M&A Vocabulary – Experts explain: Arbitration clauses in M&A transactions

​​published on 19 May 2022 | reading time approx. 3 minutes

In this ongoing series, a number of different M&A experts from the global offices of Rödl & Partner present an important term from the specialist language of the mergers and acquisitions world, combined with some comments on how it is used. We are not attempting to provide expert legal precision, review linguistic nuances or present an exhaustive definition, but rather to give or refresh a basic understanding of a term and provide some useful tips from our consultancy practice.

Dispute resolution in M&A transactions

In any M&A transaction, even if it has been well prepared and documented, the parties may come to a point where they have differing opinions regarding the procedure or content of the transaction and achieving an amicable settlement of the controversial items is no longer possible. Here, it is important that the transaction and the respective contracts provide an appropriate mechanism for dispute resolution or dispute settlement.

During an M&A transaction, various issues may become the subject of a dispute:

• purchase price adjustment,
• non-compliance with the so-called “closing conditions”, i.e. conditions that must be fulfilled prior to closing, or
• claims arising from possible warranty rights.

What is an arbitration clause?

In principle, in most jurisdictions, the parties to an M&A transaction are free to choose a dispute resolution mechanism – or not to choose any. Not choosing such a mechanism – in particular in the context of cross-border transactions – is not advisable because in such a case the general statutory rules of private international law apply and they are not always predictable for the parties involved.

When concluding a dispute resolution agreement, the parties can refer the dispute to the ordinary courts for decision or to an arbitral tribunal; an arbitral tribunal is a private decision-making body (often applying its own rules of procedure), the identity and composition of which is agreed on by the parties in the contract. In the contract, the parties also agree on the fact that they voluntarily submit to the arbitral award.

Advantages and disadvantages of an arbitration clause 

Arbitration clauses are popular because they offer the possibility for the parties to structure dispute resolution (including selecting the arbitrators) according to their own needs. Moreover, the proceedings are not public, as opposed to court proceedings. This means that, on the one hand, any business secrets will not be disclosed to the public and, on the other hand, negative PR effects during the proceedings are avoided. Usually, arbitration proceedings last shorter than ordinary court proceedings. 

Whether arbitration proceedings are less costly than court proceedings depends on the chosen arbitration institution and on the country in which the proceedings take place. Specialised lawyers' assistance is required or, at least, recommended in both cases. 

Although in most jurisdictions the parties are free to agree on any arbitration procedure they deem appropriate, the procedure is always part of the respective legal system. This means that, despite an effectively agreed arbitration clause, recourse to ordinary court proceedings may still be possible. In some countries, for example, courts always declare themselves having jurisdiction (despite a valid arbitration agreement) when a party (that is no longer willing to adhere to the arbitration clause) applies for a court order granting interim legal protection, i.e. an urgent court decision, and irreversible damage is imminent to the applying party. In such cases it should be thoroughly examined whether an arbitration clause will indeed have the desired effect.

Elements of an arbitration clause

The following elements should reasonably be made part of an arbitration clause or should be taken into consideration when drafting such a clause:

• Explicit agreement to acknowledge the arbitral award
• Choice of law for the underlying contract, i.e. the substantive law according to which the arbitral tribunal will make its decision
• Arbitral tribunal and applicable rules of procedure 
• Seat of the arbitral tribunal
• Possible prior mediation procedure
• Choice and number of arbitrators

Cross-border transactions

In the case of transactions that involve several countries it should be thoroughly examined whether it will actually be possible to enforce an obtained writ of execution at the place where the assets of the party are located. Otherwise, a writ of execution will be effective but not recoverable.

This is of relevance in particular in a situation where a writ of execution is to be enforced in a country other than the one where it had been granted (e.g. because the respective clause of the transaction agreement provides for this) but where the defeated party has its registered office or assets. Basically, this is only possible, if the state on the territory of which the writ is to be executed has in place a legal mechanism for the recognition and enforcement of such foreign writs of execution. Depending on the country, such proceedings are either possible or time- and cost-intensive or simply inadmissible.

Here, the so-called New York Convention offers an international mechanism to enforce arbitral awards. Also here, it should be verified what solution will best fulfil the needs of the parties in a given situation.

Summary

The examination of dispute resolution or dispute settlement mechanisms is part of diligent preparation of any M&A transaction. Arbitration clauses are often a good choice here because the parties may flexibly according to their needs agree on mechanisms used for deciding disputes arising from the transaction.
Arbitral awards are often also easier to execute than court decisions. But, as so often, the devil is in the details. Therefore, one should remember that “one size does not fit all”. It should be thoroughly examined which structure will have the desired effect in the individual case.