Articles & Blog Post
Mergers and Acquisitions
Mergers and acquisitions is a general term that describes the consolidation of companies or assets through various types of financial transactions. How the transaction is communicated to shareholders, employees and the board plays a role in determining whether a deal is considered a merger or acquisition.
What is a merger?A merger is the combination of two companies, who are roughly the same size, which form a new legal entity under the banner of one corporate name. Each company’s board of directors negotiate the merger, seeking to maximise the efficiency of each party’s business once merged. For example, it is likely beneficial to merge two sales teams – each pre-existing team can benefit from the client list of the other’s. Yet it may be less efficient to merge two HR teams, as one, slightly expanded, HR team may be sufficient. This may lead to salary adjustments or redundancies. The complexities, and problems, typically increase with the scale of the deal. As a new corporate entity is being created, both companies must seek shareholder approval. It is more typical that where companies are merged, shareholders on both sides of the deal retain the equivalent value in their previous shares when the new company is created. Broadly speaking, there are two main types of mergers: (1) horizontal, and (2) vertical. A horizontal merger is where two competing companies which produce/provide broadly the same goods/services. The textbook example of this type of merger is Exxon’s 1998 merger with Mobil to form the modern oil & gas company ExxonMobil. A vertical merger is where two companies in the same supply chain merge, for example, where a drinks producer merges with a bottle manufacturer. EBay merging with PayPal in 2002 is a strong example of this type of merger. Other types of merger include a conglomerate merger (where two companies without goods/services or client crossover merge) or a congeneric (where two companies without goods/services crossover, but operate in the same markets, merge). An increasingly common form of merger is a Special Purpose Acquisition Company (SPAC) merger, where a new special purpose corporate vehicle raises funds via an initial public offering (IPO) to purchase an existing (non-listed) company. That way, the existing company does not have to go through the strenuous IPO process. The popular dating app Grindr has recently undergone a SPAC merger.
What is an acquisition?An acquisition is where one company purchases another company outright. The buyer is usually much larger than the purchased company, meaning that the former absorbs the business of the smaller company. In a simple acquisition, the acquiring company obtains the majority stake in the acquired firm, meaning that its name or organisational structure does not change. Acquired companies can either be integrated into the larger business or held as a separate subsidiary. In some cases, not every part of a target company will be acquired. It is possible for an acquirer to purchase only particular assets; this has the benefit of obtaining the most valuable parts of another company to that business without taking on other, less profitable, portions – or the existing liabilities (e.g debts) over the target company.
Understanding the difference between a merger and an acquisitionWhilst companies may have similar motives for merging with or acquiring another company (accessing a different/larger market, eliminating competition, acquiring intellectual property), the type of acquisition depends primarily on motive. A merger can only occur where both companies fully accept and intend to gain from the deal. Whereas an acquisition can take place even without the consent of the target company. This is called a ‘hostile takeover’. Although there are circumstances where a target company can consent to an acquisition; in some cases a cash injection may be extremely beneficial to a target company.
How long does the M&A deal process take?It varies. Most deals take several months. Generally, the more complex the deal is, the longer it will take. The due diligence needed for complex deals is likely to take a greater amount of time.
M&A – Step by StepMerger There are generally 8 steps involved in a merger.
1. PlanningFirstly, there is a lot of planning involved. You should identify any areas in your business and sector where there are growth opportunities. You should also give your merger an approximate timescale, allowing for extra time as the process often runs for longer than expected. The aim of the transaction should be assessed, as well as how the end operating model will look.
2. Identifying suitable candidatesThen, you should make a checklist of what you are looking for in a candidate. Consider the location of their offices, what business areas they can offer, what kind and size of business you want and their culture. Contact suitable candidates to inform them of your intentions for a merger and acquisition, informing them that they have been identified as a candidate.
3. Assessing companiesAfter identifying any suitable candidates, you should create a shortlist and remove any you do not wish to progress with.
4. ValuationAfter you have created your list of suitable candidates, you will receive financial information from those who are also interested. Usually this information will only be provided under a non-disclosure agreement. Following this, a final analysis should be conducted, including the value of the company and the financial possibilities after a merger. You should assess the strengths and weakness of a merger with each candidate.
5. NegotiationsAt this stage, you should present your proposals for the merger to the chosen company, negotiating between you. Once both parties have agreed and reached a deal they are both happy with, a term sheet can be drawn up by the parties’ lawyers which will capture the key elements of the commercial deal.
6. Transaction documentsOnce the term sheet is signed off, legal due diligence can begin and the share purchase / asset purchase agreement drafted and negotiated. There are other ancillary documents that will need to be created too, for example, a disclosure letter, board minutes and service agreements.
7. ClosingAfter the contracts are signed, the deal is closed – meaning that the transition into a merged entity will begin. Both companies will integrate in all aspects – including finance and culture.
8. Ongoing monitoringBusiness performance should be monitored following the completion of the merger, to ensure there are no compliance issues.
AcquisitionNow we will briefly run through the stages of an acquisition.
1. PreparationFirstly, consider how long the acquisition will take. Generally, expect around four to six months for a deal to close. It is also important to consider the strengths and weaknesses of your company, as well as what you wish to achieve. Consider your objectives and how you are going to achieve them.
2. Initial and pre-sale negotiationsBefore entering into negotiations with a potential target, carry out extensive research, considering why you are interesting in them and finding out their sales, taxes and gross margin.
3. Due diligence and purchase agreementAfter the initial and pre-sale negotiations, the next step is due diligence and negotiation of the purchase agreement. The company should be researched extensively, including looking at their company’s balance sheet, the management team, how the company operates and the cultural fit between the two companies. The last step to complete the transition is to finalise the purchase agreement.
4. Post-merger integrationOnce the deal has closed, you need to integrate the new business into your own. This can be a lengthy process, however flexibility and planning for the unexpected will prevent the integration taking vast amounts of time.
Pros of an M&A dealM&A is a proven means for growth, allowing the newly formed business entity to:
- grow and gain market share;
- increase their geographical footprint;
- combine existing intellectual property;
- overtake/buy-out competitors;
- create new jobs; and/or
- offer investment opportunities.
Cons of an M&A dealDepending on their complexity, M&A deals can be very time consuming, sometimes taking months or even years to finalise. Much of this time will be spent on the due diligence process. Before the acquisition goes through, the acquirer will want to obtain as much information as possible about the target company, and in many cases obtain assurances from the seller/target that, amongst other things, its business is sound. Even where a merger is contemplated, each company will want to ensure it is making the right decision and is able to hold the merging entity to that decision. The due diligence needed is intensive and can therefore take away key players from their day jobs. In turn, this could potentially cause a dip in productivity and taking a toll on the companies involved. M&A deals are also risky. Proper due diligence must be carried out to ensure that the acquiring company has a full understanding of the target company, which is why it is standard practice for companies to seek external legal services to evaluate the risk of a deal. Also, merging two companies which have different cultures and ideas can be challenging. Many M&A deals run into problems at the integration stage of the deal if such has not been considered.
Damages for breach of contract: the general rule for compensationIn English law, the purpose of an award of damages for breach of contract is to compensate the injured party for loss, rather than to punish the wrongdoer. The general rule is that damages should (so far as a monetary award can do it) place the claimant in the same position as if the contract had been performed (Robinson v Harman (1848) 1 Ex 850). Damages for breach of contract are, therefore, essentially compensatory, measuring the loss caused by the breach. To put it another way, the damages enquiry involves comparing the position the claimant is in fact in, following the breach, and the position the claimant would have been in but for the breach. Accordingly, the awards are often called “expectation damages”, because they seek to put the claimant in the position it expected. The net loss is calculated by quantifying all the harms caused by the breach and then deducting or crediting all the benefits caused by the breach.
Damages for monetary lossThe majority of damages for breach of contract award compensation for financial loss. This takes many forms, including costs or liability the claimant has incurred to a third party (but would not have incurred but for the breach), and profits the claimant has foregone (that is, would have earned but for the breach).
Difference in value or cost of cureIn many cases, even though the defendant has breached the contract, the claimant can pay for a third party to cure or reinstate so as to put the claimant in as good a position as if the defendant had performed. For example, the claimant might pay for repairs to rectify a breach of warranty of quality by a seller of goods, or a partial non-performance by a builder. Where already incurred by the time of trial, such a cost will be recoverable from the defendant providing it was not so unreasonable as to be a failure to mitigate and/or a break in the chain of causation. Where the cost of cure has not been incurred at the date of trial, it will only be recoverable where incurring the cost would be “reasonable” in all the circumstances. This is because a claimant will always have a choice not to cure the problem caused by the breach. A claimant may instead, either simply live with the consequences, or use the market to offload unwanted or defective property and replace it with better property.
The presumption of breaking even and “reliance loss”In seeking to prove loss, the claimant benefits from a rebuttable presumption that but for the breach the claimant’s venture would have broken even. This means that if the claimant has already incurred costs but not yet had a chance to complete the venture, it is presumed that the breach which halts the venture caused the claimant to lose revenue equal in value to the expenditure already incurred. This is important in cases where it is impractical for the claimant to prove the profits it would have made from a venture. For example, in Anglia Television v Reed  1 QB 60, a TV company entered into a contract with an actor to take part in a film, the actor broke the contract and the film could not be made. In that case the claimant was unable to say what the profit would have been had the actor performed the contract, but because of the presumption of breaking even, the claimant was able to recover the wasted expenditure it had incurred.
Damages for breach of contract: Lost management timeA particularly well-established application of the presumption of breaking even is the award of damages for lost management time. If, as a result of the defendant’s breach, the claimant’s staff are diverted from their usual tasks in order to investigate the breach or deal with the consequences of the breach, the claimant can recover its net cost of the staff (that is, their wages). This is not because that cost was itself caused by the breach. (Unless the staff were employed specifically to deal with the breach, their cost would have been incurred even but for the breach.) Rather, it is presumed that the claimant would have earned revenue from the staff at least equal to their cost to the claimant if they had not been diverted from revenue-producing activity but for the breach. In Azzurri Communications Ltd v International Telecommunications Equipment Ltd  EWPCC 17 Birss J observed that: “if the breach can be said to have caused diversion of staff to an extent substantial enough to lead to a significant disruption of the business then it is reasonable to draw the inference of a loss of revenue equal to the cost of employing the staff.”
Damages for breach of contract: Loss of profitA claimant may prove that had the defendant’s breach not occurred, it would have earned greater revenue than its expenditure (that is, done better than broken even, and so has lost profits). Whenever a claimant is successful in a lost profits claim, it is because it proves exactly this. Alternatively, a defendant may prove that a claimant would not have broken even, or indeed that the claimant has suffered no loss because its venture or bargain was a bad one and the claimant would have made a loss but for the breach. For example, in Ampurius Nu Homes Holdings Ltd v Telford Homes (Creekside) Ltd  EWHC 1820 (Ch), the defendant construction company avoided paying substantial damages by showing that the claimant would have suffered a loss from the development if it had gone ahead.
Damages for non-financial lossThe majority of damages for breach of contract provide compensation for financial loss or property damage. Recovery of damages for such losses is restricted by the ordinary rules of remoteness and causation. Non-pecuniary and non-property damage loss falling short of personal injury have traditionally been thought to be subject to a general bar to recovery to which narrow exceptions apply. This traditional approach was applied by the House of Lords in the surveyor’s negligence case of Farley v Skinner  UKHL 49. In that case, the claimant specifically asked the surveyor whether the property he was intending to buy was affected by aircraft noise and the surveyor carelessly reported that it was not. Because “a major or important object of the contract was to give pleasure, relaxation or peace of mind”, damages for non-pecuniary loss (of £10,000) were recoverable. Professional negligence provides a range of examples in which an object of the contract was non-financial. Farley v Skinner is one example in the surveyor context. Solicitors’ negligence cases include that of a solicitor who failed to obtain a non-molestation order, another who failed to protect a mother’s custody of her children and one who mis-handled ancillary relief proceedings. In contrast, damages for non-pecuniary loss will rarely be awarded in commercial cases. There will be no award where the object of the contract was “simply carrying on a commercial activity with a view to profit” (Hayes v Dodd  2 All ER 815, Staughton LJ). Similarly, “contract-breaking is treated as an incident of commercial life which players in the game are expected to meet with mental fortitude” (Johnson v Gore Wood & Co  UKHL 65, Lord Bingham).
Personal injury and physical inconvenienceWhere the non-pecuniary damage amounts to personal injury (whether physical or psychiatric), such damage is recoverable subject to the ordinary rules of damages. Such cases arise often in such varied contexts as employment, landlord and tenant, defective goods, or defective services (holidays, etc.). Moreover, damages are frequently awarded without reference to any special test in cases of physical inconvenience caused by defective construction, landlord failure to repair, and surveyor negligence, as well as services cases such as those of defective holidays.
Quantifying lossGenerally, there are no rigid rules for the quantification of damages for breach of contract. In the end the assessment of damages is a question of fact. However, there are various principles which delimit the damages that will be awarded. The quantification of damages in litigation is often complicated and requires specialist advice from forensic accountants.
Burden of proofIt is for the claimant to prove its loss. Where the claimant’s proof of loss has been made more difficult by the defendant’s wrong, there is authority for a rebuttable presumption in favour of the claimant that gives it the benefit of any relevant doubt (see Browning v Brachers  EWCA Civ 753).
Factual causationAt the heart of the damages measure, which seeks to put the claimant in the position it would have been in but for the breach, is the question of factual causation, also known as the “but for” test. In other words, it is necessary to prove both the position the claimant is actually in post-breach, and the hypothetical position the claimant would have been in ‘but for’ the breach, and to compare the two. That is the measure of loss for breach of contract. A claimant cannot, therefore, look to recover losses that it would have sustained in any event (see Tiuta International Ltd (in liquidation) v De Villiers Surveyors Ltd  UKSC 77).
Restrictions on recovery of damagesNot all losses that in fact flow from a breach of contract are recoverable. Just because a loss was in fact caused by the breach (that is, would not have occurred but for the breach) does not mean that the law holds the defendant responsible for it. The rules on mitigation, legal causation, remoteness and contributory negligence may restrict, and in some cases prevent, a damages award.
Damages for breach of contract: Legal causationThe first major principle at play here is that of legal causation. This principle (which is materially the same in contract and tort) holds that, even though some losses were factually caused by the breach (that is, but for the breach they would not have occurred), they are nevertheless treated legally as not having been caused by the breach. The essence of the rather fluid principle of legal causation is that it is not fair to hold the defendant responsible for these particular consequences of its breach. The courts adopt a common sense approach to what intervening acts or events “break the chain of causation” between the breach and the harm. As Lord Bingham explained in Corr v IBC Vehicles Ltd  UKHL 13: “The rationale of the principle that a novus actus interveniens [Latin for new intervening act] breaks the chain of causation is fairness. It is not fair to hold a [defendant] liable, however gross his breach of duty may be, for damage caused to the claimant not by the [defendant]’s breach of duty but by some independent, supervening cause for which the [defendant] is not responsible.” Although separate from the principle of remoteness, the foreseeability of an intervening act or event, and whether it was something that the defendant’s duty aimed to protect against, will both be factors that point against a finding that the chain of causation was broken.
Damages for breach of contract: MitigationThe essence of the principle is that if the claimant unreasonably fails to act to mitigate (avoid or reduce) its loss, or unreasonably acts so as to increase its loss, the law treats those actions as having broken the chain of causation and measures damages as if the claimant had instead acted reasonably. The claimant is said to have a “duty to mitigate” (although this is not a duty enforceable by anyone, rather it is a recognition that if the claimant fails to do so its damages recovery will be affected by that failure). (BPE Solicitors v Hughes-Holland  UKSC 21). The clearest application of this principle is in the sale of goods context. Thus where a defendant seller fails to deliver goods for which a market substitute is available, the claimant cannot simply claim against the defendant all the losses which result (for example, its lost profit on a sub-sale, or lost profit from the use to which it would have put the goods). This is the case even if it does suffer those losses, because the claimant should have acted reasonably to mitigate its losses by purchasing a replacement on the market.
Remoteness of damageRemoteness of damage refers to a further important principle by which the law determines which consequences caused (in a factual/but for sense) by the defendant’s breach are within the scope of the defendant’s responsibility and should be brought into account. The traditional test of remoteness, which is in essence a test of foreseeability, is set out in Hadley v Baxendale  EWHC Exch J70. This test operates as follows:
- A loss will only be recoverable if it was “in the contemplation of the parties”, that is, foreseeable.
- The loss must be foreseeable not merely as being possible, but as being “not unlikely”, which is a more demanding test than in tort (Koufos v C Czarnikow Ltd (The Heron II)  UKHL 4).
- The loss must be foreseeable at the date of contracting, not the date of breach (Hadley v Baxendale, Jackson and another v Royal Bank of Scotland  UKHL 3, Lord Hope at para 36).
- It is not the precise circumstances that occur that must be foreseeable, but the type or kind of loss (H Parsons (Livestock) Ltd v Uttley Ingham & Co Ltd  EWCA Civ 13).
- The knowledge that is taken into account when assessing what is in the contemplation of the parties comes under two limbs: First, is the knowledge of what happens “in the ordinary course of things”, which is imputed to the parties whether or not they knew it. Second, there is actual knowledge of special circumstances outside the ordinary course of things and that was communicated to the defendant or otherwise known by the parties.