The Dos and Don'ts of Expert Determination
6 September 2021
Authors: Olli Mäkelä (Senior Associate), Anna-Maria Tamminen (Partner), and Magnus Andersson (Senior Associate)
Although the general economy has had its fair share of booms and busts during the COVID-19 pandemic, the M&A market in Finland, Sweden, and also globally has been on a bull run for the past year. Deals have been negotiated and closed under exceptional circumstances. Various purchase price mechanisms continue to be popular solutions to navigating exceptional circumstances and allocating the risk between the seller and the buyer in these uncertain times. Most prominent among such mechanisms are earn-out and closing adjustment mechanisms.
Such mechanisms work well when the parties are in agreement about the target company’s financial information. However, because accounting and financial statements are by no means an exact science, these mechanisms are also particularly prone to disputes. Typically, the parties agree in the SPA that any such disputes are to be finally resolved by an independent auditor or other (non-lawyer) expert in so-called expert determination.
Expert determination proceedings are, in many ways, different from “ordinary” disputes adjudicated or mediated before courts or arbitral tribunals. That being said, a dispute is a dispute, and many traditional rules of thumb also apply in expert determinations. We have compiled a list of dos and don’ts below to aid you in navigating these unique situations.
Do read the SPA carefully
The SPA typically includes strict procedural steps to be followed in determining purchase price adjustments, including deadlines for submitting calculations and form requirements for objections to calculations. Failure to meet such requirements can, depending on the contents of the SPA, lead to a forfeiture of rights, or at the very least, to unnecessary arguments about the subject. The procedural steps should be followed carefully, and experienced counsel can help you navigate the pitfalls (see next ‘do’).
Do hire good counsel (and hope your counterparty does too)
On the Finnish and Swedish markets, expert determination proceedings are relatively rare, so it is important to retain counsel with previous experience of such proceedings. However, even more importantly, your counsel should have a practical mindset. Expert determination proceedings are, by their nature, less governed by procedural rules and require a larger degree of co-operation between the parties. When both parties are represented by experienced and practically-minded counsel, the dispute can typically be resolved faster, more efficiently, and with less disruption to business. The fact that expert determination proceedings require co-operation between the parties is a double-edged sword; a party that aims to sabotage a proceeding has ample opportunity to invoke procedural arguments, thereby delaying the final resolution of the issues in dispute. Ultimately, however, if that party is at fault, such procedural manoeuvres just end up costing more money. Either way, this is yet another argument for hiring experienced counsel that can navigate these thorny procedural matters.
Do remember that the parties can also agree otherwise
Though the SPA should generally be followed, it can also be easily derogated from by mutual agreement of the parties. For example, in our experience, the typical 30-day limit for the duration of the proceedings is simply not sufficient for any but the simplest of disputes, and the deadline is typically extended by mutual agreement to ensure that the parties have access to the necessary underlying information and/or persons. The parties may also, explicitly or by conduct, agree to extend or skip certain procedural deadlines, bypass the expert determination phase and go directly to arbitration, or settle parts of their dispute while directing the rest to expert determination. Furthermore, in our experience, it is common that the parties and the expert agree on a set of guidelines or rules and a timetable at the outset of the proceedings. Such party agreement can provide a useful tool for the expert when managing the proceedings by, for example, narrowing down the scope of the expert’s assignment and clarifying that the expert may only rely on arguments and documents presented by the parties.
Do try to agree on the expert
Due to the relatively small number of expert determinations, there are not too many persons with experience of acting as an expert in these types of proceedings. Due to conflicts of interest, many of the chosen candidates may also have to decline a potential appointment. It is generally in both parties’ interests to try to agree on a candidate from those available and willing to accept the task. Mutual acceptance of the expert generally facilitates agreement on the process and speeds up the resolution of the dispute.
Don’t treat it like arbitration
Expert determination and arbitration are seemingly alike in that the dispute is referred to an independent external adjudicator. However, the two are in fact very far apart. Perhaps the greatest difference is that arbitrators are almost without exception lawyers, whereas independent experts are not. In our experience, the different backgrounds lead to very different styles of thinking, which is often reflected in the ultimate decision. For example, to a lawyer, it is almost instinctive to decide a matter based solely on the parties’ agreement, arguments, and evidence, whereas a non-lawyer may feel compelled to search for the “right answer” even outside this frame of material. This also means that counsel should not always advocate their case precisely like in arbitration. Whereas “mind your audience” is always an important guideline for advocacy, this is even more critical to remember when your audience has a completely different education and background.
Don’t hide material or information
Purchase price disputes typically involve significant information asymmetry in that the purchasing party has access to all of the financial data of the target company after the sale, whereas the seller may have access to the same information but prior to the sale and limited or no information thereafter. For this reason, SPAs often impose disclosure and document production obligations on both parties. The disclosing party may be tempted to conceal information unfavourable to its case, but this should always be avoided; information has a habit of rising to the surface, and in the worst case, concealing documents or providing false information may constitute a criminal offence.
Don’t forget the other agreements
Purchase price disputes can arise in private equity investments where the founder-seller(s) retain(s) a minority stake or continue(s) to work for the company. Such arrangements typically involve a shareholders’ agreement, shareholders’ loans, and/or director/employee agreements. Alternatively, a larger M&A deal may involve different co-operation agreements during the integration phase. In pursuing their purchase price disputes, parties and counsel should be mindful of their rights and obligations under such other agreements. They may include, for instance, more extensive disclosure obligations which can be used in the dispute or different confidentiality obligations which may be inadvertently breached during the proceedings.
Don’t expect too much
It is an unfortunate misconception that expert determination is fast and cheap, leads to higher-quality decisions, and is less disruptive to business. Sadly, none of these things necessarily holds true. There are no free lunches; when two disagreeing parties hire experts to represent them and a third party to resolve the dispute, it tends to be expensive, sometimes slow, and disruptive to business. However, with a practical mindset by both parties and with a focus on the core of the dispute, expert determination can also meet the high expectations.
While expert determination is often inserted into SPAs in the hope of finding a quick and expert-driven solution to a “numbers question”, if the parties cannot agree on the numbers, expert determination often turns into a dispute requiring the intervention of lawyers. In such situations, the short deadlines provided on paper rarely work in practice, and legal and/or contractual argumentation will be required in addition to discussion about the numbers. At best, expert determination can bring the parties the necessary information to arrive at an agreed settlement in a more structured framework, but at worst, expert determination is only an unclear step in a protracted post-M&A dispute that will ultimately end up being determined in arbitration. The latter outcome can often be avoided by retaining experienced counsel and experts and by taking a proactive approach to the resolution of the dispute.