Advantages of arbitration
Arbitration clauses in M&A agreements
In practice, arbitration has become the preferred method for resolving disputes arising from international mergers and acquisitions (M&A) under Swiss law. The reasons for this are, among other things, that international M&A transactions are becoming more and more complex and professional, in which numerous companies and lengthy, multi-layered contracts are typically involved.
Disputes in Swiss M&A transactions can arise from the main contracts (e.g. share purchase agreements) or side agreements (e.g. exclusive and confidentiality agreements, letters of intent, letters of intent or shareholder agreements). They generally fall into three categories of disputes:
- Pre-locking; or
- after closing.
In practice, disputes after graduation are the most common. The typical reasons for M&A disputes are listed below.
Price adjustment (including earn-out)
Price adjustments and earn-out disputes often occur after transactions are completed. Since most purchase price adjustment mechanisms are based on balance sheet items (such as working capital, net assets, net financial debt, or in some cases net assets), one of the parties – usually the buyer – must prepare the initial financial statements and the resulting purchase price adjustment calculation after the closing. Even if the agreement usually contains some information on how to determine the relevant figures and the balance sheet items they contain(1) with reference to the generally recognized accounting principles (GAAP) in Switzerland or an international accounting standard recognized in Switzerland (such as International Financial Reporting Standards), in each case as they are consistently applied by the target company over a specific period in the past or in a specific case have been applied in the financial year, many questions often remain open to interpretation. This ultimately leads to disagreements and, later, disputes.
In most cases, the sales contract provides that an independent expert determines the earn-out amount or the adjustment and that this determination by the independent expert, if one or both parties do not accept this, can be challenged in an arbitration court in Switzerland or abroad.
When determining an earn-out payment, important sources of dispute are if:
- actual key performance indicators (KPIs) of the target ultimately differ from the forecast KPIs;
- the buyer changes accounting policies or business operations after purchase, which has a material impact on the potential earn-out amount; or
- Contract terms are simply interpreted differently.
Incorrect information and warranty breaches
Vague, ambiguous, or incomplete representations and warranties in particular often lead to disputes regarding representations and warranties. In most sales contracts in Switzerland, the legal omissions (as far as legally permissible) are replaced by contractual remedies (ie in most cases in the amount of the damage resulting directly from the breach of warranties by the seller).
The buyer will usually claim that the seller is in breach of the agreement, while the seller will most likely deny such claims on the grounds that:
- the claims of the buyer are not covered by the contractual representations and warranties;
- the amount of the claims does not reach the de minimis threshold or the sum of the claims falls below the agreed basket;
- there is alternative cover for the damage (e.g. through claims against third parties or insurance); or
- the buyer was made aware of a certain issue or became aware of it as part of the due diligence process.
Fundamental error, pre-contractual failure to disclose or fraud
In close connection with claims due to deception and breach of warranties, the buyer can also demand the withdrawal and rescission of the purchase contract or the reduction of the purchase price due to material error, pre-contractual omission or malice. In the event of willful deception (including failure to disclose) the following is invalid and unenforceable under Swiss law:
- contractual waivers;
- Limitations on Remedies; and
- Restrictions on the amount of the claims (e.g. de minimis, basket or caps).
However, if the buyer was aware of the defects at the time of purchase or should have known them according to objective standards, the seller is not liable in accordance with Section 200 of the Code of Obligations. In this case, the seller is only liable if he has undertaken to indemnify and hold harmless the buyer for a certain thing or risk. In this context, it should be noted that the parties in Switzerland generally provide in the sales contract that all information provided by the seller in the data room is deemed to be disclosed, as far as an experienced buyer would be able to assess the relevant risk or the facts on the basis of a customary due diligence -Check the documents provided by the seller to determine.
Error completing a transaction
In some cases the transaction does not materialize because, for example, the buyer claims that a material adverse change has occurred or some other condition precedent has not been met. If the seller is in default with the fulfillment of his contractual obligations, for example with the measures necessary to fulfill the condition precedent, he is liable – as a rule in accordance with Section 103 of the Code of Obligations – for the damage caused by the delay. Unless otherwise regulated in the sales contract, the seller then has two options in accordance with Sections 107-109 of the Swiss Code of Obligations. He can either stick to the purchase contract and demand certain services or compensation (positive interest) or withdraw from the purchase contract and demand compensation (negative interest).
Compared to legal proceedings, arbitration has significant advantages in resolving international M&A disputes:
- Confidentiality – Unlike most legal proceedings in Switzerland, arbitration proceedings are confidential. This is a very desirable trait when resolving M&A transaction disputes;
- Expertise – the parties can choose their arbitrator (s) with the required expertise themselves, thereby ensuring that they have the necessary knowledge to resolve international M&A disputes. This is an important advantage, as judges at lower courts in Switzerland often do not have the specialist knowledge and practical experience to fully understand the specifics of complex M&A agreements and processes;
- Neutrality – in international disputes, such as such international M&A disputes, arbitral tribunals are considered more neutral than domestic courts;
- Flexibility – the parties can organize the process independently, with shorter deadlines, the language of the proceedings and the applicable law. In particular, the option of choosing English as the language of the proceedings is an advantage for foreign parties in international M&A transaction disputes compared to litigation in Switzerland; and
- Enforcement – Based on the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, arbitral awards can be easily enforced not only in Switzerland, but also in 167 other countries. This is advantageous when parties from multiple countries are involved, as is often the case with international M&A transactions.
Since time is an important factor in many international M&A disputes, especially when the completion of the transaction depends on the settlement of the disagreement, the existence of expedited or expedited arbitration, which offers shorter time limits for each procedural step, is another significant benefit of arbitration. compared to conventional Swiss court proceedings.
In the case of international M&A and subsidiary agreements under Swiss law, the parties must consider the following options when determining their arbitration clauses.
Mediation or arbitration
The parties can decide to mediate or arbitrate before the arbitration proceedings. However, if they do, it is important that the arbitration clause clearly states whether mediation or arbitration is mandatory and that it sets out the appropriate time limits and procedure.
If an M&A transaction involves multiple agreements, the parties should ensure that the arbitration clauses contained therein are identical and refer to arbitration rules such as the Swiss Rules of International Arbitration, which allow the amalgamation of related arbitrations in order to avoid multiple arbitrations before different arbitration tribunals.
Instead of ad hoc arbitration, the choice of a renowned arbitration institution such as the Swiss Arbitration Board has proven its worth. One of the advantages of institutional arbitration is the pre-established rules and procedures that ensure that the arbitration process begins on time.
Rapid and emergency arbitration
If the M&A parties opt for an arbitration institution, they can also opt for an expedited procedure by simplifying the procedure and shortening the filing deadlines. Fast-track arbitration is particularly advantageous when a quick decision (e.g. whether a material adverse change has occurred that gives the buyer a right of withdrawal) has to be made. In addition, many arbitration institutions, including the Swiss Center for Arbitration, have implemented emergency arbitration mechanisms on an opt-out basis in their arbitration rules. If parties have to deal with interim measures because they cannot wait for the final arbitration award, these mechanisms allow an emergency arbitrator to be appointed.
Due to the high likelihood of disputes in connection with M&A agreements and the obvious advantages of arbitration in resolving such disputes, tailor-made arbitration clauses that ensure efficient dispute resolution are essential components of any international M&A agreement under Swiss law.
For more information on this subject, please contact Alexander Vogel or Florian Müller at MLL by phone (+41 58 552 08 00) or E-Mail ([email protected] or [email protected]). The MLL website can be reached at www.mll-legal.com.
(1) For example, if the amount of working capital is the measure, the target company’s current assets are cash, inventories, and receivables, and its current liabilities such as common currency and other current liabilities that mature within a year.