How to mitigate litigation in an M&A process

Merger and acquisition (M&A) transactions are complex transactions that, despite their benefits, carry an inherent risk of litigation. In this article, we will explore the main causes of M&A litigation and provide proactive strategies to prevent it and mitigate its effects.

M&A processes are prone to generate litigation. Possible causes include: contingencies detected in a due diligence process, breach of representations and warranties, erroneous valuation of the asset, post-closing conflicts or changes in market conditions.

Why is this important for SMEs?

SMEs, being smaller companies, tend to have fewer resources to deal with lengthy and costly litigation. Therefore, preventing conflicts is even more crucial for them.

Key points to consider:

• A detailed analysis of the company to be acquired is essential. It should cover financial, legal, operational and commercial aspects.
• All agreements and understandings must be in writing. This includes letters of intent, memoranda of understanding and, finally, the final contract.
• Communication must be open and honest from the start of negotiations. Avoid ambiguities and false expectations.
• Having an M&A lawyer is essential to identify and mitigate risks.
• Implementing a solid compliance program helps prevent behavior that could generate liability.

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In order to mitigate the risk of future conflicts in the purchase or acquisition process, the documents should focus on the following aspects: representations and warranties (R&W), specific indemnities, W&I insurance, and the impact of the buyer’s knowledge on the seller’s liability.

• Declarations and guarantees are given by the seller with respect to the business of the acquired company, and their breach can generate compensation for the buyer. The buyer must ensure that the declarations and guarantees include the essential aspects of the company.
• Specific indemnities are indemnity instruments to cover risks known prior to the signing of the contract, where the seller assumes the negative economic consequences associated with specific contingencies. To activate this coverage, the buyer must prove the damage and the causal relationship.
• W&I insurance (R&W insurance) has increased its use in M&A transactions, covering unknown contingencies, although there is coverage for known contingencies with higher premiums. This insurance can be without recourse to the seller or with recourse, depending on the agreed thresholds and limits of liability. It is important to coordinate the policy with the purchase agreement and to analyze the seller’s liability not transferred to the insurer.
• The buyer’s knowledge of possible contingencies may affect the seller’s liability, with express provision for whether or not the knowledge affects the seller’s liability. It is advisable to negotiate a reduction in the price or to agree a specific indemnity if a relevant contingency is detected during due diligence.

Conclusions

M&A litigation can have significant consequences for the companies involved. However, with proper planning and legal advice, it is possible to prevent or mitigate these risks. By implementing proactive strategies and having an experienced legal team, companies can maximize the success of their M&A transactions.

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