Anke Meier, Noerr
This is an extract from the second edition of GAR’s The Guide to M&A Arbitration. The whole publication is available here.
In recent years, arbitration has often been criticised for its high costs and the length of proceedings. When it comes to M&A arbitration, however, another aspect can easily frustrate the parties: the alignment of parallel proceedings. According to studies conducted by the School of International Arbitration at Queen Mary, University of London, potential users of arbitration perceive that the lack of a third-party mechanism is one of the ‘worst characteristics’ of international arbitration. Since the study was first published in 2006, many leading arbitration institutions have revised their arbitration rules to facilitate multiparty disputes, the joinder of third parties and the consolidation of cases. These improvements were necessary to respond to an increasing number of cases involving more than two parties. The International Chamber of Commerce (ICC) reports that over a third of the newly filed cases in 2017 involved multiple parties, the highest figure after 2016.
Despite revised arbitration rules, it is still challenging for parties to seamlessly deal with parallel disputes that regularly arise in M&A transactions. There are specifically two contexts that typically occur in the M&A context and both require that the purchaser and seller carefully consider their choices when negotiating the arbitration clause and other provisions of the sale and purchase agreement (SPA).
On the one hand, there are typical multiparty and multi-contract situations in M&A transactions that can be addressed during the negotiations of the SPA because they arise in the context of the specific transaction, for example, where the purchaser acquires a target from multiple sellers with the SPA additionally extending to guarantors, or acquires simultaneously more than one target from the same seller or sellers through separate SPAs. The parties can handle the procedural challenges deriving out of these types of transactions rather easily if they pay careful attention to the drafting of the dispute resolution clause of the SPA or even conclude a multilateral arbitration agreement to align multiple SPAs. This requires, however, a certain attention to the dispute resolution clause, which traditionally is one of the ‘midnight clauses’ that is not negotiated with priority. Often, the attention of the parties is limited to the very basic questions of whether an arbitration clause should be used, the selection of the institution and perhaps the place of arbitration. Depending on their choices, the parties may realise only later, after a dispute has arisen, that they are not best equipped to solve the dispute efficiently. Owing to the contractual nature of arbitration, the parties would still have the right to amend or supplement an existing arbitration agreement after the dispute has arisen. Experience shows, however, that reaching an agreement on procedural issues at a later stage is unlikely, because the purchaser and the seller have conflicting interests. The purchaser in particular is well-advised to devote sufficient attention to the dispute resolution clause in the SPA to ensure that it properly addresses the specific context of the transaction, especially with respect to the choice of the applicable arbitration rules.
On the other hand, the typical substantive content of the SPA itself creates multiparty and multi-contract contexts in that potential claims between the purchaser and the seller can depend on legal relationships between the target and other parties. This usually applies to guarantees, representations and warranties given by the seller that can entail a wide variety of subjects, depending on the specific situation and particularly the target’s line of business. Typical areas regularly found in SPAs that engage third parties relate to the liabilities and material agreements of the target, the ownership of IP rights and licences, non-violation of any third-party rights and product compliance. In the event of disputes between the target and third parties relating to subjects covered by the guarantees, representations and warranties in the SPA, the purchaser often will face a situation in which it needs to pursue claims for indemnification against the seller under the SPA. The purchaser is therefore faced with parallel proceedings, involving different parties and often also different dispute resolution mechanisms.
Similar situations can arise, perhaps less frequently, out of other substantive provisions of the SPA tying the rights of the purchaser or the seller to the outcome of a legal relationship between the target and other parties. For instance, earn-out provisions or purchase price adjustment clauses can depend on certain circumstances within the sphere of the target. While situations can be manifold, this chapter focuses on the most common situations that the target is faced with third-party claims.
A third-party claim creates a different scenario from the one described above since it would, ideally, require an alignment of the dispute resolution mechanism in the SPA with those of the target concluded before, and completely independently from, the transaction. Not only will the contracts of the target date back several years but also they will show no uniform use of dispute resolution mechanisms. The target’s multiple contracts will typically contain a diverse mix of arbitration agreements referring to different arbitration rules and venues and choice-of-jurisdiction clauses. In certain areas and depending on the affected jurisdiction, the target may not even have a choice to influence the dispute resolution mechanism since the dispute is subject to the mandatory jurisdiction of specific state courts as in labour or IP disputes. Obviously, this situation is much more difficult to resolve and requires even more thought when negotiating the dispute resolution clause of the SPA.
Joinder and consolidation in international arbitration
The arbitration rules of the leading arbitration institutions address in detail multiparty and multi-contract situations, especially with regard to the nomination of arbitrators. Although many rules contain provisions on joinder and consolidation, there are no uniform standards.
The ICC was the first among the leading arbitration institutions to significantly expand the provisions on multiparty and multi-contract situations in its arbitration rules. The 2012 rules revision introduced new provisions in Article 7 et seq., which in part adopted the previous practice of the ICC Court and in part brought in innovations.
Joinder of third parties
According to Article 7.1 of the ICC Rules, a party to a pending ICC arbitration may join an ‘additional party’ by filing a request for joinder. A joinder requires, however, that the requesting party brings a claim against the additional party. It is generally insufficient to merely reserve the right to potentially bring claims against the additional party, depending on the outcome of the original dispute between the existing parties, or to pursue conditional claims. The request can only be made prior to the confirmation or appointment of any arbitrator, unless all parties including the party to be joined agree.
Most notably, a party may only request the joinder if there is an ICC arbitration agreement with the additional party that establishes the jurisdiction of an arbitral tribunal under the ICC Rules. Otherwise, the ICC Court may decide that the arbitration may not proceed against the additional party or the arbitral tribunal may decide it has no jurisdiction regarding the additional party. If there is an ICC arbitration agreement with the additional party contained in a different contract, a joinder is still possible pursuant to Article 9 of the ICC Rules. In particular, to let the case proceed against the additional party, the ICC Court must be prima facie satisfied that the arbitration agreement with the additional party is ‘compatible’ with the arbitration agreement between the existing parties and that all parties may have agreed to a single arbitration. Two ICC arbitration agreements are, for example, incompatible if they provide for a different number of arbitrators or different places of arbitration. The parties are able to rectify inconsistencies by entering into a subsequent agreement.
Under the arbitration rules of other arbitration institutions, including the Singapore International Arbitration Centre (SIAC), the Swiss Chambers Arbitration Institution (SCAI) and the Vienna International Arbitration Centre (VIAC), the provisions on joinder are more flexible. For example, a request for joinder may be filed not only by an existing party but also by a non-party wishing to participate in pending proceedings. The decision on such joinder is made taking into account ‘all relevant circumstances’, which allows flexibility.
With respect to the consolidation of two or more arbitration proceedings, Article 10 of the ICC Rules provides that the ICC Court may consolidate cases into the case that commenced first if one of the three options listed under sentence 1(a) to (c) is met. Cases may be consolidated if all parties agree or the claims in the different proceedings are made under the same arbitration agreement. Furthermore, in the event the claims arise from more than one arbitration agreement, the ICC Court may consolidate them if they are between the same parties, the disputes relate to the same legal relationship and the arbitration agreements are compatible. The ICC Court considers in particular whether the same or different arbitrators have already been confirmed or appointed.
The rules of many other arbitration institutions on the consolidation of arbitration proceedings are comparable to the ICC Rules. Under, for example, the arbitration rules of the Stockholm Chamber of Commerce (SCC), the SIAC and the SCAI, however, there is no requirement that the parties to the two proceedings be identical.
Multiparty and multi-contract transactions
In M&A transactions with multiple parties but only one SPA, there is typically only one arbitration agreement, either directly in the SPA or attached to it in an appendix. An arbitration agreement between the parties to the SPA usually includes the purchasers and the sellers and potentially further parties such as guarantors.
Multiparty contexts within the SPA
The arbitration agreement of the SPA usually enables the parties to bring multiple claims under it against multiple respondents within one arbitration. Depending on the applicable arbitration rules, cases could be consolidated if a claimant initiates multiple proceedings instead of one arbitration. Whether it is possible to join additional parties also depends on the applicable arbitration rules. If, for example, a purchaser brought a claim only against one of multiple sellers, the seller could join the others as an additional party to pursue its claims against the other sellers in one arbitration. The details would very much depend on the arbitration rules selected by the parties. Under the ICC Rules, it would, for example, be insufficient if the seller, who was named as the respondent, raises hypothetical claims against the other sellers should the purchaser prevail.
Transactions including more than one SPA
Especially complex M&A transactions can also entail multiple SPAs because, for example, a purchaser wishes to acquire from one or more sellers more than one target, potentially with the targets being located in different jurisdictions. It goes without saying that multiple SPAs should not contain different dispute resolution mechanisms to avoid different forums. It may even be worth considering a joint, overarching multilateral arbitration agreement covering all SPAs to ensure that disputes are decided efficiently. Since not all disputes will arise at the same time, the multilateral arbitration agreement should provide for the combination of different claims and counterclaims in one proceeding and solutions for the joinder of parties that are not named respondents in the arbitration that is initiated first.
Choice of the most suitable arbitration clause
In both scenarios, it may be helpful to add specific provisions on joinder and consolidation that reflect the specific circumstances of the transaction. It is, however, even more important that the parties make a deliberate decision with respect to the details of the arbitration clause when negotiating the SPA. In multiparty and multi-contract situations, the parties are well advised to conduct negotiations with a view to the content of the arbitration rules. They should assess what provisions the arbitration rules offer regarding multiparty and multi-contract situations, joinder and consolidation of cases. As described above, while all leading arbitration institutions deal with the composition of the arbitral tribunal in multiparty cases, they vary with respect to the other topics. This requires the parties to shift their assessment of the applicable arbitration rules. Frequently, the parties focus very much on the national background of an arbitration institution and perceive it as a loss in the negotiation when the arbitration institution chosen reportedly favours the jurisdiction of the other party. Also, the parties typically consider the cost structure of the arbitration institutions. While these are important factors, the parties need to look deeper into how the arbitration rules address situations of particular relevance to the individual transaction. In the long run it may be much better for a party to agree to the rules of an arbitration institution that it originally would not have chosen because of the solutions offered with respect to multiparty and multi-contract situations.
Multiparty and multi-contract contexts arising out of the SPA
In M&A transactions, the substance of the SPA typically creates situations where the purchaser has claims against the seller for the breach of obligations under the SPA on the grounds that a third party has brought claims against the target company. While the background of such claims can be manifold, these types of cases often relate to the guarantees, representations and warranties given under the SPA. All these situations involve two disputes that may not be resolved amicably but are brought before courts or arbitral tribunals, namely one between the target and a third party, and one between the purchaser and the seller (and potentially other guarantors) under the SPA.
Typical SPA provisions on third-party claims
In the situations described above two, or sometimes more disputes must be conducted in parallel with, or shortly after, each other. With respect to disputes between the target and the third party, there can be many different variations, with the dispute being subject to either arbitration or court litigation. In contrast, the SPA will typically provide for arbitration. As described above, all affected entities could enter into a new, multilateral arbitration agreement or amend an existing agreement even after a dispute has arisen. Theoretically, it would be possible to conclude a multilateral agreement combining the two disputes before one arbitral tribunal. In practice, this often will not be feasible because of conflicting interests. The purchaser in particular has an interest in aligning the cases since it wants to avoid a situation where the newly acquired target is held liable without having the possibility to hold itself harmless in proceedings against the seller. The target and the seller are not concerned so much on alignment of the cases. The target will primarily be concerned about its day-to-day business operations rather than whether the purchaser can pursue subsequent indemnification claims against the seller. The seller will mainly be interested in avoiding liability under the SPA and therefore would not mind parallel proceedings that presumably give it more flexibility in its lines of argument.
While SPAs usually contain provisions on third-party claims, they often do not state if and how a dispute between the third party and the target shall be aligned with any subsequent dispute between the purchaser and the seller. Most clauses on third-party claims oblige the purchaser to inform the seller when a third party is pursuing claims against the target. Subsequently, the purchaser has to continuously update the seller about the course of the proceedings and provide relevant information. As the case may be, the seller or the purchaser may have the right or the duty to defend the third-party claim. In this regard there is no single best practice but a number of variations. The SPAs typically also contain provisions as to which side should bear the costs of proceedings. Further, typical SPA clauses set forth whether failures to comply with any of the obligations in relation to third-party claims exclude the liability of the seller towards the purchaser.
In some cases, there are additional provisions as to whether and under which circumstances the seller is bound by the outcome of the case between the target and the third party. Such clauses are often modelled on civil law instruments in civil litigation proceedings on the involvement of third parties in such litigation. They provide for a binding effect on the seller, to the extent that the seller actually participated in the defence of the case against the third party or chose not to participate after having been given full opportunity to do so.
Alignment of an arbitration with other proceedings
The purchaser, in particular, has an interest in ensuring that the two proceedings are aligned and potential claims against the seller are not jeopardised. The measures that can be taken primarily depend on whether the proceedings are both arbitrations or whether one is a court litigation.
If the initial case between the target and the third party is brought before the courts, the applicable civil procedure rules govern whether the purchaser, the seller or guarantors can be involved. Even if the rules contain a mechanism that can bind the third party to the decision, the subsequent arbitration between the purchaser and the seller creates uncertainty. The arbitral tribunal would apply the rules chosen by the parties without being per se bound by the decision of a court. In practice, it appears likely that the arbitral tribunal would not reach a conclusion that contradicts the decision rendered by the court. This result would, however, not be based on any clear provision governing the relationship between the first and the second proceedings but on a general notion that a party would act contrary to good faith if it took a different position in the arbitration from its approach in the first proceedings.
If the initial case between the target and the third party falls within the jurisdiction of an arbitral tribunal, the options depend on whether the underlying arbitration agreements provide for the same arbitration rules. As shown above, a joinder of a third party can only be achieved, for example, under Article 7 of the ICC Rules, if all parties are subject to an ICC arbitration clause and an existing party files a request for joinder. Even if there was an ICC arbitration agreement for both disputes, the existing party must bring a claim against the additional party. This will cause difficulty in M&A transactions. The purchaser must rely on the first decision being binding on the seller. The possibility of involving the target or the third party in the dispute with the seller does not help the purchaser. In particular, the purchaser will normally not be able to assert claims against the target as required under Article 7 of the ICC Rules. Assuming there are ICC arbitration agreements between the target and the third party on the one hand, and the purchaser and the seller on the other, the purchaser must seek to join the seller to the arbitration between the target and the third party. The purchaser could reach this goal only if it assigns its claims against the seller to the target and instructs the target to file a request for joinder to add the seller, provided, however, the SPA permits the assignment of rights. Even then, the claims raised by the target against the seller may not be purely hypothetical, as Article 7 of the ICC Rules requires actual claims.
Other arbitration rules may give the purchaser and seller more flexibility to get involved in the dispute between the target and the third party by filing a request for joinder themselves. The seller, however, will have no interest in joining the dispute. Moreover, the purchaser would initially have to file a request for joinder and, after being admitted as a party, join the seller. Even if there were ‘compatible’ arbitration agreements between the purchaser and the seller on the one hand and the target and the third party on the other, a joinder that immediately fulfils the needs of the purchaser is difficult to achieve.
When the dispute between the target and the third party is subject to the same arbitration rules as the one between the purchaser and the seller, consolidation of these disputes would still be very difficult to achieve, despite improved arbitration rules. As described above, under Article 10 of the ICC Rules, a consolidation of two arbitration proceedings requires the consent of all parties. In practice, such consent will be impossible to reach in light of the deviating interests of the purchaser and the seller, but also the target and the third party. Further, cases may be consolidated if the claims in the different arbitration proceedings are made under the same arbitration agreement. This is obviously not the case with the SPA, which is limited to the purchaser, the seller and potential further guarantors. Finally, consolidation is possible under the ICC Rules if claims are brought under more than one arbitration agreement, provided that the arbitrations are between the same parties, the disputes relate to the same legal relationship and the arbitration agreements are compatible. While there would be multiple arbitration agreements, different parties are involved in the proceedings and the legal relationship would presumably be different.
Therefore the purchaser would be well advised to consider the challenges of third-party claims when negotiating the SPA and take action before a dispute has arisen by adding provisions in the SPA’s dispute resolution clause.
Impacts on the negotiation of the SPA
The parties should be aware of the challenges of multiparty and multi-contract disputes from the beginning of the transaction, although it is of course difficult to provide for future disputes while dealmaking.
During the due diligence phase, the purchaser should analyse which dispute resolution clauses the target typically used in its previous contracts. Ideally, the target will have uniformly used the rules of a specific arbitration institution. Reality shows, however, that companies often do not make deliberate choices with respect to the dispute resolution mechanism and use a variety of different clauses. If, however, the purchaser observes that the target has frequently used the same arbitration institutions – perhaps only in its material agreements – it is certainly worth considering stipulating that institution’s rules in the SPA. Although difficult, doing this would give the purchaser a better foundation for joining third parties or consolidating cases. As soon as the arbitration agreement under the SPA and under the contract between the target and the third party are heading in the same direction, there may also be better chances to reach an agreement among all the various entities to consolidate cases after the dispute has arisen. When adjusting the arbitration clause under the SPA to the dispute resolution clauses entered into by the target, the parties should bear in mind that, for example, the ICC requires the arbitration agreements to be ‘compatible’ with respect to the key elements. The parties should therefore take care not to introduce unnecessary variations.
When drafting the SPA arbitration clause, the parties should consider adding provisions regarding the potential interaction with court proceedings. For instance, the parties could clarify that the arbitral tribunal having jurisdiction under the SPA shall take into account the decisions of courts on disputes between the target and third parties that are the basis for disputes between the purchaser and the seller for purported breaches of the SPA. Any existing joinder mechanism in the court proceedings under the applicable rules of civil procedure should be honoured by the arbitral tribunal. Usually, this would depend on whether the party to be bound by the decision had an opportunity to participate in such proceedings.
Theoretically, a similar provision could also be added regarding related arbitrations, stating that awards rendered by arbitral tribunals relating to disputes between the target and third parties giving rise to subsequent claims between the purchaser and the seller shall be taken into account in arbitration proceedings between the parties to the SPA. In practice, however, it often will not be possible to involve the parties to the SPA in such arbitrations without adding further detailed provisions on how they can participate in the first dispute. The consent of the parties to the SPA to be joined in the first arbitration could be added to the arbitration clause in the SPA. In some situations, it may even be possible that all affected parties enter into a multilateral arbitration agreement.
Furthermore, when drafting the clause on third-party claims, the parties should consider implementing the binding effect of a decision between the target and the third party. Many SPAs already contain in their clauses on third-party claims a provision as to whether the seller must actively support or even take over the defence of the claims brought against the target. Rather surprisingly, many clauses end there without stating that the seller is bound by the outcome of the proceedings between the target and the third party if the seller took over the defence or refused to effect the defence after it had been requested to do so. In subsequent arbitrations between the purchaser and the seller, the arbitral tribunal would have to honour a respective provision when deciding on the effect of the decision on the parties to the SPA. Also other substantive provisions of the SPA should be assessed with a view to potential arbitration proceedings. As discussed above, the joinder may be facilitated if the purchaser could assign certain claims against the seller to the target if the SPA so provides.
Finally, as a more general note, the parties should always ensure the arbitration clause in the SPA is compatible with the dispute resolution mechanism of other agreements concluded in the broader context of the SPA. Typically, there are several other contracts between the parties to the SPA and third parties, such as escrow agents, which also create relations to the SPA. Even if these agreements do not create the highest potential for later disputes, effective dispute resolution would only benefit if there were compatible arbitration agreements.
When negotiating SPAs, the parties need to consider multiparty and multi-contract situations arising out of the transaction. Using boilerplate arbitration clauses without considering the content of the arbitration rules is insufficient. The parties need to assess which rules serve their needs best to effectively deal with multiple parties in multiple SPAs. Often, it will be best practice to negotiate a joint arbitration agreement covering different SPAs in complex transactions. This should properly address the individual challenges arising out of the structure of the transaction.
Dealing with multiparty and multi-contract situations arising out of disputes between the target and third parties that give rise to claims between the purchaser and the seller requires the parties to take particular care when negotiating the SPA. The purchaser should begin analysing during the due diligence what type of dispute resolution mechanism the target typically uses, to adjust the SPA to the target’s practice. Further, the parties should consider including provisions in the arbitration agreement that address how the arbitral tribunal shall deal with court decisions or arbitral awards rendered on disputes between the target and third parties. Finally, when drafting the provisions on third-party claims, the parties should consider adding provisions with respect to the effect of decisions in relation to third-party claims on the seller and specify under which circumstances the seller is bound by them.
Given how difficult it is to align multiple disputes arising between multiple parties out of multiple contracts, the question arises whether the parties would be better off if they refrained from using arbitration in the SPA and submitted their disputes to the jurisdiction of the courts. This would only improve the situation if disputes under the SPA and the third-party claims are subject to the courts of the same jurisdiction. This argument could only hold true for domestic transactions related to targets that also have primarily a domestic business. As soon as there is a cross-border transaction or the target is engaged in international business, it is not feasible to concentrate all disputes before the same courts. The parties should therefore continue to refer disputes arising out of the SPAs to international arbitration, provided that they make deliberate choices with respect to the details of the arbitration clauses.
Subscribe here for related content, breaking news and market analysis from Global Arbitration Review.
Covering commercial and investment arbitration, Global Arbitration Review is the unofficial broadcaster for members of the international arbitration community, keeping them feeling up to date and informed.