Article – When Deals go Bad

You’ve negotiated hard, worked until midnight too many times and the ink is barely dry on the contract when the litigation solicitors get a phone call. What could have gone wrong?

Although buying and selling companies is very much the domain of specialised corporate finance advisors, the experience of litigators and forensic accountants can be helpful in drafting contracts. This is because when corporate deals go wrong, it is they who get called upon to help to rectify the problems.

Typically things go wrong where there is misunderstanding, whether that be in the terminology adopted in the sales and purchase agreement (“SPA”) or when expectations are set incorrectly. The claw back in respect of the price paid can take the form of a warranty or indemnity claim or, if the SPA allows, an adjustment to consideration can be made by way of adjustments to completion or Earn Out accounts.

There are some obvious examples where the purchase price can be reduced, for example, fraud existing at the time of acquisition, undeclared tax liabilities or, if not protected during the deal, a previous owner setting up in competition. Few sellers would quibble about such obvious anomalies but there are also some less obvious issues to consider.

Accounting policies, procedures and standards

If not appropriately drafted, the interpretation and application of the hierarchy of accounting policies set out in the SPA is often a point of contention between the parties when it comes to completion accounts, and the subjectivity of accounting standards creates an ideal nesting ground for such disputes.

The most common issues revolve around how the specific policies, historical practices and accounting standards are interpreted and implemented in the completion accounts.

• Are the specific policies precise enough, or do they instead create ambiguity?
• What policies and procedures have historically and consistently been applied in the target?
• Are these policies GAAP compliant or do they take precedence over GAAP?
• What is GAAP?, Or is it left vague simply referring to “UK GAAP” (being UK
• Generally Accepted Accounting Practice)?
• Should these be the standards of the acquiror or acquiree?
• What happens when there is a fundamental difference?
• How does this impact the purchase price?

For example, a common area of contention is stock and work in progress, whether that be the stock of manufactured items or, as in law firms, the value of work in progress represented by people’s unbilled time recorded on timesheets. Some questions to be asked of both parties to the transactions include:

• What does the stock value include?
  • Is it simply the cost of purchases from third parties?
  • Is the cost of employees’ time added to this cost?
  • Is there any element of overhead included in the cost value?
  • Does the business use standard stock costing and variances?
• When is stock considered to be slow moving or obsolete and provided against How is the provision calculated?

A solution

When the parties are unable to agree a settlement between them and have reached stalemate, SPAs will typically refer to the appointment of an expert determiner who can be a forensic accountant. Expert determiners should seek information from both sides regarding the matters that cannot be agreed including documentation to support their arguments.

This is a much cheaper and less time consuming process than litigation but it still involves lawyers and forensic accountants. To some extent, it provides the parties with an element of control over the process, but not over the result. The results of a determination are binding and extremely difficult to appeal which should be carefully borne in mind. If an expert is appointed to determine a dispute it is very important to consider carefully the process that the expert is to adopt including:

• how many rounds of submissions each party is entitled to make
  the timetable for those submissions
• whether the expert is to be entitled to ask questions of the parties
• whether the expert is to give reasons for the determinations
• precisely what issues are to be determined
• whether, in addition to determining the issues themselves, the expert is to be instructed to determine how the costs of the determination should be apportioned between the parties.

Use of a forensic accountant

In our experience, it is easier and cheaper to get it right before the contract is signed. Using a forensic accountant can help identify any potential misinterpretation and ambiguity of accountancy terms used in the SPA.

A forensic accountant can also help during the completion accounts process, helping to formulate the positioning of certain items based on the accounting treatment prescribed by the hierarchy in the SPA.

It is also key to think about whether to include a dispute resolution clause whereby the parties should appoint an expert determiner if there is any dispute.