially lean towards mediation as the primary form of dispute resolution. Mediation is essentially a non-binding, guided form of negotiation. The parties are represented by counsel and present their position in private to a neutral mediator who then moves between the parties acting as a deal broker.
Because mediation is voluntary, there is no guarantee of a resolution at all—particularly if tensions are high negotiating in the heat of a dispute. As a result, we typically shy away from mediation as the sole form of dispute resolution for an M&A transaction. It can, however, be used in conjunction with the other methods of dispute resolution (discussed below) to narrow the points of contention and move closer to resolution, although doing so can prolong the process and increase costs.
Arbitration is a form of private dispute resolution that utilizes the services of one or more professional arbitrators to resolve the issue. Arbitration is similar to a private trial: the parties are presented by counsel, an arbitrator or panel of arbitrators—usually highly experienced attorneys or retired judges—act as private judges, ruling on evidence, hearing the parties' arguments, and rendering a verdict.
The process occurs outside of the court system and therefore has the benefit of remaining private and out of the public eye (if the parties so choose). Due to heavy caseloads and backlogs in the courts as a result of COVID-19, arbitration is also a faster path for parties in contentious disputes to have their case heard and decided by a third party in a way that can be legally binding.
This also has its drawbacks—arbitrators are not bound by the law in the same way that a judge or jury is, and therefore arbitration can be less predictable. The process moves more quickly than the court system, which means expenses are incurred in a consolidated timeframe. Depending on the dispute and the arbitration service used, it can also be more expensive than litigation and is not necessarily more efficient.
Arbitration can be either binding or non-binding, although it is rare to find non-binding arbitration in an M&A transaction given the expense and effort involved.1 Overall, for parties who are not able to resolve their conflict through mediation and need to resolve their dispute within a year, arbitration may be the favored path forward.
Litigation is the form of dispute resolution that most people are familiar with, where the parties file a lawsuit in court and have their issues resolved before a judge and possibly jury. Litigation is the "default" when the parties do not specify the form of dispute resolution in their transaction documents. The parties can also expressly agree to litigation either as the sole dispute resolution mechanism or in conjunction with one of the other options.
Litigation can be costly and time-consuming, and given court caseloads following COVID-19, even simple M&A disputes can take more than a year to get to trial. Trials can be heard in front of either a jury or a judge, although many M&A transactions expressly waive a jury trial due to the complexity of the issues (which are often better suited to a judge).
Any jury trial waiver should typically be express and conspicuous (i.e., in bold caps). It is also common for parties engaged in litigation to attempt mediation at some point in the case in order to streamline the issues in dispute.
A Note on "Forced Negotiations"
Some buyers and sellers want to include a "forced negotiation" provision in the transaction documents, where both parties agree to discuss a dispute in good faith for a certain period of time before either party can pursue one of the dispute resolution options above. The purpose of such a clause is to save the expense and headache of an actual lawsuit or arbitration proceeding, while giving the parties some time to cool off and (hopefully) find a creative solution.
When the parties are open to comprise, they do not need a forced negotiation provision to try to work things out. But when the parties are at a standstill and do not want to voluntarily negotiate the issue, then a forced negotiation provision is still likely of little benefit.
A forced negotiation clause can often be broadly interpreted and is generally difficult to satisfactorily enforce if the parties are not getting along. It also results in delay in solving the dispute, with no guarantee of a resolution. For this reason, parties should think long and hard before including a "forced negotiation" provision in their transaction agreements.
Drafting the Dispute Resolution Provision
Once the parties have agreed upon a dispute resolution mechanism in principal, the transaction documents should be updated to reflect the agreed-upon mechanism. Generally, each transaction document should be governed by the same dispute resolution mechanism (to avoid a scenario where one transaction document will be arbitrated in Oregon, for example, while another transaction document will be litigated in California).
When drafting a dispute resolution clause, the following should be considered and, if appropriate, incorporated into the draft:
- The dispute resolution clause should be very clear as to whether mediation, arbitration, or litigation is the sole method of dispute resolution, or whether numerous methods are available. It is unusual in M&A deals to use both arbitration and litigation, but it is more common to require mediation first before pursuing one of the other options.
- To ensure there is no ambiguity about the dispute resolution mechanism selected, the language should include words such as "solely and exclusively." Otherwise, the language may be ambiguous as to whether the dispute resolution provision listed is optional or mandatory.
- In the rare instances in which both arbitration and litigation are included as dispute resolution options, it is important to clearly articulate when each option can or must be used. In the M&A context, you may see certain categories of disputes (e.g., a breach of the representations and warranties) that must be litigated, while others (e.g., whether an earn-out threshold has been met or not) must be arbitrated.
Regardless of the dispute resolution mechanism selected, it is imperative that the language in the dispute resolution clause be precise and detailed so that there is no ambiguity as to how the parties must proceed.
With respect to arbitration provisions, special care should be taken in determining who the arbitrator should be. Unlike in litigation, parties to an arbitration proceeding have complete freedom to choose who will preside over the dispute.
Often, parties are given a list of potential arbitrators from the arbitration organization. The parties can select one or more arbitrators, although the more arbitrators who are involved, the more expensive the arbitration will be. The location of the arbitration may also benefit or detriment a particular party as to the cost of travel for arbitration proceedings.
As a result, the arbitration clause should explicitly state (i) the number of arbitrators, (ii) the jurisdiction in which the arbitration will occur, and (iii) the particular arbitration organization whose rules will govern the proceeding (generally AAA or JAMS).
As noted above, unlike litigation (which is typically public), arbitration can be held confidentially. To ensure that arbitration proceedings remain private, the arbitration clause should require the parties to keep all information regarding the dispute confidential.
Choice of Law and Choice of Venue
In addition to the dispute resolution provisions mentioned above, the transaction documents should clearly state which jurisdiction's laws will govern disputes. This applies regardless of whether the dispute is to be litigated or arbitrated, although it is possible the arbitrator will stray from such laws.
Likewise, the parties should select where the dispute resolution proceedings will take place. The party with the most leverage will usually try to insist on their preferred city as the location for the dispute resolution proceedings, although parties often end up choosing either a neutral location or the location in which the seller's business is located.
If the issue is litigated, the parties can also choose whether the case must be filed in state or federal court, and they can require that the case be filed in a specific county or in a certain federal district.
Although very few parties enter into a purchase and sale transaction with disputes at the front of their mind, the dispute resolution clause in the transaction documents can have a significant impact on which party walks away victorious. Given its importance, be sure to have competent legal counsel review your dispute resolution clause and custom tailor it for your deal.