Last Thursday, the Association for Corporate Growth hosted a talk in Dallas about deals that result in a lawsuit or arbitration. Several dozen deal-makers, mergers and acquisitions lawyers, and consultants attended. The Honorable Jeff Kaplan of JAMS, Elizabeth Brandon of Vinson & Elkins, and I gave the talk. Ladd Hirsch of Diamond McCarthy organized and moderated the event. In a little over an hour, we discussed the characteristics that commonly occur in transactions that produce formal claims, offered suggestions on how deal-makers can manage the risk of earl disputes, and answered several thoughtful questions from the audience. I enjoyed the session immensely. Please see my review of the lively discussion below.
Traits of deals that produce claims
Judge Kaplan started by saying that Elizabeth and I handle commercial trial work and that the members of the audience — as deal people — would not want to meet us. I said that — as a trial lawyer who often has the job of taking apart deals that people like them put together — I do want to meet them.
I proposed that a combination of three circumstances tend to recur in deals that go bad. The first circumstance — a clash of cultures — refers to the differing styles, sophistication levels, and mores of buyers and sellers. An entrepreneur who stays with a business after a change in control as an officer or minority owner often has a hard time adapting to the systems, rules, and schedules that the new owners bring to bear in the post-closing world. Even if the founder leaves, the company may remain vulnerable to misunderstandings with the new owners.
The second trait relates to he tendency of buyers and sellers to suppress misgivings that arise during due diligence. The thing that bothers you, especially if it touches on questions of integrity and trustworthiness, probably should concern you. Pushing it out of your mind will not make it go away, and it may well provide the spark for a post-closing blow up.
Disappointment of economic expectations supplies the third trait of deals that go bad. Oil and gas firms and other businesses that depend on commodity prices have more than their share of this characteristic. But many other negative outcomes may occur post-closing and put stress on the parties’ relations.
Any one of the three circumstances will seldom by itself cause a falling out, but combining all three — a clash of cultures, nagging questions about integrity, and poor results after closing — summons a potent mix of dispute-fostering volatility.
Managing dispute risk
Elizabeth and I offered several ways in which deal-makers can lower the risk of a high-stakes dispute over an equity or asset purchase. They included these:
- Avoid calling the buyer or seller a “partner” or “joint venturer”. Those words imply special duties rather than an arm’s-length deal to which caveat emptor applies.
- Make sure that letters of intent specify in big bold letters that they do not create any obligation to close a deal and that only a definitive agreement, should one ever come about, will bind the parties to a transaction.
- Include in the final contract specific provisions about resolving future disputes — particularly WHO will decide the disputes (jury, judge, or arbitrators), WHERE the trial will take place (e.g., Delaware for Delaware entities), and WHAT rules will govern the parties’ contract and legal relations relating to it (often Delaware or New York for commerce-friendly laws).
I noted that a lawyer in a mediation recently told me his case would have two or three times as much value if could trait to a jury instead of to a judge or in arbitration.
Elizabeth pointed out that more than 90 percent of deals involving public companies generate litigation and that the lawsuits average between $500,000 and $1.5 million to defend. I added that few of the cases pose a serious threat and involve weak claims that implausibly question the terms of the deal.
I said that I love juries and believe in them deeply and worry that relegating disputes to arbitration has negative effects on the system of civil justice. I added that “juries focus on doing justice, but you may want them to enforce your contract.”
Questions from the audience
The audience asked several good questions.
One had to do with making sure that arbitration clauses included short deadlines for getting to a final decision. I said that that will work fine in most cases but that you should also include a “blow” clause for the bet-the-company case that may come along. You will want the extra time then, I assured them.
Someone inquired about integration clauses in deal contracts. Elizabeth and I both stressed that courts will enforce provisions that negate promises outside the four corners of the contract, that deny reliance on oral representations, and that waive fraud claims but that they will not reject fraud claims under a general caveat emptor approach. People who do not like how a deal turns out may resort to claims of fraud, and you should protect yourself with specific contract language.
I also suggested that lawyers who draft mergers and acquisitions contracts should consult with dispute lawyers about dispute resolution and negation-of-fraud language. The trial people have more intimate knowledge of how courts handle the relevant provisions.
I mentioned the importance of clarity and directness in drafting agreements. I noted that a lawyer recently told me that he sometimes considers creating ambiguity in a contract a win for his client. I said that that is like a third marriage — a triumph of hope over experience — and that, although I understand the strategic thought behind the tactic, it represents a clear win only for me.
We offered a plug for the Delaware court system, especially the Court of Chancery for its expertise on complex corporate and commercial matters. We praised its reliability and the high quality of its judicial officers.