There are some simple steps that can often be taken when drafting a Share Purchase Agreement (SPA) to help avoid getting into a post-deal dispute over completion accounts.
Clear and unambiguous drafting of specific accounting policies
Early involvement of advisers and principals on both sides in drafting the SPA is crucial to ensure the accounting policies in relation to completion accounts operate as expected. When parties draft the accounting policies using standard template policies from other deals or based on the target company’s statutory accounts, they are unlikely to be fit for purpose. Firstly, policies need to be adapted to fit the business. Secondly, they need to be specific to completion accounts.
We regularly see parties in dispute over policies (or the lack of them) in relation to the more judgemental areas of the accounts such as revenue recognition, inventory/stock valuation, dilapidation provisions, bad debt provisions or other accruals/provisions. Accounting standards are not necessarily prescriptive enough or appropriate in a completion accounts context, so specific accounting policies should be included in the SPA.
For example, it may be the seller has always relied on the directors’ judgement to establish if a bad debt provision is required, whereas the buyer wants a more formulaic approach, applying fixed percentages according to the age of debts. Both policies could be in accordance with accounting standards, and both could be ‘materially correct’ for the purpose of statutory accounts, but for completion accounts, the concept of materiality does not usually apply, and the specific policies agreed between the parties would override any requirements of accounting standards.
We often see disputes relating to issues identified some time after completion, so it is important to have a clearly defined cut-off policy to establish when post balance sheet events should be taken into account in the completion accounts. For example, how long should the parties review debtors for payment post-completion and how does this tie in with the timing of preparation or review of the completion accounts?
Procedural issues
It is also important that key procedural issues are properly addressed in the SPA. Usually, one party prepares the draft completion accounts then the other party has time to review. If the reviewing party disagrees with the draft completion accounts, it must issue a dispute/objection notice before the deadline agreed in the SPA.
It is important to consider which party is best placed to prepare and review the completion accounts. The buyer will have access to the books and records, but the seller will have better knowledge of the business pre-completion. It is also worth bearing in mind that post-completion, the company will be under the buyer’s ownership and key personnel may have changed, or have shifted loyalties, which could impact decisions on judgemental or more complex accounting treatments.
What needs to go in a dispute notice?
There are key questions to consider when setting out in the SPA what the dispute notice should include. Does each disputed item need to be quantified? Can an expert be asked to determine any matters not included in the original dispute notice? The SPA should make all of these points clear. We have seen several disputes where it is unclear whether or not new issues can be added to dispute after issue of the dispute notice, or whether the value of a notified disputed item can increase.
Expert determination
The SPA should set out the process to follow in the event of a dispute. The usual process agreed in the SPA allows the parties to attempt to resolve matters between themselves. Then, if this does not happen within a set timescale, there is a referral to an independent expert accountant, agreed between the parties, for a process known as an expert determination. An expert determination is normally final and binding (in the absence of fraud or manifest error) so helps in swift resolution of disputes without involving the Courts.
At Quantuma, we regularly act as that expert accountant in a determination, or we advise one of the parties to the dispute in negotiating with the counter-party, or drafting submissions to the expert accountant, making the most of our experience to help our client explain why their approach is aligned to the SPA’s provisions.
Summary
All too often, we see completion accounts disputes which could have been avoided had the SPA been properly drafted pre-deal. After investing considerable time and effort in due diligence, pre-deal negotiations over valuation, and drafting of legal documents, either party can still end up losing considerable value if the completion accounts policies don’t reflect the parties’ intentions or aren’t sufficiently clear.
Should you wish to discuss any of the above points further, or find yourself involved in a completion accounts dispute, please get in touch and we would be happy to assist where we can.
