Navigating M&A counterparty claims in Italy

All questions

Counterparty claims

Under Italian law, the parties are required to conduct negotiations in good faith.²⁹ As a result, the parties cannot withdraw from the negotiations once they have reached an advanced stage if the other party has a legitimate expectation on their successful completion or if the withdrawal is unjustified or unreasonable under the circumstances.

Withdrawal from negotiations is legitimate when the conduct of the other party shows no particular interest in the transaction. The Court of Bologna recently dismissed a claim as the plaintiff's own conduct showed a clear lack of interest in the transaction: the plaintiff was supposed to identify a third-party assignee of a minority shareholding but did so only after many months of unjustified silence.³⁰

Pre-closing litigation in the context of M&A deals typically involves the liability resulting from interim arrangements such as a letter of intent, a memorandum of understanding or a term sheet. In general, the binding nature of such documents is assessed based on a fact-intensive analysis, and express statements regarding their non-binding nature are not determinative of the outcome of the case, to the extent that the parties had reached an advanced stage of the negotiations justifying pre-contractual liability,³¹ or even contractual liability if the fundamental elements of the transaction had been agreed.³²

Liability can be established for specific obligations that the parties agreed to assume, even in the context of interim arrangements. For example, the Milan Court of Appeal recently ruled on the effect of an exclusivity clause.³³ Two shareholders of two different companies signed a letter of intent with a fund willing to purchase their shareholdings simultaneously. The letter of intent had an exclusivity clause, preventing two sellers from selling their shares for a given time period. The shareholders then entered into two separate share purchase agreements with the fund, subject to certain conditions precedent. Following the fulfilment of the conditions precedent, one of the sellers informed the fund that he had already sold the shares to a third party, and the fund abandoned the deal. The Court ruled that the seller breached the exclusivity clause and was therefore required to compensate the other seller for the full amount he would have obtained from the sale to the fund.

Post-closing disputes typically arise from (1) the breach of representations and warranties or (2) special indemnities granted by the seller to protect the buyer against certain well-defined events (e.g., sanctions issued by public authorities, tax liabilities or product liability). Breach of representations and warranties is by far the most frequent source of M&A litigation. Indemnification claims run the full gamut of business warranties (e.g., alleging inaccuracies in the financial statements or undisclosed litigation, non-compliance with laws, infringement of third-party intellectual property rights, labour, tax or environmental liabilities).

For example, if the buyer finds undisclosed contingent liabilities after the acquisition of the target company, it can seek indemnification equal to the contingent liability.³⁴ Nonetheless, even if the occurrence of a contingent liability and the breach of the relevant business warranty are clear, the dispute may be time-consuming on quantum, and if there is court litigation, Italian courts typically defer to the opinion of a court-appointed expert.

Another stream of disputes revolves around the purchase price, in particular (1) price adjustment mechanisms and (2) earn-out clauses.

The Italian Supreme Court recently ruled that a price adjustment clause is also valid if it does not provide that the determination shall be made by a third-party expert.³⁵ What matters, in fact, is that the criteria to determine the price adjustment are clearly set out. The relevant determination could then be deferred to an expert appointed by the court.

With respect to earn-out clauses linking the payment of part of the price to the achievement of certain financial results, the Court of Rome ruled that they are fully valid, even if the buyer may be deemed to have de facto control over the financial results of the target company following the acquisition. The Court noted that the financial statements are drafted not by the buyer but by the company's directors, who are ultimately third parties with regard to the buyer and responsible for the accuracy of the information in the financial statements.³⁶

Remedies typically include compensation or indemnification for damages and losses but may extend to (1) the annulment of the contract for fraud or gross negligence when granting the relevant representations and warranties or (2) contract termination for breach (although share purchase agreements typically contain a sole remedy clause excluding the latter).

Quantification of the damages and losses is an area of particular focus. One of the controversial issues may be when the damages and losses can actually be deemed to justify compensation and indemnification. For example, in a recent case where the contractual definition of damages included 'any loss or damage to the buyer or the company', the Court of Milan held that the buyer had no right to be indemnified absent documentary evidence showing the costs actually paid from the buyer or the target for asbestos removal work.³⁷

The defence against claims for breach of representations and warranties or specific indemnification rights typically relates to (1) the existence of the breach (including on the basis of the disclosure provided at the time of the deal, through a data room or otherwise) or the indemnification right, (2) applicable time limitations for bringing the claim (based on the share purchase agreement or general rules of Italian law) and (3) quantum (including contractual limitations thereto).

In recent times, M&A litigation has also seen the impact of the covid-19 pandemic and the conflict between Russia and Ukraine (including the resulting EU sanctions regime), which provided specific (and rather novel) defences to parties deciding to abandon M&A deals or sellers sued by buyers whose investment expectations were frustrated.

Many M&A disputes, especially high-value ones, are resolved through arbitration. Following a recent reform of the Italian rules of civil procedure, starting from March 2023, arbitrators are empowered to grant interim measures, if the parties granted them this power (including indirectly, by agreeing to the application of institutional arbitration rules contemplating this power).³⁸

Interim measures ordered by arbitrators may be challenged before the Court of Appeal, but only on grounds similar to those available for the annulment of arbitral awards, or in cases where the relevant interim measures are contrary to public policy.³⁹

A recent issue arising in the context of M&A disputes concerning the breach of representations and warranties is the possible impact of warranty and indemnity (W&I) insurance.

W&I insurance with the typical features of the common law systems is increasingly considered in the context of M&A deals in Italy, without much thought being given to its compatibility with Italian mandatory law provisions. A problematic example is the clause providing for termination of the policy if the declarations made by the policyholder are inaccurate, irrespective of their relevance for the correct assessment of the risk and without differentiating the remedy based on the degree of fault of the policyholder. According to Italian mandatory law provisions, termination may be sought only in cases of wilful misconduct or gross negligence.⁴⁰