Negotiation is typically the stage at which parties are worn down, tired and fraught. The due diligence process can cause frustrations for both parties: one wondering why questions are so pedantic; the other wondering why information has not been forthcoming. Sometimes these frustrations create a motivation for parties to set demands merely to “make a point” during negotiations, or deal sponsors, tired of a seemingly never-ending process, to set deadlines.
The key to successful negotiation is to ensure emotions never get in the way of logic and that artificial deadlines do not jeopardise the careful documentation of terms.
It is important to approach negotiations with an understanding of your counterparty’s needs as well as your own and get the balance between holding on to value and managing risks, versus getting stuck on points of principle. Important questions to consider are:
- Have we agreed how purchase price and working capital adjustments will work?
- How will we agree to manage the business between signing and completion?
- What transitional services are required?
When bridging gaps or differences it is best to avoid complex solutions – what makes sense in the heat of a deal may not meet expectations in a subsequent dispute. Last minute, middle of the night drafting of terms is sometimes a commercial reality but this is scant comfort if you face a dispute arising from rushed, vague or poorly worded clauses.
When disputes arise we often see expert determinations required to decide financial clauses containing terminology or concepts with no foundation in accounting principles and insufficiently defined within the agreement to overcome this. We can often trace this to the lack of involvement of financially trained advisors in the drafting of financial terms or lack of a “cold” review by a suitably qualified person far enough removed from the detail of the drafting.
This is an important step as poor drafting can be an outcome of time pressure or the belief that the parties have a common view on what is intended. When a dispute arises, personnel may have changed and views and recollections often diverge.
A Canadian case involving a supply contract perfectly illustrates how simple grammar can be an undoing:
“[…This Agreement] shall be effective from the date it is made and shall continue in force for a period of five (5) years from the date it is made, and thereafter for successive five (5) year terms, unless and until terminated by one year prior notice in writing by either party.“
Does this clause provide the right to terminate at any time upon one year’s notice or a right to terminate only at the end of the current or a renewed five-year term? It was held that the second comma was key, allowing termination after one year.
Wording of clauses in relation to inventory and stock can be a rich source of disputes. In one example we performed an expert determination relating to “stock”, which was to be valued based on the average selling price of all stock in the previous month. However, stock included a one-off batch of consumable product that was “off specification”, deemed unsuitable for human consumption, saleable only for animal feed for a low price and for which there were no previous sales. The Seller argued that under the wording, this stock was to be valued based on the average of all stock, not this specific stock, which would result in a much higher valuation on transfer.
It may seem simple but ambiguity and mistakes, intentional or accidental, are a rich source of disputes. As far as practically possible, explicitly confirm your understanding of key clauses or seek a fresh pair of eyes to review wording and application.
Similarly, review of the completion or earn-out mechanisms is a must. We have seen many examples of mechanisms that do not make sense and an independent worked example following the wording to the letter may result in a markedly different outcome to what the parties intended.
We also caution any references to “materiality”. This is not a term that is quantitatively defined in accounting or academic literature. It is inherently subjective and is notoriously difficult to assess for an expert or a Court, meaning increased uncertainty in the outcome of the decision.
This article is part six of the ‘Transaction lifecycle’ series.