Share purchase agreements – issues surrounding expert determination
Things to consider when drafting and negotiating the expert determination provisions.
Expert determination clauses are an extremely important part of, but often under-considered provision, in sale and purchase agreements (“SPAs”) and require careful consideration at the drafting and negotiation stage. It is all too easy to focus upon the key commercial terms of the SPA, for example the purchase price, warranties, indemnities and limitations, but getting the expert determination provisions wrong or not thinking them through properly can have a significant financial impact for the buyer and/or the seller.
In other insights in this series, we have addressed issues arising in respect of warranty claims both before and after they arise. The purpose here, however, is to highlight some of the issues to consider when drafting and negotiating the expert determination provisions, setting out some practical real world examples of issues that can arise.
Expert determination clauses
Expert determination clauses are very commonly included in SPAs to set out the parties desired approach in the event that a dispute or disagreement arises. A major advantage of these provisions is that the parties can go straight to an expert who will determine the outcome of the dispute without the need to go through other dispute resolution processes.
It’s typical, for example, that disputes about the agreement of the final price following the production of completion accounts or earn out accounts are to be referred for expert determination.
In other areas of dispute, for example, a warranty or indemnity claim or as regards a breach of seller restrictive covenants, are more usually left for the courts to determine.
Given the issues subject to expert determination typically go straight to the price payable and also relate to one of the most fertile areas for dispute - how exactly should the completion accounts or earn out accounts provisions be determined? It is important that care is taken in the drafting of the underlying expert determination provisions themselves.
When a dispute arises – the process set out in the expert determination clause
The usual process that will apply is that once the parties have identified between them that a dispute has arisen, a form of notice identifying the subject of the dispute must be served by the relevant party on the other. The parties are then usually required to use reasonable endeavours to try to reach agreement as to the matter in dispute, failing which the matter will be referred for determination to an expert. The parties are, again, usually required to use reasonable endeavours to agree the identity of the person to be appointed as the expert as soon as reasonably possible. If agreement is not reached within a specified time, either party can make an application to the relevant body (usually, The President of the Institute of Chartered Accountants of England and Wales (“PICA”) for accounts and earn-out disputes) who will appoint an expert to consider the matter in dispute. That expert will determine the outcome of the dispute which will be final and binding on the parties, save in the case of manifest error or fraud.
The drafting of the expert determination provisions is clearly very important as it gives a third party the authority to decide and determine the outcome of the dispute with which the parties are faced. Let’s now have a more detailed look at the more specific provisions to identify areas of risk and ambiguity.
In order to make the process of determining the outcome of a dispute as simple, cost effective and as timely as possible, there are some basic considerations:
- Consider first of all how one party communicates to the other that a dispute has arisen. As set out above, you would usually expect there to be a provision stipulating how to notify the other party - by way of a resolution notice in writing, for example. It should clearly set out what details that notice is required to specify, i.e. to provide sufficient details of the matter in dispute to enable the other party to be able to identify the nature of the dispute and (where possible) the amount involved.
- Be clear about what type of disputes are covered by the expert determination clause (completion accounts disputes, earn out disputes and specific claims) which will ensure that anything falling outside of that clause can still be treated as a contractual dispute in the courts. If drafted too ambiguously, the provisions could be used by one party to extend the scope of their application, to their advantage, to areas that were not within the contemplation or the intention of the parties, and thus require expert determination as opposed to another form of dispute resolution procedure.
- What type of expert will be most appropriate to deal with those types of disputes? An accountant is the most commonly stated expert to be appointed under these provisions, for example in cases of completion account or earn-out calculation disputes.
- Taking this one step further, it may be appropriate to be a bit more specific in terms of the level of qualification or experience required in respect of the expert that will be appointed, such as stating an accountant must be from a top 20/30 by revenues national practice or an international firm or have x years expertise in dealing with a dispute of the value and complexity of the issues in dispute.. This sort of specification will assist in ensuring that any expert appointed is sufficiently capable of and experienced in dealing with and determining the dispute at hand.
Appointment of the expert
It is vital to consider the mechanics of how that expert is appointed to avoid any ambiguity or an inappropriate appointment. For example, as either party may be entitled to apply to refer the matter to the PICA, it is important to ensure that the provisions are detailed enough to ensure clarity and avoid any ambiguity as to how and when the appointment is to be made. For example, it is wise to think about:
- The time period that the parties have to try and agree their joint appointment of an expert. This needs to be balanced between progressing the matter in dispute as against giving the parties time to consider and put forward suitable alternatives.
- Whether a notifying party has to provide a copy of the application to or otherwise notify the opposing party that they have invoked their entitlement to apply to the relevant authority to appoint the expert due to their failure to agree a joint appointment.
- What information and documentation should the application contain? For example, should the drafting simply state that either party may apply to the relevant body to appoint an expert, or should they be required to provide a full and detailed breakdown of the matter in dispute together with relevant details from the SPA as to the experience level of the expert to be appointed? Experience suggests that more details should be required to be provided to ensure that the relevant body understands the extent and complexity of the dispute at hand and can appoint an expert sufficiently qualified and experienced to be able to determine it. Failure to do so can result in an inexperienced expert being appointed and the parties having no ability to challenge the appointment.
- The expert is required to be independent, i.e. not connected with either party so as to avoid giving them an unfair advantage over the other, but if either party has a particular concern in that regard, it is better to expressly stipulate that the appointed expert is not to be connected to either party (i.e. a current or past accountant or auditor or tax adviser) or even pre agree who the expert should be. Consider also the possibility that conflicts, real or perceived, may reduce the range of firms that maybe available, particularly where either or both of the parties are publically listed and have received audit and tax advice from two members of the Big 4 and may of course have changed advisors recently. Finding an expert acceptable to both sides may become challenging. An option to consider is pre-agreeing who the expert (individual or firm) will be.
Submissions to the expert
It is usual to see a clause allowing both parties to make submissions to the expert once appointed and a requirement to provide such assistance, documents and information as the expert may require. Should the submissions be capable of being made orally, or should they be kept to written submissions for certainty as to what each party has submitted? As stated above, written submissions are often considered to more appropriate for certainty. Further, should each party be entitled to see the other’s submissions and should they then also be given the opportunity to respond to those submissions?
In terms of the expert’s determination, how is that to be communicated to the parties? Consider how long the expert has to provide the report from the date of the appointment?
Is it appropriate to allow the expert to instruct other professional advisers to reach their determination and if so, who should bear the cost of those appointments? The usual position is that the parties are to share the costs and expenses of the expert(s) equally or as the expert determines. If this is not appropriate for whatever reason, stipulate how the cost is to be apportioned.
Beware – final and binding
Normally, “save in the event of manifest error or fraud, the expert’s determination is final and binding on the parties”. What happens then if the expert’s “determination” is literally a bare sentence, paragraph or two setting out in whose favour they have resolved the matter in dispute, but no further details as to why or what factors influenced them? It does happen! In these circumstances, there would be very little opportunity for either party to challenge the determination as to whether an error has been made or if any fraud has occurred. The flip side of this of course is that where the expert sets out in considerable detail the reasoning behind their determination, this then gives the parties a lot of detail which is then capable of challenge. The parties should therefore consider whether it is appropriate to set out what level of detail the expert is required to report on in delivering their opinion.
We have highlighted the importance of expert determination provisions and some practical considerations in relation to their drafting. Whilst the above considerations are relevant to the expert determination provisions, see our other insights on how to deal with warranty claims and the measure of damages in warranty claims. Claims of this nature do not fall within the expert determination clause and will usually be dealt with by way of litigation or other alternative dispute resolution processes.