The Makings of a Modern M&A Dispute

Volatility,disruptionandfraud:
themakingofamodernM&Adispute
A RESEARCH PAPER BY
BRGBerkeley Research Group

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to identify key issues in disputes and to link
them into the quantification of damages or
investigations of fraud.
In essence, most private M&A disputes
relate to disagreement over “value”
transferred from seller to buyer at closing.
The target may be worth less than what
the buyer paid for (for example because
it becomes clear that the target’s future
earnings will be lower than expected, or
liabilities were concealed). This could be
either by accident or design.
Cross-border M&A and LBO transactions
that end up in disputes are often resolved
through international arbitration. BRG
experts often work on the quantification of
damages and forensic accounting matters
in arbitrations, including matters related to
closing accounts, breach of warranty, fraud,
and earn-out disputes. We work as advisors
or expert witnesses. Where appropriate, we
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A few weeks after closing, the target’s
management requests additional cash
to cover unexpected operating losses
$
18 months after the deal closes,the owner manager of the targetsues over his earn-out
Long-term contracts initially valued
at millions of euros discovered to be
worth a fraction of that amount
European country near the target
elects ultra right wing leader. Bond
yields move sharply
What could possibly
go wrong?
Purchaser discovers that the target
has been the victim of industrial
espionage
A whistleblower calls the purchaser
shortly after closing and mentions
social security fraud
100,000 of the target’s customer
accounts get hacked
C
H
A
N
C
E
A forensic analysis of the target’s
accounts uncovers fabricated invoices
Purchaser accountants become
suspicious about the level of the
target’s provisions
Political uncertainty causes the buyer’s
home currency to crash. Earn-out
payments become more expensive
After the transaction is signed,
but before it is closed, the largest
customer of the target decides to take
its business elsewhere
?
$

Foreword
At BRG we have seen more than our fair
share of disputes arising from mergers
and acquisitions. These disputes are time
consuming, costly and best avoided. This
paper focuses on post M&A disputes, how
they come about and some of the ways
dealmakers can avoid them.
If we had to give just one bit of advice
about how to avoid a dispute it would
be this: make sure everyone on your
team works together and communicates
effectively.
This may seem banal, but we have seen
hundreds of disputes that took place
because a lawyer forgot to share a clause
in a document with an accountant, or
because a risk expert didn’t look over an
accountant’s assumptions.
This risk of avoidable error is multiplied
in cross border disputes where local
practices differ. For example, in Europe
most deals now close using a mechanism
called a “locked box”, a practice that is
very rare in the US. Conversely,
representations and warranties insurance
has long been a common feature of US
deals, but has only recently caught on in
continental Europe.
As a result, this paper includes the
perspectives and views of many
different BRG experts from across
our global practice. We hope you find
it interesting and would welcome
your feedback.
Volatility. Disruption.
Fraud. Dispute.
Author: Heiko Ziehms
Edited by James Lumley
Thank you for the helpful comments from:
Anna Baird, Matthew Caselli, Ron Evans,
Ben Johnson, Amy Kingdon, Eric Miller,
James Rusden, Alice Sheridan and the
experts interviewed for this paper.

Interest rate environment
and the valuation of
liabilities
Debt, both on and off balance sheet, plays
an important role in M&A disputes and
fraud cases. Real interest rates have been
exceptionally low for a significant period
of time, and even negative in some large
economies. Low interest rates are causing
long-term liabilities on company balance
sheets to increase. They are creating
record pension deficits which in turn
weigh on deals. And extremely low interest
rates also affect long held practices in
valuation, both when valuing a transaction
or quantifying damages.
We focus on this in the section on debt
PAGE 16 to 18
Completion
mechanisms
All of the factors listed above have led to
disputes that BRG experts have worked on.
But where are these mistakes made and
where is the smoking gun?
For dealmakers, the deal’s blueprint is the
SPA. In M&A disputes the SPA is most
often – though by no means always – the
battleground. A key part of the SPA is the
completion mechanism.
The following article explains more.
5
Elements of a
dispute
Disruption and volatility
One frequent element of an M&A dispute
is disruption – the unexpected creeping
into a deal.
Curve-ball events often lead to breaches of
representations and warranties or alleged
material adverse effects. Surprised buyers
tend to look for reasons for their surprise,
and, because humans make mistakes,
lawyers and accountants who get paid to
uncover inconsistencies and errors, tend to
find them.
Unsurprised buyers tend not to question
the deal they have just done, and so
sleeping dogs are allowed to lie. It is safe to
assume that many breaches of warranties
and even frauds go unnoticed.
Unexpected events can impact final prices
in unexpected ways, and the world in which
we are living at the moment appears to be
one where the unexpected is increasingly
becoming a factor. The markets, as we
all know, were wrong-footed by the UK
electorate’s decision to leave the European
Union. The market volatility that followed
the Brexit vote is a testament to that.
Companies with large exposure to foreign
exchange rate movements have been
affected considerably. This type of market
volatility has found its way into valuations
of companies and measurements at
closing.
Add to that technology-induced volatility,
such as flash-crashes and hacked
customer data and it is plain to see
that there are an increasing number of
variables that can cause nasty surprises,
leading to disagreement over accounting
measurements when setting the final
price or so-called material adverse
change (MAC) events, which often lead to
renegotiations of prices after signing the
Sale and Purchase Agreement (SPA).
We discuss these on PAGE 10
Overconfidence
Human frailty and fallibility is a constant.
There have always been, and will always
be, sellers who get “deal fever” and ignore
due diligence red flags, only to regret it
later. Overconfidence in decision-making is
a major contributor to post deal disputes.
In our experience, buyers systematically
overestimate their knowledge and ability to
make a transaction a success.
Buyers who overestimate how well they
understand the target and its markets
are likely to make technical errors. They
are also likely to underestimate the
challenges they may face when integrating
their acquisition. This is why many deals
fail, disappointment may well set in after
closing, and dispute could be the result.
We highlight the perspective of a
behavioural economist on PAGE 9
Ambiguity
Even level headed sellers are likely to take
an optimistic viewpoint when preparing
their accounts pre M&A. This is to be
expected as accounting, after all, allows a
great deal of scope for judgment. Disputes
often arise where judgment goes beyond
optimism into bias and outside of
acceptable ranges of estimates.
Nowhere is ambiguity or subjectivity in
transactions more relevant than in the
target’s projections and in the accounting
for working capital and provisions.
We discuss this theme on PAGES 16 to 18
Fraud
Sometimes bias can cross into intentional
misrepresentation, and intent is what often
suggests fraud.
Fraud is particularly difficult to detect
before signing. We, however, highlight a
number of red flags. Overly complicated
documentation might suggest a fraud is
taking place. Earnings that don’t convert
into cash is another hallmark. Also, if
a seller is restricting the information it
disclosed to the buyer, it might be a sign
that they have something to hide.
Fraud most often affects revenue
recognition and the recognition of earnings
which are the basis of price.
We discuss this on PAGE 11

Learning to love completion
mechanisms
6
Whether a dispute is caused by fraud,
ambiguous wording in the SPA, or just
changed circumstances, the battleground is
often the SPA, and the devil really is in the
detail.
Anybody who has ever been involved in the
nitty-gritty of an M&A transaction knows
that they can be fraught and pressure-
fuelled processes. Principals and their
advisors (accountants, lawyers, bankers,
consultants), under the pressure of
extremely tight deadlines, must deal with
complicated technical issues that span
disciplines and workstreams. At the
best of times, the atmosphere is collegiate,
at the worst: outright adversarial.
Once the SPA is signed, closing conditions
need to be met. The closing period is
a time in which target, purchaser and
vendor continue to trade. Or maybe one of
them goes bankrupt. Management might
change. Legal disputes that the target is
engaged in may be resolved. New ones
may start. Markets might fall. Or rise.
Regulators will scrutinise the deal. Key
managers or customers may leave. Large
construction projects that the target is
engaged in may be delayed or cancelled.
The target may even be the victim of a
cyber attack. All these things can, and do,
happen.
Much can happen in weeks, months or a
year.
And then, when the closing conditions are
met, the lawyers and accountants who
worked on the SPA spring back into action
and interpret the SPA as they draw up the
completion accounts. What has changed?
What does the SPA say must be done in the
event of such a change? These are among
the reasons why completion of an M&A
deal can be extremely complex.
The transaction timeline
There are many reasons why complex M&A
transactions do not sign and close on the
same day. Transactions are often subject
to antitrust and other regulatory approvals.
Increased vigilance from regulatory
and antitrust authorities takes time.
Closing conditions are set out in the SPA.
And so, after signing, an M&A deal will
usually go into a closing period before all
the conditions are met and the transaction
closes.
The closing period is often weeks or a few
months, but can be significantly longer,
especially in highly regulated industries.
This time lag means that there is
uncertainty at signing as to the precise
balance sheet at closing. The longer the
closing period, the greater the uncertainty.
It is also difficult to predict the exact
length of the closing period at signing.
This introduces an additional source of
uncertainty.
Daily changes in the balance sheet
mean that more, or less, value could be
transferred at closing than the parties
bargained for. The parties, therefore, need
a mechanism in place to ensure that the
Signing
Closing period Post-closing
period
Closing
Intent
to do
the deal
Final
purchase
price
Diagram: Transaction timeline

7
value transferred at closing corresponds to
what the parties bargained for when they
signed the SPA.
As well as protecting the purchaser from
uncertainty, without safeguards it would
be possible for the seller, who controls the
business until closing, to “extract value”, or
for value to leak.
There are many different ways to extract
value between signing and closing,
including dividend payments, adjusting
transfer prices in transactions with
related parties or changing management
compensation. Each of these may reduce
the commercial value of the equity to be
transferred to the buyer at closing. Even in
the absence of the seller’s manipulation,
there is a rationale for protecting either
party from possible disadvantages due to
changes in the balance sheet up to closing.
A good completion mechanism means a
fair and “clean” transaction, and therefore
fewer problems down the line.
Marry in haste,
repent at leisure
There are two principal ways to deal
with the uncertainty that this causes: the
purchase price adjustment and the locked
box. There is also a hybrid approach, which
combines elements of both.
While locked boxes tend to be generally
seller friendly and straightforward in
many cases, there are good reasons to
use purchase price adjustments on many
deals. Purchase price adjustments have
more moving parts than locked boxes in
which the purchase price is fixed.
Both locked boxes and purchase price
adjustments have been used in thousands
of transactions, most of which never went
into a dispute. However, at BRG we deal
with the fallout caused in the atypical
cases where mistakes are made or
circumstances change and disputes take
place. Maybe that makes us Cassandralike,
but we prefer not to repent at leisure.
We have noticed similar patterns of
mistakes replicated in many post M&A
disputes. The following article presupposes
a level of knowledge about transactions,
and doesn’t offer generic solutions: every
M&A transaction is different. However,
there is a benefit to understanding disputes
and their typical causes.

The makings of a
modern M&A dispute

“A firm’s decisions,
including those related
to M&A transactions, are
made by individuals, and
their behavioural traits
influence outcomes.
Research indicates that
chief executives tend to
be more optimistic and
more open to risk than
the general population.
It is also a natural
tendency for people to
surround themselves
with likeminded people.
But in doing so, they
risk making themselves
vulnerable. One
important way to improve
decision-making and
avoid overconfidence
is diversity. The more
diverse the pool of
individuals involved,
the better the decision-
making probably is.
That is because diversity
combats group-think.
If you have a large pool
of people working on a
deal, but they all think
in the same way, they
all may make the same
mistaken assumptions,
and validate them to
each other.”
Dr Shireen Meer
Commerce, on the whole, likes certainty,
not volatility, disruption and unforeseen
circumstances. Yet disruption and the
unforeseen have become a disturbingly
recurring theme recently.
A year ago, the probability that 2016
would see the dual outcomes of the Brexit
referendum and the US presidential
elections as they were, would have been
considered remote by serious market
commentators. Similarly, predicting the
UK stock market bull run, or the volatility
in exchange rates that accompanied
these political events, would have been
exceptionally difficult. Such major
movements will certainly have handed
some businesses unforeseen opportunities,
and provided others with unexpected
hurdles. They will also have made some
pending cross-border M&A transactions,
for example those into the UK, more
attractive and others less so.
Besides political events, technological
developments have introduced new sources
of disruption that would have been almost
unheard of even a decade ago. Take cyber
security. Revelations that the Yahoo/
Verizon deal is facing problems following
news that Yahoo was the victim of a
massive cyber attack is another example of
a wild card event.
More generally, there haven’t been many
M&A disputes over cyber security, so
there isn’t a market in ideas yet. There is
what we call “craft ignorance” and a lack
of recognised standards. But it is fair to
assume there will be many disputes in
precisely this area in the future, and the
stakes are high.
So, what should be the response of people
like us, people who work in M&A disputes
and transaction services?
M&A disputes tend to be complicated,
time-wasting and expensive. In the context
of an M&A transaction, although we have a
good idea about where the usual hot spots
for disputes lie, we know that we can’t truly
predict what disruptive event might run a
coach and horses through our carefully,
or not-so-carefully worded drafting. This
means that we know we can’t cut corners.
In putting together this paper, we have
analysed a large number of M&A disputes
and have spoken to BRG experts across
the firm’s practice areas and geographies.
We hope that you find that each expert
interviewed for this paper brings an
interesting perspective to M&A disputes.
This paper summarises our findings and
discusses the various ways in which a
poorly worded SPA combined with the
unexpected can lead to a purchaser or
seller getting less than what they had
bargained for, leading them to seek
redress. Although we may not be able to
predict them, we are able to consider the
potential effects of “long tail” events.
First, we discuss fraud, where one party
sets out to deceive another party for
financial gain. Or, more subtly, when a
seller goes beyond “gilding the lily” and
makes fraudulent misrepresentations.
We then discuss revenue recognition, the
most common area of financial statement
fraud. Our next topic is debt, both hidden
and apparent. We then look at working
capital, an area of the balance sheet that
can be used to double-dip a buyer, either
by accident or design, and an area where
volatile real world events find their way
into balance sheets and cause surprises
that often lead to disputes. Our next topic
is earn-outs. They are a great way to
incentivise the former managers of a target
company, but equally a way to widen the
window for litigation. We then consider
transactions with a fixed purchase price,
the so-called “locked box”. Although it
reduces the risk of disputes, it has its own
quirks. Our final topic is the assessment of
damages in M&A disputes.
While this publication has a technical
focus on corporate finance and accounting
aspects of transactions, M&A disputes
have taught us the importance of “softer”
factors, including culture, overconfidence
and other cognitive biases. More generally,
the limitations of human beings to process
information play a significant role in
disputes. When volatility and disruption in
markets find their way into a transaction,
the behavioural view becomes even more
relevant. Behavioural economics has much
to say about this. We bring this perspective
into the analysis throughout the paper.
But before we go any further, we must
clearly set down what we mean by an “M&A
-related dispute”.
Introduction:
the makings of an M&A dispute
9

What is an M&A-related dispute?
10
It may seem obvious, but for the purpose
of this paper it is important to define what
is meant by an M&A-related dispute.
An M&A-related dispute is any dispute,
whether litigated, arbitrated, mediated
or prosecuted, arising from the sale of
one business, or part of one business, to
another, or a merger of two businesses.
Most M&A-related disputes arise during
the period after closing. However, this is
not always the case. Disputes can also
arise before the deal is signed, and during
the period in between signing and closing,
known as the closing period. This is shown
below.
1
1/ At the time of writing, the deal is still in its closing period. Recent revelations that half a billion of
Yahoo’s customers had their accounts hacked have, according to newspaper reports, led to Verizon
seeking a discount or even considering pulling out of the deal based on MAC. Adam Samson, James
Fontanella-Khan, and Hannah Kuchler, “Yahoo email hacking may have ‘material’ impact on Verizon
deal,” Financial Times (13 October 2016), available at: https://www.ft.com/content/458c2bf4-917b-11e6-
8df8-d3778b55a923. In this deal, the MAC event was one that would “reasonably be expected to have a
material adverse effect on the business, assets, properties, results of operation or financial condition of
the Business, taken as a whole.” Vipal Monga and Ryan Knutson, “Will Yahoo’s Data Breach Derail Verizon
Deal?”, Wall Street Journal (23 September 2016), available at: http://www.wsj.com/articles/will-yahoos-
data-breach-derail-verizon-deal-1474588172.
Pre-signing Closing period
Post-closing
period
Pre-signing disputes typically
relate to letters of intent,
heads of terms, exclusivity or
confidentiality agreements.
Disputes arise, for example
when the parties fail to
agree whether a letter of
intent is binding, or when
one party alleges breach of
an exclusivity agreement.
Pre-signing disputes can
also relate to pre-contractual
duties, in particular
disclosure obligations.
There is scope for the parties
to fall out over whether
closing conditions have been
met if these are subject to
interpretation. For example,
disputes arise over MAC
clauses which allow a buyer
to withdraw from the deal
if the value of a target has
been adversely affected
by a significant adverse
development before closing.
The acquisition of Yahoo by
Verizon may be a case in
point. 1
While an obvious source
of potential closing period
disputes, in reality, even
when purchasers do threaten
to exercise MAC clauses,
MAC events are rare. Instead,
it is more common that the
buyer uses a potential MAC
event in order to renegotiate
the price.
Most M&A-related disputes,
fall into this category. These
disputes usually relate to
purchase price adjustments,
or alleged breaches of
representations and
warranties. They may also
relate to seller’s obligations,
indemnifications, or earn-
outs.
A frequent trigger of
post-closing disputes is
unforeseen liquidity needs
of the target soon after
closing. As a result, many
post M&A disputes happen
in the months after closing.
However, mechanisms such
as earn-outs mean that the
buyer might have to continue
to pay the seller for years
after closing. As long as that
is happening, a dispute is
always on the cards.
SIGNING CLOSING

Most disputes occur because of mistakes
and oversights in the negotiating process
and while drafting the SPA. But this is not
always the case. Sometimes one party
deliberately attempts to deceive the other
party. And that is fraud.
While there are different categories of
fraud, this paper will focus on those that
are most relevant in a transaction context:
financial statement fraud and corruption.
Financial statement fraud is the deliberate
misrepresentation or omission of
financial statement data for the purpose
of misleading the reader and creating
a false impression of an organisation’s
financial strength. It typically relates to
misrepresentations by the target entity or
the seller about the target entity. However,
we at BRG have also seen disputes where
misrepresentations were made by the
buyer or by financial institutions.
A useful framework for analysing fraud
is what has become known as the fraud
triangle. The fraud triangle was first
introduced by the American sociologist
Donald R. Cressey who hypothesised that
three factors must be present in order
for someone to commit fraud: pressure,
opportunity and rationalisation. 3
Fraud
11
2
2/ Association of Certified Fraud Examiners, What is Fraud?, available at: http://www.acfe.com/fraud-101.
aspx.
3/ Donald Ray Cressey, Other People’s Money: A Study in the Social Psychology of Embezzlement, Glencoe
(Ill.): The Free Press, originally published in 1953.
4/ See, for example, Erlson Precision Holdings Ltd –v- Hampson Industries plc [2011] EWHC (Comm), 20
April 2011.
Fraud includes any
intentional or deliberate
act to deprive another
of property or money
by guile, deception, or
other unfair means. 2
Pressure
Opportunity Rationalisation
The fraud triangle can be a tool to
understand fraud in a transaction context
because M&A processes often give rise
to circumstances in which some or all
of the elements of the fraud triangle are
particularly relevant.
So, what is the source of pressure, in a
transactional context? There are many
potential sources: the seller may come
under pressure to avoid disclosing bad
news during the negotiations. It may
present inflated projections and maintain
them when things deteriorate and
against better knowledge, which can lead
to inflated assumptions on which the
purchase price is agreed. Similarly, the
seller may feel under pressure to conceal
debt that the buyer would have otherwise
deducted from the purchase price (if it
would not keep it from buying the business
altogether). Pressure often intensifies as
the transaction progresses and, especially
towards the end of long negotiations, some
sellers feel a need to avoid disclosing bad
news, or to “soften” its impact, at almost
any cost.
As pressure builds, the downward spiral
begins. If, in such a situation, the seller
presents misleading forecasts and
decides to stay silent about recent adverse
developments (for example, the loss of a
key customer), this may be considered a
fraudulent misrepresentation if the buyer
relies on the sellers’ forecasts. 4
“A client in the extractives
sector who decided not
to do rigorous pre and
post-M&A due diligence
on a deal in sub-Saharan
Africa, led to Department
of Justice scrutiny.
A catalogue of FCPA
infringements which
breached a Deferred
Prosecution Agreement,
led to punitive fines,
negative press
coverage, activist and
environmentalist scrutiny,
a sharp decrease in
share price, dire investor
relations and, finally, the
demise of the company.
At the risk of being a
Cassandra, conducting
deep reputational due
diligence in opaque and
challenging jurisdictions
really does pay
dividends.”
Sarah Keeling

Identifying fraud before signing can
be particularly difficult as one party is
intentionally attempting to conceal it from
the other party. A seller who is committing
fraud will typically also attempt to restrict
access as much as possible during the due
diligence phase.
Given the multitude of schemes, identifying
fraud often requires expert knowledge.
It can therefore be important to include
forensic accountants or fraud examiners
in the financial due diligence team, at least
when the risk of fraud appears significant.
It is also a good idea to keep an open mind
and healthy scepticism throughout the
transaction process, even amid infectious
enthusiasm. “Deal fever” can lead to a
buyer feeling pressurised into signing a
transaction, and regretting it later. It is,
therefore, important to listen to impartial
advice.
The last element of the fraud triangle,
rationalisation, is the ability of the person
who commits the fraud to convince him or
herself that their actions are acceptable or
justifiable. In a transaction context, there is
often an (tacit) understanding that sellers
are expected to “dress up the bride”. It
is generally true that sellers present the
target company in the best possible light.
In most M&A situations, the purchaser will
accept that the lily is often gilded. But if a
seller crosses a line and makes intentional
misstatements, instead of simply treating
the glass as half full, a fraud has taken
place.
Fraudcontinued
12
The second element of the fraud
triangle, opportunity, is due in part to the
information asymmetry between the buyer
and seller in a transaction. Unsurprisingly,
the seller normally knows far more about
the target business than the buyer, and the
seller can typically influence accounting
choices or disclosures. Buyers attempt
to level the playing field by conducting
comprehensive due diligence, but access
may be limited, in particular in competitive
auction processes. Importantly, detecting
fraud is not typically the focus or even the
scope of standard buy-side financial due
diligence. However, if there are concerns
over the numbers or “red flags” that are
starting to emerge during the negotiations,
an effective response can be to incorporate
forensic expertise and fraud examination
tools in the financial due diligence. See
some common“red flags” to look out for on
the diagram on this page.
Red flags for fraud
When analysing
organisational structure
look out for:
Unnecessarily
complicated
corporate structure
or financing
arrangements
Dominant
CEO/
chairman
Impending/
recent
flotation or
buy-out
Consistent
adoption of “racy”
but acceptable
accounting
policies
Involvement of
non financial
management in
accounting
Weak
finance
function
High
level of
related party
transactions
When analysing profitability
and cash flow,
look out for:
Sales that do not
turn into cash — red flags
include deteriorating
collection ratios, receivables
ageing, inventory turnover,
and sustained cash outflow
from operations despite
profit growth
Pressures on
profitability as
evidenced by
declining profit
margins
Straight line
or “hockey stick”
earnings/profit
growth
High
financing costs
compared to
debt levels
That fraud may be found out, or may lie
undetected on (or off) the company’s
books. Once the transaction closes,
the new owner takes control and has
the opportunity to find out more about
the target’s financial statements and
disclosures. Somewhat surprisingly,
many buyers do not take advantage of the
opportunity. It is therefore safe to assume
that many frauds remain undetected.
“We did a cybersecurity
check on a company that
was an M&A target. We
found so many problems,
all of them unrelated to
the deal itself, that the
transaction was pulled
and the target needed
to spend a considerable
amount on network
upgrades. Parties on
both sides of a deal are
well advised to consider
cyber due diligence as
part of their transaction
process to reduce this
relatively new breed of
risk.”
Tom Brown

13
5/ Gerry Zack, “Inventory inflation schemes come in many flavours”, Fraud Magazine November /
December 2016, p. 8.
However, there are some common
triggers which may lead a buyer to uncover
fraudulent behaviour. BRG experts often
see buyers become suspicious when
they discover soon after closing, to their
surprise, that the target entity is in need of
additional liquidity.
Even in the absence of unforeseen liquidity
needs it is often appropriate to conduct
post-closing due diligence.
If this reveals unknown off balance
sheet liabilities, or that the seller’s
accounting has gone beyond optimism,
then there might be a case for fraud. A
difficult task is ahead: unpicking financial
statements requires a combination of
expertise of transaction specialists,
forensic accountants and even intelligence
professionals, all trying to unravel
something other experienced professionals
have sought to conceal.
The most common financial reporting fraud
scheme is incorrect revenue recognition.5
We therefore focus on this topic in the next
section.
Corruption risk in
transactions
Corruption is a type of
occupational fraud that can be
categorised into bribery, conflicts
of interest, illegal gratuities
and economic extortion. Of
these, allegations of bribery
have received significant press
coverage in recent times, and
enforcement of anti foreign-
corruption statutes has been
stepped up in many countries.
The downsides of uncovering
corruption post-closing, and the
reputational and other damage,
can be significant. It is therefore
appropriate where relevant to
involve specialist expertise in the
financial due diligence.
“If a company buys
another company that
has been involved
in corruption, for
example bribing foreign
officials, the liability
for wrongdoing may
transfer with the M&A.
In situations where
corruption might be an
issue, I recommend post
deal due diligence to
shake any problems out.
That way you can control
the issue and be on top
of it, rather than getting
surprised by a whistle-
blower.”
Piers de Wilde
“We see many M&A
disputes in Asia, where
foreign investors
acquiring local targets
operate in an unfamiliar
business environment,
and where standards of
corporate governance
and regulatory scrutiny
are often not as mature
as in more developed
markets.”
Mustafa Hadi

14
6/ The International Accounting Standards Board (IASB) and US Financial Accounting Standards Board
(FASB) recently jointly issued IFRS 15 as a new revenue recognition standard to replace most existing
revenue recognition rules in IAS and US GAAP. IFRS 15, which is very similar to the new US standards, will
be effective 1 January 2018. The basic principle in the new IFRS 15 is that an entity recognises revenue to
depict the transfer of promised goods or services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for those goods or services (IFRS 15 IN7).
7/ IAS 11.
8/ On the other hand, if a long-term contract is expected to be loss-making, the loss should generally be
recognised immediately.
Revenue recognition is the battleground
for some of the largest, most high profile
and complex post-M&A disputes. To a
significant degree this relates to a common
link between the purchase price and the
earnings of the target. When profitable
sales increase earnings in a period, and
those earnings are used as the basis of
the valuation (for example, as an EBITDA
multiple), then the question of the quality
of those earnings and the timing of their
recognition takes centre stage. An incentive
to overstate earnings is then magnified
by the multiplier. For example, if the
enterprise value (EV) is eight times a recent
period’s EBITDA, the seller has an incentive
to look for ways to increase EBITDA
because it will have a direct, magnified
effect on EV.
Revenue recognition rules are exceptionally
complex, and important changes to
IFRS and US GAAP-accounting rules are
underway.6
When to recognise revenue
is typically associated with two key
uncertainties: whether the product or
service has been provided and whether
cash will be collected (i.e., whether it
is realisable). Disputes originate when
revenue is recognised that turns out not to
be realisable or had not been earned in the
relevant period.
An area that is particularly vulnerable
to bias is the accounting for long-term
contracts. This is the focus of the next
section.
Long term contracts
When a company works on a long-term
contract, it may, under certain conditions,
recognise revenue before the contract is
completed, by allocating contract revenue
and contract costs to accounting periods
in which construction work is performed.
This is called the percentage of completion
(POC) method of revenue recognition.7
It
means that part of the contract’s overall
estimated profit can (but not necessarily
should) be recognised for contracts that
have not yet been completed in full.8
A
judgment call is required on both the
degree of completion of the work, and the
overall contract profit or loss. Both are
open to bias.
There are two common ways companies
overstate profits using the POC method:
Overestimate the degree of completion.
This accelerates the recognition of
contract profitability (typically by moving it
into a financial year on which the valuation
is based), even in cases when the estimate
of overall profitability is correct; and/or
Underestimate the costs to complete
work under the contract. This means that
the expected margin on the contract is
overstated.
Estimating the degree of completion and
the remaining costs needed to complete
large, long-term projects requires a deep
technical understanding of construction-
related matters. These estimates are
difficult even for someone who has full
access to information and is familiar with
the evolution of the project. They can be
all the more challenging for a buyer when
access to information is limited. In addition,
we often observe that internal project
reporting in many companies is weaker
than other aspects of internal reporting.
“In my experience, in
construction, one of
the biggest causes
of disputes is human
optimism in the face
of obvious uncertainty.
Construction has a “bad
news” culture in which
business problems often
don’t get dealt with
until they are too big to
ignore. This, combined
with accounting
rules for long-term
contracts that require
significant judgment,
puts their accounting,
and due diligence,
at the intersection of
disciplines: technical
engineering competence
and financial and
accounting knowledge.
In the context of M&A
disputes and in a culture
such as in construction,
hindsight has many
benefits.”
Sean Fishlock
Issues relating to revenue
recognition
3

15
9/ The contract terms were between 36 and 48 months. They are scaled here (with some simplifying
assumptions) to be comparable for analysis.
Below is a summary of cumulative profits
under the POC revenue recognition method
under IAS 11, reported over the lifetime of a
portfolio of four long-term contracts for an
undisclosed target company.9
In this acquisition, the valuation of
the target company was based on the
earnings of a period that included profits
of the four contracts as reported before
the contracts ended. Over the contract
terms, management was consistently
too optimistic about the overall contract
profitability. The benefit of hindsight shows
that this led to overstated profits up until
the completion of each contract. Only when
each contract ended, in the absence of any
future periods into which to defer losses,
did the company report the cumulative
losses actually incurred over the term of
the contract. In three out of four cases
there were cumulative losses, despite the
previously (incorrectly) reported profits.
This suggests, at the very least, bias in
accounting estimates. Further review
revealed not only an overestimate of the
overall profitability of each contract, but
also of the degree of completion. In effect,
this moved (ultimately non-existent) profits
into even earlier reporting periods. The
buyer paid for profits that, in reality, did not
exist. This led to a post M&A dispute.
Overstating profitability is one
of the most common areas of
disagreement about revenue
recognition of long-term
contracts in post M&A disputes.
Prematurely recognised or
overstated profits are not part of
recurring earnings, and buyers
should not include them in the
basis of valuation. Identifying bias
in earnings recognition is a first
step in removing them from the
basis of valuation by quantifying
an EBITDA or EBIT adjustment.
An analysis of past reporting
periods (like the one in the
graph) is a tool to identify bias in
estimates.
Reported contract profitability over time (cumulative,Cm)
20%
0
40
80
40% 60% 80% 100%
Percent completed
Contract I Contract II Contract III Contract IV

16
Capital structure, valuation
and the completion
mechanism
A firm engages in operating, investing,
and financing activities. It does this with
the intention of generating value and
subsequently distributing surpluses to
the investors in the firm who have given
up cash to acquire entitlement to the
distribution of future surpluses, whether
through acquiring debt or equity.
One can value the firm and then divide
the firm’s value among the various
claimants—shareholders and debtholders.
The relationship between firm value and
the value of the claims on the firm may be
set out as follows:
Value of the firm = value of debt + value
of equity
In transactions, the value of the firm is
commonly referred to as enterprise value,
but also as the “headline price” (often
in letters of intent in the early phases of a
deal) or “cash and debt free price”.
Below is a simple version of the “equity
bridge” that shows that a valuation
approach that leads to the valuation of the
firm (as in practice many do) requires the
deduction of debt and similar items, and
the addition of (free) cash and equivalents,
to arrive at equity value—the price for the
claims on the firm by its shareholders. In
share deals, this is the price for 100% of
the equity ownership interest in the target.
The buyer and seller must agree upon the
items to be deducted or added to arrive at
equity value in the negotiations. However,
as the business (and its balance sheet)
changes every day, both before and after
the SPA is signed, any time delay between
signing and closing of a transaction means
that the parties are uncertain about the
precise balance sheet to be transferred at
closing.
Issues relating to net debt4
Enterprise
value
-
Debt-like
items
+
Cash and
equivalents
Equity
value
“There is due diligence
and good due diligence.
It isn’t enough to just tick
boxes. Soon, it is likely
that companies will not
just have to demonstrate
to regulators that
they have done due
diligence, they will have
to demonstrate that they
have done good due
diligence.”
Ben Johnson
The net debt deduction and
related disputes
The net amount of debt-like items less
cash and equivalents is referred to as “net
debt”. A net debt clause is a very common
type of purchase price adjustment. As
there is no legal or generally accepted
accounting definition of net debt, defining
items to be treated as debt-like or as free
cash equivalent is a matter for the parties
to negotiate and agree on. In the case of a
purchase price adjustment, the document
that captures this is the SPA.
Purchase price adjustments – overview
A purchase price adjustment adjusts the
preliminary purchase price by measuring
the relevant balance sheet and other
financial statement items at closing.
The SPA sets out the mechanism,
definitions, basis of preparation, and
process to determine the adjustments. The
idea is that firm value is fixed at signing.
Purchase price adjustments adjust the
equity value, not the enterprise value. The
adjustments relate to short-term changes
between signing and closing, while the
headline price is unchanged.
Purchase price adjustments pin down the
exact levels of debt, cash, working capital,
and other items at closing. They thus
ensure that the purchaser is compensated
for debt at closing and that the vendor
receives value for any surplus cash at
closing.
There are a number of specific purchase
price adjustment mechanisms that can be
used. They are listed in the table below, and
discussed in this and the following sections.
BASIS OF ADJUSTMENT COMMENT
Net debt To adjust from a debt-free/cash-free basis
Net working capital Used in combination with net debt. For a seasonal business
or a business subject to some volatility in trading; for a
cash-free/debt-free basis as protection against seller
manipulation by reducing working capital
Capital expenditure Used in combination with net debt. For a capital expenditure-
intensive business and a cash-free/debt-free basis, used
as protection against seller manipulation by slowing down
investment spend
Net assets/equity Typically used instead of net debt adjustment (sometimes
used as a “floor” in addition to a net debt adjustment).
Rarely used these days
Other Marketing, RD spend, EBITDA. Used in combination with
net debt adjustment. Rare

17
In practice, a large number of items can
be considered to be debt or similar in
nature. Here is a list of items that are
sometimes discussed in negotiations,
ranked (somewhat subjectively) from
“harder” items at the top (i.e., items that
are commonly deducted), to “softer” items
(i.e., that are less commonly treated as
debt) towards the bottom. Off balance sheet liabilities
Off balance sheet liabilities come in many
varieties and forms but all do broadly the
same thing: reduce debt. For example, off
balance sheet liabilities might relate to
obligations in a whole separate entity such
as a special purpose vehicle (SPV) that
is not consolidated in the parent entity’s
financial statements, but for which the
parent company is responsible. Other
common types of off balance sheet debt
include: factoring of trade receivables,
leasing or unfunded pension deficits.
The use of SPVs, factoring, leasing or other
types of off balance sheet debt is perfectly
appropriate in most circumstances
and does not typically involve violations
of GAAP. However, the way they affect
financial statements can be used to
achieve outcomes that are favourable
to one party. For example, factoring, a
financing transaction, may be used to
maximise the cash position at closing
with no offsetting deduction for factored
receivables (unless it is treated as debt),
leaving the buyer to pay more than the
value it bargained for.
Financial statement fraud schemes
perpetrated by concealing debt are a
different matter. An example is Enron
which used off balance sheet accounting to
appear to be a high-value company when in
reality it was sitting on an ocean of debt.
Agreeing net debt deductions typically
reflects each side’s relative strength in the
negotiating process. This section discusses
three broad categories of net debt that
play a significant role in practice and that
could become cause for disagreement in
negotiations.
Debt hot spots
Bank
and other
(explicitly)
interest-bearing
debt
Break
costs and early
repayment
penalties
Current tax
assets and
liabilities
Deferred tax
assets and
liabilities
Trapped
cash and cash
items that are
working capital in
nature (e.g., cash
in tills)
Debt
factoring /other
receivables
financing
Capital
expenditure
creditors
Foreign
exchange
losses
Deferred
revenue
Intercompany
items
Restructuring
provisions
Dilapidation
provisions
Accrued
bonuses
Operating
leases
Warranty
provisions
Derivative
instruments
Non-
controlling
interest
Pension
deficits
Supplier
finance
Finance
leases

Issues relating to net debt
continued
18
10/See,forexample,“BHSbuyer’sbankdroppedoutoverpensionissue”,FinancialTimes(7June2016).
11/See,forexample,DistrictCourtfortheWesternDistrictofPennsylvania,Case3:16-cv-00204-KRG.
Provisions
A provision is a liability of uncertain timing
or amount. The amount recognised as
a provision has to be estimated. Some
provisions, such as for pensions (see
separate section below), are almost always
treated as debt-like in transactions. For
others, like warranty provisions, the case
is less clear cut. It is because provisions
require estimates that they are prone
to disputes. GAAP can give significant
discretion to the preparer of the financial
information, and estimates can be biased
or perceived to be biased.
One case BRG experts have worked
on relates to the acquisition of a
top-tier basketball club. The SPA
definition of debt included “long
and medium-term bonus claims”
of players, whereas short-term
obligations were not included in this
definition. However, the definition
of “medium-term” or “short-term”
was not clear. The dispute arose over
whether a significant bonus was
correctly classified as “medium-
term”
A practical way to avoid disputes
is to aim to limit the reliance on
estimates at closing. Using fixed
values for deductions that reflect
expected valuations for liabilities,
agreed at signing, is one option.
Alternatively, when outcomes are
uncertain, indemnifications may be a
more appropriate instrument than a
deduction.
Pensions
Pensions don’t often cause disputes but,
when they do, they can be eye-catchingly
high profile because the amounts of money
involved are often large relative to the size
of the transaction. Even if the dispute is
resolved properly and beneficiaries are
not affected, a pension dispute has the
potential to worry many current and former
employees. 10
Pension disputes, like almost all other
disputes, can occur when professionals
involved in the deal do not draft definitions
tightly enough. For example, at BRG we
recently saw a case which rested on the
definition of “defined benefit obligation”.
The parties were in dispute about whether
a French “Indemnité de fin de Carrière”
— a type of defined benefit plan—
fell under the definition of “financial
indebtedness” which included certain
defined benefit obligations. There could
have been no dispute if a list of defined
benefit plans had been included in the
definition of net debt.
There are also pension-related disputes
where it was claimed that the actuarial
report contained errors in determining the
defined benefit obligation and the pension
provision. 11
Other disputes
related to debt
Disagreements over net debt arise when a
party claims that a particular item does or
does not fall under the SPA definition of net
debt. This can happen when the net debt
definition leaves room for interpretation.
For example, catchall definitions such
as “... and other interest-bearing debt”,
in which the term “interest-bearing” is
not defined, leave considerable room for
interpretation: is a pension obligation
interest-bearing? Vagueness causes
problems.
Disagreements also arise at the
intersection of debt and working capital.
For the mechanisms to work properly,
a seamless interaction between the
definitions of the two is important.
When things go wrong in completion
mechanisms, it is often here.
An item may be captured twice, both as
working capital and net debt (for example
a capital expenditure creditor), or an item
may not be captured at all (for example
accruals for outstanding supplier invoices).
This may give the seller an opportunity
to manipulate the cash position at the
effective date. Consequently, the buyer
overpays. We will look at this interaction
more closely in the following section.
Net working capital
Net debt Capital
expenditure
A “clean” interaction between
different adjustments is important
“We look at our private
affairs with friendly eyes,
and our bias always
gets in the way of our
judgment”
Seneca

19
The working capital section of the balance
sheet is a hot spot for post MA disputes.
It is the place where volatile events in
the real world are most likely to have an
impact on transactions. Unsurprisingly, it is
therefore where the financial crisis of 2008
and 2009 left its most visible balance sheet
scars.
Most businesses require a certain (positive)
level of working capital as part of their
normal operations. This is in part because
sales usually do not convert to cash
immediately and because businesses need
raw material or finished good inventories.
Working capital is needed to keep
operations running smoothly.
What relevance is this to an MA
transaction? It is common for offer letters
to specify that the headline price is based
on the assumption that the business will
transfer with an “appropriate”, “normal”
or “adequate” level of working capital.
If, at closing, that level is not “normal”, a
working capital adjustment compensates
for the difference. There is a good reason
for this. If at closing, the business has
more working capital than is normal
(more than it needs to operate), then it is
reasonable that the buyer should pay for
the excess. If, on the other hand, there is
a deficit in working capital, the purchase
price should be reduced by the shortfall
because the buyer will, in theory, have to
inject additional liquidity to bring it back to
a sufficient level.
The same concept applies to a locked
box transaction, only that there is no
adjustment at closing; a surplus or deficit
in working capital at the locked box date
should be reflected in the fixed price.
Although in principle the concept is logical,
issues can arise when working capital
and net debt become confused. If the net
debt and the working capital mechanisms
interact as they should, they exactly offset
each other. As a result, the seller does not
have the ability to artificially increase the
cash position, thus reducing net debt, by
collecting receivables early, or stretching
trade payables. But if they do not work as
they should, then either the buyer will pay
too much, or the seller will get paid too
little. While this is not necessarily a breach
of provisions in the SPA, the frustration of
the party that overpays contributes to the
risk of a dispute.
What magnifies the risk of disputes
over working capital is the scope for
disagreement over valuation matters of
working capital items: trade receivables
are subject to estimates for unrecoverable
amounts, and inventory is valued at the
lower of cost or market value. This is where
market volatility enters the completion
mechanism. Consider rapidly changing
prices for inventory in some renewables
markets in recent years where volatility
was such that establishing a “market price”
at a specific date was a challenge. This is
a reason that a disproportionate number
of transactions in renewable energies
companies result in disputes.
It is, therefore, vital that working capital
is properly defined in the SPA and all the
parties are clear about the accounting
methods that will be used to calculate it.
This requires considerable attention from
the professionals involved. The devil really
is in the detail.

Issues relating to working capital5
What is working capital in a transaction context?
There is no uniform definition of
working capital in a transaction context.
A convention is that working capital
should, at a minimum, always include
trade receivables, trade payables, and
inventory. This is often called “core” or
“trade” working capital. While these
components should always be included
in the definition of working capital, they
are however, almost never sufficient.
What criteria should guide someone
involved in an MA transaction or
analysing an MA dispute to determine
whether an item in the balance sheet
is, or should be, working capital? We
find the following three almost always
appropriate.
Operating nature: This means that
working capital items are the result
of business activities, not financing
activities. A normal level of working
capital is therefore part of the value of
the operations, or EV.
Short-term conversion into cash:
Working capital converts into cash wihin
a short time period. This means that
customers pay, inventories turn over
and suppliers get paid, all within a few
weeks or months (usually well under a
year).
Recurring nature: Working capital
items are constantly revolving, which
means as they convert into cash they
are replaced by new (short-term)
assets and liabilities. At any given point
in time, there is a certain net level of
working capital in the business (but the
level may change).
“In the US, we are seeing
a growing trend in ‘post
deal due diligence’ on
closing working capital
balances. Because of
the current competitive
MA market, deals
may be going lighter
on due diligence prior
to closing, and that
leads to a degree of
subjectivity in the SPA as
it relates to determining
working capital. So, in
response to this, I’m
seeing companies get
the diligence team
back together after
closing to go though the
closing working capital
documentation to make
sure the calculations
are consistent and the
parties will be happy with
the result.”
Dan Galante

20
Earn-outs are contingent payouts that
depend on the realisation of a certain
goals of the target company. They are
calculated by reference to the performance
of the company over a period after closing,
the earn-out period. The measures of
performance on which the earn-out
payments are determined can be financial
or non-financial. Earn-out periods are
often between one and three years, but we
sometimes see periods of up to five years.
The simplest reason that earn-outs are
prone to disputes is that they lengthen the
period of time it takes to fully determine the
total purchase price. The longer the earn-
out period, the more prone to disputes
the transaction will probably be. This is
unsurprising as a longer period means
greater changes to the target business. In
addition, as time passes, a seller who is no
longer involved in the management of the
target company is not responsible for its
trading results.
As well as this obvious practical reason,
there are a number of accounting reasons
why earn-outs are particularly dispute-
prone if based on metrics such as EBITDA,
EBIT or net profit. When setting the
parameters for earn-outs, it is important
to ensure they are thoroughly defined. They
should also be closely related to “value”.
When measures of profitability such as
EBITDA are used, questions over the
quality of the profits can arise. Profits
can include, for example, non-cash,
non-recurring earnings that may have
nothing to do with “value”: if the target has
historically set aside provisions that are too
high, they might be released into income,
increasing profits. Similarly, earnings that
are artificially lowered by mere accounting
changes or non-cash, non-recurring write
offs may reduce — or altogether wipe out
— any earn-out payment, to the frustration
of the seller. All these things could cause
the seller and buyer to fall out during the
earn-out period.
Issues relating to earn-outs6
“I have noticed one trend
in earn-out disputes
that happens time and
time again. Earn-outs
are often used to bring
small entrepreneur-
owned businesses into
larger corporations,
many of which are
public-reporting entities.
Often the entrepreneur
continues to run that
part of the business
as a separate division.
If things go well, that
part of the business
gets access to a bigger
market and can grow
revenue considerably,
but this leads to
considerably more
back-office costs, some
of which support the
growth and some of
which could be related
to public-reporting
requirements. If that’s
not addressed in the
SPA in terms of which
costs apply against the
earn-out, it can lead to a
dispute.”
Ron Evans
One way to minimise the risk of a dispute
is to use comparatively simple earn-out
parameters that, further, leave little
to the buyer’s discretion when they
are determined. A general rule is that
the higher up in the profit and loss the
parameter is, the fewer opportunities to
“manage” the earn-out basis. Sales, or
even volumes sold or prices, are often less
dispute-prone than net profit. Thorough
definitions of the accounting policies to be
applied can also help avoid disputes.
Changes made to the newly acquired
business after closing may affect the ability
of the target to report earn-out metrics on
a consistent basis. The longer the earn-out
period, the more changes the buyer may
make to the target company. For example,
a strategic buyer may integrate the target
into the acquiring company’s operations.
A private equity sponsor may merge it into
another portfolio company’s operations
in order to achieve synergies. As a
result, the company may share overhead
functions and cost allocations. When the
target becomes a division of the acquiring
company, it may not report profits on a
comparable basis as it did when it was a
stand-alone company and when the earn-
out was designed. In this scenario, a single
recharge for group services could wipe
out profits which would have otherwise
triggered a significant earn-out payment.
Anticipating the reporting structure during
the earn-out period is therefore important,
and if it is the intention to integrate the
target into other operations post-closing,
earn-outs should be linked to metrics that
are not affected by the integration.
Finally, it is important to ensure the buyer
has access rights to the target company to
review the seller’s calculation of earn-
out payments. These rights need to be
specified in the SPA.

21
The purpose of an earn-out clause
Earn-outs can be very useful mechanisms.
However, they are also prone to disputes.
Here are some reasons why earn outs are
used:
1. Narrowing the price-expectation
divide
Earn-outs are often used in practice when
the parties’ price expectations are far
apart. They can be an effective mechanism
to bridge the price-expectation divide.
2. Incentive for sellers remaining
in the business
Earn-outs are also often used as a
mechanism to incentivise an existing
owner-manager who is selling his or her
business and who will stay on managing
or otherwise contributing to the company.
The incentive to these types of sellers is to
maximise their efforts as they will continue
to share in the rewards after closing.
3. A method of acquisition finance
An earn-out is also a financing instrument.
This is because the earn-out component of
the purchase price is effectively paid out of
the target’s operating profits after closing
only if these profits are actually achieved.
This deferred component of the purchase
price does not need to be financed by
the buyer. This aspect made earn-outs
particularly popular after the financial
crisis when acquisition finance was difficult
to obtain and significant components of the
total consideration were deferred into the
earn-out period.
4. Allocation of risk
One way to think about an earn-out is that
it changes the allocation of risk between
buyer and seller. A valuation before signing
requires estimates of future returns of
the target company. These estimates
are almost always subject to significant
uncertainty. Without an earn-out, the
buyer typically bears the risk associated
with their achievement: if the target falls
short of the projections, then the buyer
receives less in value (at closing) than they
bargained for. If the actual developments
exceed expectations, then the buyer
receives more.
Case study: A clarification missing
in an earn-out clause leads to a
complicated
multi-party dispute.
In ICC 14691, US and Brazilian companies
(purchasers/claimants) entered into an
SPA with Brazilian and German sellers
(respondents) over the purchase of shares
in a Brazilian subsidiary. The SPA included
an earn-out provision that made additional
payments conditional on the achievement
of certain targets. An advance on the
earn-out payments was paid by the buyers
in US$. The earn-out itself was payable
in R$ (Brazilian real). After closing, the
claimants alleged intentional breaches
of representations and warranties. One
respondent counterclaimed for the earn-
out component of the purchase price.
The parties disagreed over the exchange
rate to be used to convert the advance
payment made in US$ into R$. The buyers
argued for the exchange rate just before
closing, whereas the sellers argued that
the exchange rate should be the rate at
the time the earn-out was paid, two years
later. Further, the counterclaim related to
the earn-out basis which excluded several
items (recurring credits) in the PL.
The tribunal found that the appropriate
exchange rate was that prevailing near the
time the main earn-out payment became
due. Further, the tribunal held that an
expert determination, which had excluded
the recurring items credits, was final and
binding.
The tribunal noted the parties “devoted
substantial time and effort, both in their
written submissions and at the hearing…”12
to the question of the exchange rate. This
claim dispute could have been avoided
by inserting a clarification in the SPA, for
example specifying that the exchange rate
at the due date of the earn-out payment
should be used and, further, specifying the
source of the exchange rate (for example
Bloomberg or Reuters mid-spot rate).
12/ ICC Case 14691 Final Award in ICC International Court of Arbitration Bulletin, Vol 24, No. 1 (2013), p. 132.

22
The concept of the locked box first
appeared in private equity auctions in
Europe in the early 2000s. It has come to
be adopted in a wide range of transactions
and is now the most popular completion
mechanism in Europe. Locked boxes are
generally considered to be seller friendly.
In a locked box transaction, the transfer of
the target company is economically (but
not legally) backdated to a historical date,
typically the date of the last audited balance
sheet. There is no true-up at closing for net
debt, working capital or other items. The
date of the economic acquisition is termed
the “locked box date” or “effective date”.
The time between this date and closing is
known as the “locked box period”. During
this period, profits generated by the target
principally accrue to the benefit of the
buyer who obtains the closing date balance
sheet without further adjustments to the
purchase price.
An advantage of a locked box is that a
fixed purchase price makes it easier for
a seller to compare bids in an auction
process. Other advantages of the locked
box are that it avoids the necessity to
prepare completion accounts and the
often time-consuming negotiations over
accounting definitions in the SPA. This
can save considerable time and effort.
This also eliminates significant scope for
disagreement post-deal.
Profits generated by the target business
between the effective date and closing
accrue to the purchaser (as cash generated
is transferred to the buyer). To compensate
for the fact that the seller foregoes those
profits, the SPA sets out an interest rate,
sometimes called the “daily profit charge”,
to be applied to the purchase price. The
interest, or daily profit charge, is payable
by the buyer for the locked box period. This
charge represents the opportunity cost to
the seller of backdating the transaction.
“Locking the box” stipulates that the seller
does not extract value from the business
between the reference date and closing.
No value must leak. This means there
Locked box-related disputes7
“Whereas the
damages related to a
misrepresented income
stream may be assessed
by determining the
capitalised loss of profit,
there is also the need to
consider the valuation
impact on the remainder of
the business enterprise.
If, for instance, the pricing
mechanism is based on a
multiple of EBITDA, then
consideration should be
given as to whether there
should be a reduction in
that multiple. This may
arise because the overall
level of true profitability
suggests that the size of
the enterprise now falls
below a benchmark of
previously comparable
entities, or, perhaps more
understandably, a concern
that there may be other,
as yet undiscovered,
problems that will
impact on profitability.
If discounted cash flow
is the primary valuation
approach, then this will
result in an increase in the
discount rate to reflect this
additional uncertainty, or
perceived risk.“
Andrew Caldwell
should be comprehensive “value leakage
protections” in the SPA. Leakage can come
in many forms, from dividend payments
before closing to changes in transfer
prices with related parties, changes to
management compensation, management
fees, or waiving liabilities. Effective leakage
protection requires foreseeing any such
eventuality.
It is important to keep in mind that
the items giving rise to purchase price
adjustments are equally relevant to the
locked box: even though there are no price
adjustments when a locked box is used, the
fixed purchase price should reflect debt
items, any deficit or surplus in working
capital against a normal level, and any
deficit in investment spend.The difference
is that these items are measured in a
locked box at the locked box date, and in a
purchase price adjustment at closing.
This brings us to disputes. The absence
of purchase price adjustments in locked
boxes makes locked box SPAs less
complex than those containing a purchase
price adjustment. The fixed purchase
price removes the price adjustment as an
important area of post MA disputes and
therefore reduces significantly the risk
of disputes in locked box transactions.
Disputes do occur, however, and these
often relate to warranty breaches, alleged
fraud or closing conditions (e.g. MAC
clauses). Locked box-specific disputes also
have to do with leakage. These disputes
can be over interpretations of what
constitutes a breach of a leakage covenant.
For example, we have seen disputes
related to the interpretation of “arm’s
length” transactions with related parties.
In conclusion, while simpler to handle than
other closing mechanisms, the locked box
is not immune to disputes. As we have
seen throughout this paper, imprecise
drafting can lead to problems down the
line. However, a locked box eliminates
disputes in relation to purchase price
adjustments.

23
A short word about quantum
in MA disputes
End word
8
Damages theories differ significantly
between jurisdictions. Whether related to
fraud, breaches of representations and
warranties or other matters, damages in
MA disputes often involve claims of lost
profits or lost business value or both. Lost
profits can be defined as the difference
between the claimant’s profits but for the
wrong doing and the claimant’s actual
profits. Damages experts use a variety of
valuation approaches, including the income
approach (in particular the discounted cash
flow method), the market approach and
the net asset approach. The valuation itself
may relate to a single asset or liability,
or alternatively to the value of the equity
interest in the target entity or the value of
the business.
One way damages can be categorised
is into actual (but for) damages, caused
directly by the wrong doing, and
consequential (or indirect) damages.
Consequential damages may include
effects on other products of the acquiring
company or on the target’s competitive
positioning or reputation. Their assessment
can be particularly complex.
In the context of valuing damages related
to income streams of a going concern,
or valuing long-term liabilities, discount
rate often takes centre stage. The fact that
present values can be very sensitive to
even minor changes in discount rates has
been magnified by the current interest rate
environment.
In putting together this paper, we have
spoken to BRG experts across the firm’s
practice areas and geographies, in order to
shed light on how disputes come about, how
to deal with them effectively, and how to avoid
them. I hope that you have found that each
expert interviewed for this paper has brought
a unique perspective to post MA disputes. It
is the combination of these perspectives that
helps us understand disputes better. Such
diversity of thinking characterises BRG.
Disputes have lots of different causes, but
many disputes are avoidable. A few lessons
have emerged:
Technical mistakes in transactions that lead
to disputes often occur at the intersection
of disciplines. For example, the SPA, a
legal document which may incorporate
accounting and financial terminology and
concepts needs to have drafting input from
more than just a lawyer, or more than just an
accountant, or even more than just a lawyer
and an accountant.
Judgment errors often occur because of
overconfidence or groupthink. Likeminded
individuals working on the same task have a
tendency to validate each other and replicate
mistakes. A diverse transaction team will
combat this. Diverse groups tend to break
groupthink and be more creative at problem-
solving and better at anticipating what can go
wrong. Diverse teams tend to lead to better
investment decisions.
There is no substitute for thoroughness.
Getting the detail right is vital. This means
that even at two in the morning on the day
before signing, we know we can’t cut corners.
Fraud frequently goes unnoticed at the time
of a transaction, but seems more easily
detectable with the benefit of hindsight.
The truth is that often warning signs are
not taken seriously. Understanding the
factors that may make fraud more likely
in a transaction and getting an expert to
examine red flags may well save time and
money in the long run.
Lastly, parties should consider carefully
how unforeseen events around closing
could impact the transaction and find
their way into provisions in the SPA: where
could volatility meet ambiguous wording
or vague measurement concepts used
in the SPA? Then, the parties should
aim to limit or eliminate where possible
subjective elements in SPA definitions
or in accounting policies. They should
also consider different scenarios for the
fallout of major political decisions or other
external disruptions.
It is, of course, impossible to always expect
the unexpected, but if we go into every
situation aware that all of our assumptions
may turn out to be false, we will, at the very
least, be prepared when disruption strikes.
Heiko Ziehms
“The low interest rate
economy can make
calculating the discount
rate used to value
long-term contracts
problematic. Low or
negative interest rates
result in lower discount
rates and therefore
the value of your
future losses is higher.
And many post-MA
disputes involve the
quantification of future
losses.”
David Saunders

24
Heiko Ziehms
Heiko Ziehms focuses on the
quantification of damages
and forensic matters in
complex commercial
disputes, including MA, joint venture,
and insolvency-related matters. He has
been appointed as expert in multiple
disputes. He has worked on matters in
ICC, DIS, LCIA, ICSID and SIAC arbitration
forums, ad hoc arbitrations and the courts.
Heiko has worked on some of the most
complex corporate disputes in Europe with
values up to several billion euros. He is
experienced in giving oral expert testimony.
Heiko also provides transaction advisory
services and advises on completion
mechanisms in MA transactions. He has
advised on several hundred transactions.
Heiko is based in London.
Heiko Ziehms
Managing Director
+44 (0) 20 3514 8578
hziehms@thinkbrg.com
Daniel Galante
Dan Galante has more than
25 years of experience and
has developed extensive
transaction experience
serving as an adviser to companies all
over the world. He has been involved
with more than 600 buy- or sell-side
transactions for scores of different private
equity investors, hedge funds, lenders,
and strategic corporate acquirers. Dan
provides transaction-related diligence that
typically includes a blend of commercial,
financial, operational, and tax services. He
has advised on target companies ranging
from startups to more than $3 billion in
revenues. Dan is based in New York.
Daniel Galante
Managing Director
+1 312 429 7982
dgalante@thinkbrg.com
Sean Fishlock
Sean Fishlock is a member
of EMEAA Construction
Group of BRG with over
30 years of experience in
the construction industry. He trained in
surveying, construction management,
project management and engineering
with a major international contractor, and
spent 14 years in site and construction
management, four years in property
development and asset management and
three years managing £1billion prime
contracts constructing and maintaining
land and marine infrastructure, housing
and property and estates for the UK
Ministry of Defence in the UK and overseas.
Sean is based in London.
Sean Fishlock
Managing Director
+44 (0) 20 3725 8380
sfishlock@thinkbrg.com
Simon Ede
Simon Ede is an economist
with over 15 years of
experience working with
companies operating in
the global energy markets. His broad
range of project experience includes
transaction support, market analysis
and forecasting, arbitration, litigation,
strategy development, and auctions. He
also provides expert analysis for clients in
disputes. Simon is based in London.
Simon Ede
Director
+44 (0) 20 3725 8368
sede@thinkbrg.com
Piers de Wilde
Piers de Wilde has over
10 years experience in the
investigations industry. In
his career he has focused
on pre-transactional due diligence,
specialist investigations and strategic
intelligence. His work has included:
assisting in activist investor situations;
supporting MA strategies through
the provision of intelligence; informing
clients’ strategic communications in
complex disputes; overseeing major fraud
and corruption investigations including
UKBA and FCPA matters; asset tracing
and litigation support; providing new
market entry support and political risk
analysis; and conducting anti-counterfeit
investigations.
Piers’ clients have included private equity
firms, financial institutions, family offices,
law firms, multi-national corporations and
governments. He has worked throughout
Europe, Africa, and the Middle East, and is
based in London.
Piers de Wilde
Director
+44 (0) 20 3514 7147
pdewilde@thinkbrg.com
Biographies

25
Ben Johnson
Ben Johnson is a
member of BRG’s Global
Investigations + Strategic
Intelligence practice. He
has over 17 years of experience in forensic
accounting, including fraud and financial
investigations, bribery and corruption,
audit negligence, asset tracing, and
litigation and arbitration. Ben has led many
investigations and reviews into suspected
accounting irregularities, bribery and
corruption issues, and misconduct on
behalf of regulators and private clients
in both civil and criminal proceedings.
He has significant financial services
experience, having led investigations
into alleged misconduct at banks in
multiple jurisdictions, and he has led
more than eight investigations on behalf
of accountancy regulators in relation to
accounting issues in recent accounting
scandals. Ben is based in London.
Ben Johnson
Managing Director
+44 (0) 20 3808 4758
ben.johnson@thinkbrg.com
Daniel Ryan
Daniel Ryan is the co-head
of BRG’s London office.
Daniel has over 20 years
of experience in valuing
businesses, shares, and intellectual
property assets in both contentious and
non-contentious matters, including sale
and purchase transactions, shareholder
and post-acquisition disputes, intellectual
property licensing, infringement of
intellectual property rights, fiscal
valuation, and transfer pricing. He is
regularly appointed as an expert witness
and is experienced in oral testimony. His
experience covers matters in the UK High
Court, before arbitral tribunals in the UK
and internationally, in fiscal courts, and
before the Copyright Tribunal.
Daniel Ryan
Managing Director
Co-Head of London Office
+44 (0) 20 3725 8358
dryan@thinkbrg.com
Ron Evans
Ron Evans is a member of
BRG’s Corporate Finance/
Transaction Advisory
Services practice. He has
over 16 years of due diligence experience
serving a variety of private equity and
strategic clients. He has worked on
over 250 transactions providing buy and
sell-side financial due diligence, synergy
validation, carve-out transactions, and
finance department integration, and has
advised clients with developing balanced
scorecards and strategic plans. Ron has
significant private equity experience and
public and private corporate experience.
His primary industry expertise includes
construction, energy, manufacturing and
distribution, transportation, and retail.
He has also worked on transactions in a
variety of other industries, including media
and telecommunications, banking and
insurance, and consumer and industrial
markets. Ron is based in Miami.
Ron Evans
Managing Director
+1 786 725 3806
revans@thinkbrg.com
David Saunders
David Saunders is an
expert accountant and
the co-head of BRG’s
London office. He works
in a variety of industries, jurisdictions,
and forums, including the UK courts
and international arbitrations, with
particular expertise in valuations and the
quantification of damages. David has been
appointed as expert accountant on over
70 occasions and has given oral testimony
on 15 occasions both in the UK courts
and to arbitral tribunals in a range of
jurisdictions. He is an experienced fraud
and regulatory investigator. David’s cases
have covered a range of business sectors,
including oil and gas, commodity trading,
construction, property, pharmaceutical,
telecommunications, manufacturing,
hotels, retail, entertainment, and financial
services. David is based in London.
David Saunders
Managing Director
Co-Head of London Office
+44 (0) 20 3725 8361
dsaunders@thinkbrg.com
Shireen Meer
Shireen Meer is an applied
economist with a speciality
in behavioural economics.
She applies economic
analysis to litigation and consulting
matters related to areas such as class
action, intellectual property, antitrust,
breach of contract, product liability,
healthcare reimbursement, and general
commercial damages. Her work has
spanned industries such as healthcare,
high technology products, consumer
products, metal refining products, banking,
and pharmaceuticals. She has taught
undergraduate courses, been published in
a variety of journals, is a public arbitrator
for the Financial Industry Regulatory
Authority and a member of the American
Economic Association, American Bar
Association, and Women’s Council on
Energy and the Environment. She has a
Ph.D. and M.A. in economics from
Emory University. Shireen is based in
Washington DC.
Shireen Meer
Associate Director
+1 202 480 2695
smeer@thinkbrg.com
Thomas Brown
Tom Brown is Global Leader
of Berkeley Research
Group’s Cyber Security/
Investigations practice. He
specialises in helping clients manage
cyber risk, respond to incidents, remediate
vulnerabilities, and address post-incident
regulatory enquiries and litigation.
Prior to joining BRG, Tom served for
12 years as an Assistant United States
Attorney in the U.S. Attorney’s Office in
Manhattan, where he supervised the
Complex Frauds and Cyber Crime Unit.
He led some of the most technologically
challenging cases ever pursued by the
U.S. government, including successful
investigations of the underground drug
website Silk Road and the hacktivist
group Anonymous. Tom is a recipient of
the FBI Director’s Award for Outstanding
Cyber Investigation and was named
“Prosecutor of the Year” by the Federal
Law Enforcement Foundation in 2011. He
is a member of the New York bar. Tom is
based in New York.
Thomas Brown
Global Leader, Cyber Security/
Investigations
+1 646 862 0979
tbrown@thinkbrg.com

26
Andrew Caldwell
Andrew Caldwell is an
experienced valuation
specialist in the United
Kingdom, with more than
30 years of involvement in the valuation
of companies, shares, and intellectual
property. His experience includes fiscal and
statutory valuations, and those required
for financial reporting and regulatory
purposes, particularly of Level 2 and
Level 3 assets; and acting for FTSE 100
companies.
Andrew has been instructed as an expert
witness in a large number of cases, in
respect to both valuation and the quantum
of damages or loss of profits arising
from breach of warranty or contract
claims, post-acquisition and cross-
border disputes, and the infringement
of intellectual property rights. Andrew is
based in the London office.
Andrew Caldwell
Managing Director
+44 (0) 20 3725 8354
acaldwell@thinkbrg.com
Mustafa Hadi
Mustafa Hadi is the
Head of Disputes and
International Arbitration for
Greater China and North
Asia, and is based in BRG’s Hong Kong
office. He is an experienced consultant
on economic, financial, accounting, and
strategic business issues, and specialises
in addressing issues of valuation and
damages in the context of commercial
disputes.
Mustafa has been instructed as an
expert witness in both national courts
and international arbitrations, and is
experienced in giving oral testimony.
He has worked on cases involving the
valuation of businesses, shares, and
intangible assets, and the quantification
of complex damages arising from
contractual, shareholder, joint venture,
post-acquisition, and intellectual property
disputes. Mustafa was “highly rated”
by Who’s Who Legal in its 2016 guide to
leading experts in international arbitration.
Mustafa Hadi
Head of Disputes and International
Arbitration – Greater China and North Asia
+852 2297 2271
mhadi@thinkbrg.com
Sarah Keeling
Sarah Keeling is a
member of BRG’s Global
Investigations + Strategic
Intelligence practice. A
former senior British government official,
she has 23 years of experience in national
security and intelligence matters across
jurisdictions both in the United Kingdom
and overseas. After leaving government
service, Sarah embarked on a career in
the private sector. Her practice includes
helping global corporates enter high-
risk new and emerging markets. She
also provides strategic, survival-level
intelligence and support in assessing
and managing risk to their operations.
She has worked on numerous complex
multijurisdictional investigations including
FCPA, asset tracking and asset recovery.
She also consults on litigation matters
for international arbitration and disputes.
Sarah is based in the London office.
Sarah Keeling
Managing Director
+44 (0) 20 3514 6973
skeeling@thinkbrg.com

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