This article is an extract from GTDT Swiss M&A 2022. Click here for the full guide.
Litigation versus arbitration
In the majority of M&A transactions in Switzerland, the parties choose arbitration over litigation. There are many reasons for this.
To begin with, arbitration allows the parties to appoint arbitrators with the qualifications (eg, in corporate law, accounting, etc) and experience (in negotiating M&A transactions, resolving complex commercial disputes, etc) the parties consider necessary. Given that few high-stakes M&A disputes end up in state courts, judges rarely have comparable levels of experience.
Arbitration is flexible. It allows the parties to tailor the procedure to their particular needs. As long as the parties agree, there are few limits to what they can do in structuring the proceedings. They can choose the language of the proceedings, the number of submissions, the duration of time limits, the availability and extent of document production, the degree of confidentiality, etc. In arbitration, parties generally have more control over the proceedings, particularly regarding the taking of evidence. They can submit written witness statements and expert reports, and they can cross-examine the other party’s witnesses and experts. In contrast, in litigation, the court controls the taking of evidence. Witnesses and experts are heard only if the court allows it. Also, only court-appointed experts may give expert testimony, and the parties have no right to cross-examination. Normally, the judge examines the witnesses, and the parties may ask a few additional questions if the judge permits it. In addition, in most Swiss courts there is no verbatim transcript of the hearing. Instead, witness depositions are only summarised by the court in the minutes of the hearing. The summary made by the court rarely conveys the exact meaning, nuances and subtleties of what the witnesses say. Witness testimony in state-court proceedings can thus be extremely frustrating.
Arbitration is less formalistic. In state courts, it can be difficult to obtain full compensation in commercial cases involving complex damages calculations.2 Even though, as a matter of law, the substantiation requirements and evidential burdens are not materially different in litigation and arbitration, courts tend to apply these rules more strictly and in a manner that, at times, may insufficiently take into account the complexity of the case.
Arbitration and its users are also more up to date with regard to modern technologies and how they are used in the M&A process. Most courts still use paper submissions, though electronic submissions are gradually becoming more common.
In addition, in arbitration, the procedural calendar is more predictable. At an early stage in the proceedings, arbitral tribunals consult the parties and devise a procedural timetable that includes all major steps in the arbitration. This includes not only the dates for the parties’ submissions, but also the hearing date, and frequently an indication of when the parties can expect the final award. Such predictability is rare in Swiss state-court proceedings, where party-agreed procedural calendars are unheard of. Instead, courts set deadlines in reaction to the parties’ submissions. Swiss courts have considerable discretion as to how to organise the proceedings and they rarely consult the parties before they exercise their discretion. This can lead to substantial delays in the proceedings, depending on the court’s own agenda and workload.
Speed and finality are also important aspects. While the duration of a typical M&A arbitration rarely exceeds two to three years, it is not uncommon for similar disputes in Swiss courts to take longer in the trial court alone, not even considering the duration of an appeal. In arbitration, however, the arbitral award is final and enforceable from the date of its notification to the parties (unless suspensive effect is granted on appeal). Arbitral awards are not subject to appeal with full review of facts or law. Instead, there are only limited grounds on which arbitral awards can be challenged, largely for procedural errors.
Finally, enforcement aspects are important and must be considered as well. In an ideal world, the losing party would comply and promptly pay what is stipulated in the award. Alas, in reality this is rarely the case. Often, the prevailing party must take steps to enforce the award. For cross-border transactions involving parties in different jurisdictions, arbitration has a clear advantage over state-court proceedings in this respect. Indeed, at the time of writing, 169 countries were party to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards signed in New York on 10 June 1958 (the New York Convention). All major jurisdictions are party to the New York Convention, including all European countries and the United States. The New York Convention facilitates arbitration in two respects: First, it guarantees that the arbitration agreement entered into by the parties will be recognised and enforced by the courts of member states. This prevents recalcitrant parties from defeating the dispute mechanism agreed by the parties by initiating court proceedings in their home jurisdiction or in another favourable jurisdiction. Second, it guarantees that the arbitral award will be recognised and enforced in the member states. By contrast, as we shall see below, treaties facilitating the recognition and enforcement of state-court judgments are rare.
Arbitration is sometimes perceived as an expensive means of resolving disputes. That is not necessarily the case. In some instances, arbitration can be cheaper than state-court proceedings, if only because challenges against the arbitral award are more limited. One effective way of keeping the costs under control is to opt for institutional arbitration, that is, arbitration administered by an institution, such as the International Chamber of Commerce or the Swiss Chambers’ Arbitration Institution (see ‘A few words of advice for M&A dealmakers’). The arbitration rules of such institutions determine in a precise way the costs of administering the case, and cap the arbitrators’ fees, thereby providing predictability. Other options include appointing a sole arbitrator rather than a three-member tribunal, agreeing to an expedited procedure, or, where appropriate, agreeing on limited document production.
Even though arbitration is the preferred means to resolve M&A disputes, occasionally some cases still end up in the court system. The reasons for this can be manifold.
Certain disputes are practically only decided in the courts, such as challenges of shareholders’ resolutions to approve or disapprove a merger, or appraisal law suits (actions in which shareholders submit their shares for valuation to the court rather than accepting the deal price).3 In other cases, litigation is chosen because the party with more bargaining power has imposed it on the other. The practical difficulties for claimants, who bear the burden of proof, to obtain damages awards in complex high-stakes disputes may work to the advantage of respondents. The seller may thus attempt to impose state-court litigation on the buyer in the hope that it will make the buyer’s life more complicated in the event of a dispute.
Not all state-court cases are created equal. Much will depend on the court and how experienced it is in resolving M&A disputes. Parties generally prefer, when they have a choice, courts with experience in commercial disputes in economic centres over smaller courts in rural areas, which may not be equally experienced and have fewer resources.
Most commercial cases are decided in one of Switzerland’s main commercial hubs: Zurich and Basel for the German-speaking part of the country, and Geneva for the French-speaking part. Commercial courts in other cantons (Aargau, St Gallen and Berne) also regularly decide commercial disputes. The Zurich Commercial Court has the highest caseload in the country and enjoys a reputation as being business-minded and pragmatic. It is composed of judges (lawyers) and commercial judges with in-depth experience in specific business segments such as banking, insurance, auditing, construction, etc. The Zurich Commercial Court has a high success rate in facilitating settlements. The majority of cases before the Zurich Commercial Court end in a settlement, voluntary withdrawal or claim recognition by the defendant. When cases are not settled early, the Zurich Commercial Court tends to decide based on the documents before it, rarely ordering witness testimony or expert evidence.
In contrast, Geneva does not have a commercial court, and commercial disputes are decided by the ordinary court of first instance. Complex cases, however, are assigned to experienced judges. Contrary to the Zurich Commercial Court, witness testimony is common in Geneva. However, as mentioned previously, witness depositions are only summarised in the minutes of the hearing, and much of what witnesses say is lost in the process. In addition, contrary to arbitration, counsel for the parties are essentially prohibited from talking to potential witnesses prior to the witness hearing. Witness hearings are therefore much more unpredictable compared with arbitration because the trustworthiness and actual knowledge of the witness cannot be assessed in advance of the hearing. This typically leads legal counsel in state-court proceedings to avoid relying on witness evidence, or at the very least limit witness evidence to what is strictly necessary, such as when no other means of proving certain facts are available.
As mentioned above, treaties facilitating the recognition and enforcement of state-court judgments are rare. The Hague Judgments Convention was concluded in 2019 but has not yet entered into force. In March 2022, the Swiss Federal Council announced its intent to sign the Hague Judgments Convention.
One notable exception is the Lugano Convention, which applies between the European Union as well as Switzerland, Norway and Iceland. Between those countries, judgments are easily and swiftly enforced pursuant to a largely uniform set of rules. Outside of those countries, however, the recognition and enforcement of a Swiss court judgment will be entirely governed by local law, with unpredictable results. The risk is high that the losing party will seek to challenge the Swiss judgment and relitigate the case before the local enforcement court. If, foreseeably, the judgment may need to be enforced in a country outside the European Union, Norway or Iceland, where no international instrument applies, then state-court proceedings are not recommended. Contrary to widespread belief, state-court proceedings are not necessarily cheaper than arbitration. Much will depend on the amount in dispute and the issues at stake, as well as the number of levels of appeal. For smaller disputes, state-court proceedings may end up being cheaper, even when taking appellate proceedings into consideration. For larger disputes, however, the court costs – which are set in proportion to the amount in dispute – can climb rapidly. One additional thing to bear in mind with state-court litigation is that the amount of attorney’s fees granted to the prevailing party does not necessarily cover that party’s actual legal representation costs.
In M&A disputes, parties frequently combine arbitration or litigation with other means of dispute resolution or prevention.
This includes expert determination. The idea is to outsource disputes relating to certain technical issues, such as questions of accounting, to an accounting or industry expert, without going through the process of an entire arbitration. Expert determination is often used in connection with purchase price adjustment mechanisms. But, as always, the devil can be in the detail. Sometimes the exact delineation of tasks between expert and arbitrator is not clear. This requires attention and care in formulating expert determination and arbitration clauses. Parties tend to prefer locked-box transactions precisely to avoid disputes related to purchase price adjustments. Another mechanism frequently seen in practice is multitiered dispute resolution clauses.
Such clauses can come in different forms. The idea is to provide several steps to help settle or narrow the dispute before the parties resort to arbitration. That is why the first step or tier involves either negotiation, conciliation or mediation. It can also provide that both sides should first escalate the matter internally, say to the CFO or CEO, and only after a negotiation or cooling-off period can the next step be taken. The Swiss Federal Court recently held that omitting certain mandatory steps in a multitiered dispute resolution clause does not necessarily deprive the arbitral tribunal of its jurisdiction; rather the tribunal should as a rule stay the proceedings and allow the parties to complete the step that was omitted (DTF 142  III 296).
Settlement facilitation by arbitrators is another option. By way of example, article 19(5) of the Swiss Rules of International Arbitration (2021) provides the following:
With the agreement of each of the parties, the arbitral tribunal may take steps to facilitate the settlement of the dispute before it. Any such agreement by a party shall constitute a waiver of its right to challenge an arbitrator’s impartiality based on the arbitrator’s participation and knowledge acquired in taking the agreed steps.
Settlement facilitation has a long tradition in Switzerland. Against this background, it should not be surprising that a considerable number of M&A dispute settle.4 But this is true not only for M&A disputes. High settlement rates are common across all types of disputes. According to the latest available statistics of the Swiss Chambers’ Arbitration Institution, from 2004 to 2019, 588 cases ended with final awards, whereas 490 ended with either a settlement, withdrawal or termination.
On 1 January 2021, the Swiss Parliament enacted the revised Chapter 12 of the Swiss Private International Law Act. The amendments made to Chapter 12 selectively adjust and amend statutory rules on international arbitration and further strengthen Switzerland’s position as the premier venue for arbitration. Geneva and Zurich are today among the world’s leading venues for international commercial arbitration. One of the most salient features of the revised act is that challenges of arbitral awards before the Swiss Supreme Court can now be made in the English language. Exhibits can also be filed in English, without the need to provide a translation. The Supreme Court will, however, render its decision in one of Switzerland’s official languages (German, French or Italian).
New legislation has been proposed with regard to state-court litigation. In February 2020, the Swiss Federal Council issued a bill to amend the Swiss Civil Procedure Code. One of the primary goals of the bill is to facilitate the enforcement of rights by lowering cost barriers (particularly the amount the courts can ask as an advance for costs, which today is higher than in most other jurisdictions in Europe). The bill also includes proposals to allow parties to choose a commercial court for international disputes, and to allow cantons to provide for English as the language of the proceedings. Parties should also be able to use English in appeals before the Swiss Federal Court if they used English in the cantonal court. It remains to be seen whether the bill will become law. If it does, it will significantly increase the attractiveness of the Swiss Commercial Courts for international disputes, including for M&A disputes.
Overview of common M&A disputes in Switzerland
M&A disputes can arise in all phases of the deal: pre-signing, between signing and closing, and post-closing.
Pre-signing disputes are not very common. Under Swiss law, the parties are in principle free to end negotiations at any time so long as they have not acted in bad faith. This is a high threshold that is difficult to prove. Even if bad faith can be proven, compensation is typically limited to reliance damages (the economic position quo ante).
Confidentiality covenants may sometimes give rise to disputes. In merger negotiations, sharing business secrets with a potential buyer may be a risky business, particularly when that buyer is a competitor. It is impossible to un-disclose a secret once it is out. Therefore, such disputes typically focus on the right amount of compensation.
Disputes for failing to close
Disputes between signing and closing often relate to conditions precedent (eg, merger control approval) or covenants (obligations to ensure or avoid certain actions until closing) set forth in the transaction document. Disputes over such issues can occur, for example, during a financial crisis or if one of the companies becomes financially distressed and fails to close. But such disputes are not common. This is because, in this phase of the deal, the parties’ interests are still aligned and both want to close the transaction. Where closing fails, however, this can have significant consequences. In a recent major arbitration, the transaction failed to close and the seller had to sell the target at a significant discount, after which it sued the buyer for failing to fulfil the covenants. The case eventually settled.
The majority of M&A litigations in Switzerland involve post-closing issues. In such disputes, the purchasing party realises or suspects that it did not receive what it was entitled to expect.
Price adjustment disputes are quite common. In many cases, the parties agree to submit such disputes to experts. But experience shows that arbitration is sometimes unavoidable, particularly where issues of fact and law are disputed. Parties rarely want an accounting firm to decide legal questions of how certain accounting standards ought to be interpreted or whether the collectability of certain receivables was correctly estimated. Given that the line between the tasks of the expert and the arbitrator can be blurry under Swiss law, disputes sometimes include the issue of whether a prior expert determination is binding on a court or arbitral tribunal.
Earn-out disputes may be the most common post-closing dispute of all. While earn-out clauses may seem like a good idea in the negotiation phase, they tend to increase the risk of post-closing disputes. After closing, the seller no longer has access to the company and is unable to influence its business operations. This scenario may distort the parties’ incentives post-closing. Thus earn-out disputes often revolve around the issue of whether the buyer’s underperformance could be for reasons for which the buyer should be responsible (eg, bad business judgement or even manipulation). Swiss law will deem a condition precedent fulfilled where a party has in bad faith prevented it from occurring. Share purchase agreements often include a right of the seller to access the buyer’s books and records in order to verify earn-out calculations.
Post-M&A disputes also often revolve around alleged misrepresentations or breached warranties. Many such disputes involve issues of contract interpretation. In Swiss law, extrinsic evidence is admissible to prove the likely intent of the parties even where the text of the contract as such seems unambiguous. This is because, in Swiss law, what is decisive is not necessarily the objective meaning of the contract but the parties’ true and common understanding at the time they entered into the contract (article 18 Code of Obligations). Sometimes, the issue can arise as to what the seller and the buyer knew at the time of contracting. This, in turn, can make it necessary to look deep into the negotiation history, including the due diligence disclosures, adding to the complexity of such disputes.
In a considerable number of Swiss M&A disputes, the buyer’s inspection and notification duties may become an issue.5 Did the buyer inspect the purchased object soon enough, did it notify the seller soon enough, was the notification sufficiently detailed? Such questions regularly come up. These issues, however, can largely be avoided with careful contract drafting.
A few words of advice for M&A dealmakers
M&A transactions come in different shapes and sizes. However, whether you advise clients on M&A transactions, or whether you are the seller’s or buyer’s CEO or in-house counsel, there are a number of essential points you should keep in mind that could prevent a costly dispute or, at the very least, make things a lot easier in the unfortunate event there is one.
The infamous ‘midnight clause’
Discuss choice of law and dispute resolution from the onset. It is never pleasant to address dispute resolution mechanisms when negotiations have barely begun. Unfortunately, precisely because no one wants to contemplate the possibility of a dispute when negotiations begin, dispute resolution mechanisms are all too often discussed at the last minute (hence the term ‘midnight clause’) and given little attention, if any. This can be a grave mistake. Setting the framework for dealing with possible future disputes from the onset is just as important as discussing price and warranties, and since it is a necessity, the parties might as well do it at the very beginning of the negotiation process. There is nothing worse than discovering, after months of hard work on the terms and conditions of the transaction, that, because of differing company policies or past experience, the parties are unable to agree on arbitration versus state-court litigation, Geneva courts versus Zurich courts, or Swiss law versus English law.
Bottom line: get these (seemingly uninteresting, but crucially important) aspects out of the way from day one.
Choose a reputable arbitration institution
Parties should choose a reputable arbitration institution. The best known is certainly the International Chamber of Commerce in Paris (ICC). The ICC scrutinises each award before it is issued, which ensures quality. Arbitration under the auspices of the ICC and the ICC Rules of Arbitration is often the preferred choice for cross-border transactions.
In Switzerland, the Swiss Arbitration Centre administers arbitration proceedings under the Swiss Rules of International Arbitration.
Use the model arbitration clause
Reputable arbitration institutions such as the ICC or the Swiss Arbitration Centre provide model arbitration clauses, and you should use them. These clauses have been carefully devised and are the result of decades of experience. In other words, model arbitration clauses are tried and tested. There is rarely any benefit in departing from the model clause. Unfortunately, time and again, the parties amend the language of the model clause or add elements that are ambiguous or, worse, can defeat the entire arbitration clause.
Multitiered dispute resolution clauses (ie, clauses providing that the parties must seek to resolve their dispute amicably before initiating arbitration proceedings) can sometimes cause mischief if certain possibly mandatory steps have not been complied with. Here, too, we recommend using standard clauses such as those relating to the ICC Mediation Rules.
Another recurring example is mixing the arbitration clause with choice-of-court language taken from another contract or document. It is not rare for dispute resolution lawyers to come across arbitration clauses containing extra language saying that the parties agree on the exclusive jurisdiction of a certain state court, without specifying the relationship between the two. This can potentially result in both the arbitration and the choice-of-court clause being ineffective.
Bottom line: copy and paste the model arbitration clause and stick to it. Be wary of the other party’s seeking to modify it; it may have a hidden agenda.
Keep organised records
Keep an organised and comprehensive record of all phases of the transaction, from the first day of the negotiations to the signing of the contract. Except for disputes turning exclusively on a purely legal issue (these are rare), facts will almost always play an essential part in an M&A dispute. Having access to the relevant information and documentation can thus make the difference between losing or winning the case. It is no secret nowadays that people tend to change jobs often: in no time, those who were involved on a given transaction will have moved on to other positions and may be out of reach. It is therefore very important to keep a well-organised and comprehensive record of the transaction.
Under Swiss law, draft contracts exchanged between the parties during the course of the negotiations can be useful to show the parties’ intention on a given aspect, or how a specific clause is to be interpreted and applied. Cover emails may shed light on the parties’ understanding of a specific word they used, the scope of a representation or the extent of a particular warranty, to name but a few. The record should therefore include all documents created in connection with the negotiation phase, such as letters of intent, factsheets, offers, confidentiality agreements, document request lists, draft contracts, final contract and closing memorandum. Ideally, the record should also include all communications between the parties (ie, mostly emails nowadays). Of course, the sheer volume of communications in certain complex transactions may make it impractical to keep copies of every single email. Modern e-discovery tools and service providers may help.
Larger transactions will often involve sophisticated buyers and sellers using no less sophisticated tailor-made tools for record-keeping purposes. However, for smaller transactions, there is a simple way to keep an effective and practical record of the transaction without needing dedicated software: all it takes is creating an Excel spreadsheet and making an entry for each relevant circumstance (meeting, email, draft contract, etc), with the corresponding date, and then link the entry to a document in an associated database. If a dispute arises years after the deal was made, the only thing that needs to be done is hand over the Excel document with the associated database to outside counsel, and outside counsel will have a well-organised, chronological overview of the relevant facts, with direct links to supporting documents. The time spent in creating and maintaining the database during the negotiation process will be nothing in comparison with the savings on legal costs. This will also greatly reduce the risk of missing valuable arguments.
Arbitration is the preferred means of dispute resolution for high-profile, high-stakes M&A disputes, or disputes involving a cross-border aspect. As a premier venue for arbitration, Switzerland’s arbitration law offers the parties flexibility, predictability and finality. In some cases, however, state courts can be an alternative, especially for smaller or purely local transactions. Parties are well advised to consider the advantages and potential drawbacks of each dispute resolution mechanism and keep organised records. Consulting outside counsel early in the process may prevent issues at a later stage.