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Navigating post-merger and acquisition disputes

January 12, 2023

This article was originally published by Finance Derivative on 16 December 2022:

Despite the restrictions that were imposed during the COVID-19 pandemic, the number of merger and acquisition (M&A) transactions globally were higher in 2021 compared to 2018. They increased by 33%, amounting to a total transaction value of USD 3.9 trillion.[1]

By contrast, according to the Institute for Mergers, Acquisitions and Alliances, the Gulf Cooperation Council (GCC) saw the highest volume of transactions in 2018 with some 433 deals. These subsequently dropped in the first half of 2022 to approximately 140 M&A transactions.[2] Some of this activity has been fuelled by the liquidity in the market and historically low interest rates.

However, with financing costs rising and the macro-economic climate becoming more challenging, acquired businesses – especially those which are highly leveraged – will be under more financial strain. One consequence of this will be more post-merger and acquisition disputes.

In the event of a dispute, it’s important to differentiate the factors contributing to the alleged underperformance of an acquired company. The impact of the Covid-19 pandemic and the global macroeconomic climate, for example, must be distinguished from misrepresentations around a business’ financial performance. This will enable the buyer to understand whether or not they are covered by the warranty provisions.

The impact of Covid-19

Consequently, when assessing the potential for warranty claims, the buyer must try to understand whether the poor performance of the acquired company is fact due to their own poor assessment resulting from the pandemic.

The global macroeconomic climate

A difficult macroeconomic climate – marked by high interest rates and soaring inflation – and geo-political tensions have also raised the risk of M&A disputes in recent years.

These dynamic market factors affect the financials of companies, putting pressure on their revenues, profits and earnings growth, and ultimately enabling performance to fall below the buyer’s expectations.

However, changes in macroeconomic factors rarely form part of the warranties provided by the seller. If a business’ due diligence did not include, for example, scenario testing for the doubling – or even trebling – of interest rates, its acquisition may be underperforming.

In addition, as inflation continues to rise, buyers and sellers should expect to see more heavily negotiated purchase prices, alternative payment methods, and longer exclusivity periods.

Extracting the macroeconomic impacts on the performance of the business post-acquisition is key to establishing whether there is any potential claim against the seller.

Accounting misstatements

The most successful post-acquisition claims invariably evidence elements of accounting misstatement or misrepresentations by the seller, such as revenue recognition and debtor recoverability.

To attract the most interest, a seller will often present the financials in the most attractive form. As such, thorough due diligence at the time of purchase will provide a clear picture of what was represented.

The challenges ahead

The COVID-19 restrictions and the tough global macroeconomic climate have impacted the level of due diligence carried out in recent M&A transactions, making it harder for buyers to quantify post-merger or acquisition claims.

Prior to commencing costly litigation, buyers should engage professional advisors to assist them in identifying the potential claims based on accounting misrepresentations by the seller as distinct from Covid-19 or macro-economic impacts on business performance.

[1] Global Data

[2] S&P Global Market Intelligence

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