Mergers and acquisitions (M&A) are complex transactions, often involving millions or even billions of dollars. Legal disputes can arise long after the ink has dried on the final agreement, and the consequences can be significant for all parties involved. The specific challenge can take several different forms, but the most frequent legal claim post-closing is a breach of contract. Still, other claims can include fraud, negligence, or misrepresentation. Understanding the common causes of these disputes, and their potential impact, is crucial in today’s competitive and litigious business environment.
Common Sources of Legal Disputes
1. Breach of Representations and Warranties
One of the most frequent sources of legal disputes after an acquisition involves breaches of representations and warranties. Representations and warranties (reps and warranties) are legally binding statements made by both parties in a merger and acquisition (M&A) transaction. The most frequent source of a dispute relates to the seller’s representations and warranties. The seller’s representations and warranties can include representing they (a) complied with all laws, (b) paid taxes, (c) provided
accurate financial statements, (d) disclosed all liabilities, and (e) aren’t aware of any potential litigation or regulatory issues.
If the buyer discovers that these representations were false or misleading after the acquisition closes, it may trigger a dispute over indemnification or other forms of redress. For instance, if a seller failed to disclose significant pending litigation or environmental risks, the buyer could be entitled to compensation under the indemnity provisions typically outlined in the purchase agreement. These disputes often involve complex fact- finding and legal analysis, especially when dealing with subjective claims of fraud or negligence.
2. Earn-Out Disagreements
Earn-out provisions are common in acquisitions, particularly when the buyer and seller have differing views on the future value of the acquired company. These provisions typically tie part of the purchase price to the company’s performance post-acquisition, meaning the seller may receive additional payments based on achieving specific financial or operational milestones. Some acquisitions are structured entirely using an earn-out provision with zero cash at close. Disputes often arise when there is a disagreement about whether the agreed-upon targets were met or how the targets should be calculated. Issues like accounting methods, performance measurement, and interpretation of contractual terms are frequent points of contention. These disagreements can lead to lengthy negotiations, mediation, or even litigation. In these legal disputes, its an advantage to work with attorneys who are familiar with generally accepted accounting principles (GAAP) and understand how financial statements are assembled.
3. Working-Capital Adjustment
Similar to the earn-out discussion, a working capital adjustment is common in acquisitions—here the buyer typically places a smaller portion of the purchase price in escrow, which pays to the seller based on the company’s performance over the next year. Whether called an earn-out or working capital adjustment, these disputes require financially literate counsel.
4. Post-Closing Integration and Operational Challenges
Integration issues can also give rise to legal disputes. While not inherently a legal issue, operational problems—such as failure to integrate systems, supply chains, or teams—can lead to disagreements over contractual obligations, delays in performance, or broken promises regarding the integration process. If either party feels the other is not living up to the expectations set out in the agreement, this can result in claims of breach of contract.
Integration-related legal disputes often arise when companies fail to align on key terms of the acquisition, such as intellectual property rights, customer contracts, or shared resources. Even small disagreements over these details can become significant legal matters.
How to Avoid or Address Post-Closing Legal Disputes
While it's impossible to eliminate all risks of legal disputes after an acquisition, there are steps that both buyers and sellers can take to minimize their exposure:
1. Thorough Due Diligence:
process to uncover potential liabilities, regulatory issues, and operational concerns. A well-conducted due diligence effort reduces the likelihood of surprises after the deal closes.
2. Clear Contractual Provisions:
Having clear, unambiguous terms in the acquisition agreement—particularly regarding representations and warranties, indemnities, and earn-out provisions—helps to minimize misunderstandings. Ensuring that post-closing obligations are well-defined can prevent disputes over the interpretation of the contract.
3. Dispute Resolution Mechanisms:
Including detailed dispute resolution procedures in the acquisition agreement, such as mediation or arbitration, can provide a more cost-effective and efficient means of resolving conflicts without resorting to lengthy litigation.
4. Financially Literate Counsel:
If you’re involved in a post-closing legal dispute, you must retain counsel that understands financial statements, accounting methods, and contracts to help you negotiate a resolution or to represent you in
litigation, arbitration, or mediation.
Conclusion
While acquisitions are often hailed as vehicles for growth and expansion, the legal disputes that can emerge after a deal closes are an unfortunate reality. Whether stemming from breaches of contract, fraud, negligence, or integration issues, post-
acquisition disputes can significantly impact everyone’s bottom line. The lawyers at King & Jones not only have handled these types of disputes but have the financial background to address the issues that arise in these types of disputes.