Expert Insights: Navigating W&I Claims in M&A with BDO's Nick Andrews. Forensic Accounting Partner at BDO LLP
Warranty and Indemnity (W&I) claims are a common but often contentious aspect of mergers and acquisitions (M&A). These claims, which arise when a breach of contract is alleged regarding warranties made during the deal, can significantly affect the value of a transaction and the relationship between the parties involved. In this interview, Nick Andrews, a Forensic Accounting Partner at BDO LLP, offers his expert insights into the complexities of W&I claims and the vital role forensic accounting plays in resolving these disputes. Drawing on his 25 years of experience, Nick discusses key challenges, common pitfalls, and the evolving role of forensic accountants in M&A transactions, providing valuable guidance for companies navigating this intricate area of financial risk.
Nick Andrews, Forensic Accounting Partner at BDO LLP
With your extensive experience in forensic accounting, what key insights can you share about the nature of Warranty and Indemnity (W&I) claims in M&A transactions?
Multiple surveys carried out by market participants have found that the most common type of W&I claim following an M&A transaction relates to the accounting warranties. In my experience, these most often relate to the last Accounts not showing a True and Fair view of the trading and/or the financial position of the target acquired.
Other commonly alleged accounting breaches in W&I claims include claims relating to:
- i) asset values, such as the condition of fixed assets, the realisability of inventory and the recovery of receivables;
- ii) omission of liabilities, including contingent liabilities, from the Accounts;
iii) fair and consistent presentation of management accounts;
- iv) consistency with IFRS and historical accounting practices and policies.
A particularly contentious area that I have also seen relates to the warranted absence of material adverse change to trading, financial position and (less commonly) prospects of the target.
Other non-accounting breaches that I have encountered, and which nonetheless involve assessment of financial damage by forensic accountants, include a range of regulatory breaches, breach of “no threatened litigation” warranties and tax covenant breaches.
What common pitfalls do you see companies encounter when addressing W&I claims, and how can they be avoided?
When considering making a W&I claim following an acquisition through a Sale and Purchase Agreement (SPA), it is important that a company intending to make a W&I claim seeks both legal and accounting advice.
First, the company needs legal advice on whether the warranty it may think has been breached has in fact been breached from a legal perspective. This will involve the company assembling the fact pattern behind its view of breach and then being challenged by lawyers as regards possible defences. Such defences might involve a different legal interpretation of a warranty, a challenge to the veracity of the facts or exceptions provided for in the SPA.
Other defences to a W&I claim which constitute potential pitfalls for a claimant company include “disclosure” and “knowledge”. If information has been fairly disclosed to the company during the transaction process, which is indicative of a warranty breach, then this will fetter a claim. Similarly, if it can be demonstrated that the acquirer had prior knowledge of the facts, for example through its due diligence, that will also frustrate a potential claim.
When it comes to quantum, a common challenge that we see is that the basis of valuation an acquirer is asserting it used for the purposes of the transaction cannot be substantiated. This is vital because the standard basis of quantifying loss in relation to a warranty claim (other than where the remedy for loss is on a “£ for £” basis) is the difference between the value of the target entity with the warranties true versus the value of the entity with the warranties false (i.e. valuing the target in its actual state, with the alleged breaches).
In such a situation, it is important that the claimant can demonstrate the basis of valuation employed in the transaction, rather than attempting to “reverse engineer” the asserted basis of valuation after the event for the sole purpose of quantifying a claim.
As someone who has acted as an expert witness in numerous cases, what role do you believe expert testimony plays in resolving W&I disputes?
If a matter cannot be settled between the parties, then a process of litigation or arbitration will typically ensue. As part of this process, the parties will invariably need to appoint expert witnesses in relevant disciplines, including accounting.
Often, the parties will have been directed to enter a mediation process along the way, at which expert input is often sought, and experts may present their views on loss before a mediator. They may also be encouraged to have a meeting of opposing experts to try and narrow differences and potentially assist in enabling the parties to settle.
However, if all else fails and a full hearing occurs, then the expert witnesses for each party will give oral testimony on their written expert evidence submitted during the process.
Ultimately, once a court or tribunal has heard all the evidence and legal argument, a finding, and if appliable an award will be handed down. Accordingly, an expert’s testimony can be critical to the outcome.
Can you describe your process when assessing a W&I claim in the context of post-acquisition disputes?
Our initial process when instructed to assess a W&I claim, whether on behalf of claimant or respondent, is to make sure that we have access to all the relevant key documentation, which will include the SPA and, if applicable, the W&I insurance policy. We will also seek to understand the background to and nature of the claim. This can lead to a range of follow-up investigatory actions, from the review of principal accounting documents, such as annual accounts, to a detailed forensic investigation into all the relevant underlying documentation (e.g. due diligence reports and contemporaneous evidence regarding the basis of valuation of the target).
Once we have reviewed all the relevant financial and contractual documentation, we will, in discussion with the client and its lawyers, give an initial overview of our opinion as to the robustness of a claim and any potential weaknesses (from an accounting perspective). We will also provide an initial assessment of the potential range of loss. We will typically provide a preliminary report in advance of the discussion with the client and lawyers.
From then on, the process we follow will depend on whether or not settlement can be reached, or whether the matter progresses to formal dispute resolution. Whichever way the matter progresses, we will work closely with the client and its lawyers, following the instructions of the latter as to what reports we need to prepare and meetings to hold with opposing expert accountants.
How has the landscape of W&I insurance evolved over your 25 years in the field, particularly concerning M&A transactions.
When I was first involved in the field of W&I claims, W&I insurance was virtually unheard of in the UK. It started in Australia some 20 years ago and has only been a real feature of the UK landscape in the last 15 years or so. Even at that time, it was comparatively rare with only half a dozen insurers initially offering W&I policies.
In the last ten years, the W&I insurance sector has expanded apace and there are now some 30 to 40 insurers active in the W&I market in the UK. From our wider M&A experience of live transactions, it seems as though on most deals of significant size, it is the norm to at least explore W&I insurance, with some sectors such as real estate and private equity having been early advocates of using it. It is also notable that there is a big appetite for W&I insurance amongst overseas buyers of UK companies.
In your experience, what are the most critical factors that can influence the outcome of a W&I claim?
In order to succeed with a W&I claim, whether an insured claim or not, a claimant needs to demonstrate breach, causation and loss. Ultimately, the outcome will come down to the terms within the W&I contract, whether just the SPA, or also the insurance policy in insured cases.
Factors that can influence the outcome include a clear description of and rationale for the alleged breach, backed up by supporting contemporaneous evidence, preferably documentary in nature. Then, as regards causation, the claimant needs to be able to demonstrate why the breach has caused it to suffer loss. Finally, as regards quantum of loss, the claimant will need to substantiate with evidence how it has arrived at its claimed loss figure.
This is where expert accounting support is important, to assess the quality and relevance of evidence from an accountant’s perspective and to make an independent assessment of the value of the business acquired as at Completion and the impact on that value of the warranty breaches.
What strategies do you recommend for companies to effectively prepare for potential W&I disputes before they arise?
An effective strategy to prepare for a W&I dispute before one arises is to draw on what factors can influence the outcome of a claim, as noted in the previous answer.
In summary, it is important to methodically maintain a record of all key discussions and decisions made during the course of a transaction. It is also important to retain all relevant financial and accounting records and details of the valuation process and how that evolved over time during the transaction, as more information came in.
Looking ahead, how do you foresee the role of forensic accountants evolving in relation to W&I claims and M&A disputes in the coming years?
One aspect of M&A disputes that could see a change is an increase in the trend towards alternative dispute resolution (ADR) as a means of resolving disputes. This is already happening in relation to completion accounts and earnout disputes, where the use of independent determination by expert accountants has been common for many years.
Turning specifically to W&I claims, it is possible that in order to avoid long drawn-out formal litigation or arbitration processes, there will be a movement towards other forms of ADR. In recent years, I have been involved in a number of W&I claims, where the process has lasted three or four years before an outcome has been reached, which feels too long for all concerned.
Looking at the art of the possible, rather than arriving at a prediction, two forms of ADR which may be attractive in such situations are double-headed expert determination and adjudication.
The former would involve a named duo of an expert W&I legal practitioner and an expert forensic accountant working together to determine respectively the two aspects of breach/causation and quantum of loss.
Adjudication, which could be for smaller and less complex claims, could be designed in a similar way to adjudications commonly used to resolve disputes in the construction sector. The adjudicator could be a lawyer, insurance industry professional or a forensic accountant, provided both parties could agree on such a person.
About Nick:
Nick has been a partner in the Forensic Accounting market for 25 years, focusing on Disputes. He is a very experienced expert witness, having acted as expert accountant or valuer on over 200 cases. He has given oral testimony on 20 occasions.
Nick's primary specialism is M&A disputes, where he has considerable experience of post-acquisition SPA disputes, including Completion Accounts, Earn-outs and Warranty Claims, including W&I insurance claims. He is one of the UK's foremost Independent Expert Determiners.
Nick has also undertaken over 100 business valuations in contentious situations, including shareholder, joint venture, post-acquisition, High Net Worth Matrimonial and CPO disputes.
Nick Andrews
Partner, BDO
Forensic Accounting Services
FCA | MAE | MEWI
BDO London - Baker Street
Tel: 07788 435618 | 0207 893 3780
www.bdo.co.uk
