Looking back at the strongest M&A market in history and the conflicts that have arisen.
2021 was a record year for mergers and acquisitions (M&A). Driven by high valuations and ample liquidity, the global total value of all deals reached an all-time high of $5.9 trillion, up 64% from 2020. Since then, headwinds from geopolitical turmoil, and a continuing inflationary environment have surprised many. Recession fears have slowed M&A activity to pre-pandemic levels last seen in the first half of 2019.
Despite the slowdown, the effects of the market frenzy of 2021 are still being felt through a flurry of post-acquisition disputes. These controversies are actually a continuation of some trends that have been developing for several years. Here are four.
Trend 1: High ratings, greater scope for disappointment
A period of exceptionally high valuations does not necessarily mean that markets, or individual acquisition targets, are overstated. However, high-value deals mean an increased scope for disappointment by the parties to the transactions. Buyers are disappointed when the acquisition target is less than the expected returns priced in the bid. Sellers can be disappointed when a significant shortfall against expectations results in lower than expected dividend payments. Disappointment breeds disagreements.
Trend 2: An accelerating trend of dispute arbitration
Most private M&A disputes arising from an exceptionally strong market are resolved in arbitration. According to one recent estimate, over 75% of SPAs have arbitration clauses.1 Arbitration institutions, moreover, report that shareholders, stock purchases, or joint venture agreements account for a large part of the caseload. For example, these types of agreements accounted for 14% of cases administered by the London Court of International Arbitration in 2021.2
Overall, arbitration has experienced consistent, long-term growth over the past decade. FTI Consulting recently estimated that international arbitration filings worldwide grew steadily at more than 3% annually from 2010 to 2019, and increased by 9.9% in 2020.3 A record period of mergers and acquisitions, which has already led to related disputes, has accelerated the rise in the popularity of arbitration and put M&A disputes among the more relevant types in the recent past.
Trend 3: Higher Warranty and Indemnity Insurance
Warranty and Indemnity (W&I) insurance is intended to protect the parties from loss arising from breaches of representations and warranties. W&I insurance can provide sellers a “clean” way out. The insured party is compensated for the claims covered by the insurance company. Traditional W&I policies cover some of the warranties that are included in the SPA. Newer forms extend coverage to “completely synthetic warranties,” where the buyer can get protection for matters that the seller cannot or cannot guarantee.
In recent years, W&I insurance has experienced significant growth, and many beneficial innovations associated with W&I insurance have become an important aspect of M&A transactions. According to American Bar Association studies of private merger and acquisition activity within the United States, the percentage of deals that mentioned representation and warranty insurance (RWI), the American term, grew from 29% in 2017 to 52% in 2019 to 65% in 2021. .4 Similarly, 2021 saw an increase in insured transactions in European markets, especially for high-value deals in the UK.5
W&I insurance has introduced new complications in many merger and acquisition disputes. For example, differences in indemnity clauses in a SPA and equivalent clause in an insurance contract can mean different approaches to assessing damages in relation to the same alleged infringement. Synthetic warranties, which cover matters that the seller will not guarantee (and thus remain outside the SPA), can lead to additional complications.
Trend 4: The growing importance of third-party financing
Third party financing is the financing of litigation or arbitration by an unrelated institution, often a specialist financier. The financier generally receives a share of any payments (otherwise financing arrangements can be flexible). Third party financing has been around for decades but has grown rapidly in recent years, and across many types of disputes. One indication of the increasing importance of litigation finance is the increase in use of the term in publications as shown in the chart below.
Analysts expect more significant growth. According to one estimate, the global market was valued at US$11.5 billion in 2019 and is expected to grow to US$24.1 billion by 2028.6 Very common in investment arbitration or class action lawsuits, third party financing is also used to finance M&A related disputes. Financiers’ approaches to financing decisions influence M&A disputes in different ways. Funders are very selective about the disputes they fund, and tend to involve specialized experts; Moreover, the arbitration process can be more tightly regulated than for those without funding.
As the second half of 2022 begins, it will be interesting to see how this year’s headwinds continue to affect M&A activity. The fallout from the exceptionally active 2021 market is expected to continue to shift to a greater number of post-M&A disputes, and the trends identified above will remain relevant.
1: Elsing/Pickrahn/Pörnbacher/Wagner, Merger and Acquisition Disputes Before DIS Arbitral Tribunals (CH Beck, 2022), p. Fifth
2: LCIA Annual Business Report 2021, available at https://www.lcia.org/LCIA/reports.aspx
3: International Post-Pandemic Arbitration, FTI Advisory Report – Published March 2022, 3.
4: American Bar Association, Point Studies of Special Targeted Acquisitions and Mergers (2017, 2019 and 2021).
5: CMS European M&A Study 2022, 55, 56.
The content of this article is intended to provide a general guide to the topic. It is recommended to take the advice of specialists in such circumstances.