Using Mediation to Maximize Value in M&A Disputes
Joe Basile, Managing Director, Pari Passu M&A Mediation LLC
Anyone who has spent meaningful time in the world of mergers and acquisitions knows that professionals in this arena are hardly shrinking violets. Individuals who effectively act on behalf of companies and investors in M&A transactions are almost to a person proactive, assertive and outcome-driven. It is therefore quite surprising that when an M&A transaction leads to a dispute, many parties who would never consider allowing an outsider to make their initial deal readily turn the task of deciding the outcome of their dispute over to a stranger – sometimes an arbitrator, but more often a judge.
Outsourcing the resolution of legal disputes has a such a long tradition that the move is almost hardwired in the thinking of businesspersons and their advisors. It offers the comfort of a (more or less) defined path leading to a finality that is anointed by the widely accepted legitimacy of the process. On the other hand, outsourcing the resolution of a legal dispute carries a number of significant disadvantages, including time, expense, adverse publicity and, most importantly, the loss of opportunity to negotiate a more valuable outcome than a judge or arbitrator could impose.
Mediation can be an attractive alternative to outsourcing. In mediation the disputants retain control over resolving their disagreement. The parties jointly engage a professional neutral to facilitate the negotiation of a resolution to which the parties themselves agree. Unlike a judge or an arbitrator, a mediator does not decide the outcome of a dispute. Rather, the mediator’s job is to help disputants find a solution that is a better alternative to not reaching agreement.
Retaining ownership of a dispute and its resolution is harder work, and can be more emotionally taxing, than dumping it in the lap of a stranger. However, by keeping as much control over the resolution of a dispute as the parties exercised in making their initial deal, the parties, with the assistance of a skilled mediator, can frequently achieve a more valuable outcome than would be available in litigation or arbitration. This case study examines why and how this is so.
In the tradition of medical students who learn by close examination of cadavers, we will begin by dissecting something that came to an unfortunate ending.
A Real Hypothetical
To illustrate the value maximizing potential of mediation, let us consider the following summary of an M&A dispute and its outsourced resolution. The events described below are based on publicly available descriptions of an actual case, with identifying facts changed and a few embellishments added for didactic purposes.
Background of the Dispute
ConvenienceCo LLC, a private equity-backed company “(Seller”), owned a large, nationwide chain of combination convenience store/gas stations (“Sites”). In early 2014, Seller’s sponsor decided that it was a good time to sell 100 Sites located in the Midwest.
Seller engaged a well-known sell-side financial advisor (“I-Banker”) to conduct a sale process. The bidding procedures called for bidders to receive access to a virtual data room containing information about the Sites after signing a Confidentiality Agreement. The Confidentiality Agreement provided in part:
The Parties agree that unless a definitive agreement providing for the sale of the Sites has been executed, no contract between the Parties providing for such a transaction shall be deemed to exist and neither Party will be under any legal obligation of any kind whatsoever to the other with respect to such a transaction. The term “definitive agreement” does not include an indication of interest, letter of intent or any other preliminary agreement or bid, unless specifically so designated in writing and executed by both Parties.
On April 2 Mary Brown, the I-Banker executive leading the sale process, emailed potential bidders announcing the sale of the 100 Sites. She attached to the email a first-round process letter that gave bidders a deadline of May 9, 2014, to submit non-binding indications of interest, including a proposed bid price. Minute Stop, LLC, another private equity-backed operator of convenience store/gas stations in the Midwest (“Minute”), expressed interest. Brown emailed Bob Sweeney, Minute’s head of corporate development, the Confidentiality Agreement, which Sweeney signed.
On May 9, the deadline under the first-round process letter, Minute emailed Brown its IOI, which included a bid of $250 million for all 100 Sites. Minute’s IOI stated that the bid was “subject to the execution of a mutually acceptable Asset Purchase Agreement (“APA”)”. Five other bidders, including Quick Gas, Inc. (“Quick”), another operator of convenience store/ gas stations but only in the Southeast, also submitted IOI’s. Quick’s bid was $230 million. Brown sent a second-round process letter to Minute and Quick, notifying them that they were the two leading bidders and giving each one week to consider raising their bids and to submit a fully marked-up version of the APA that Seller had posted to the virtual data room.
Both Minute and Quick submitted marked-up APA’s reflecting various proposed “buyer-friendly” changes. Minute increased its bid to $260 million and Quick moved to $235 million. Seller reacted badly to a number of the APA changes that Minute and Quick proposed. On May 23, after a week of difficult negotiations, Sweeney emailed Brown to let her know that Minute could no longer pursue the transaction under the terms being required by Seller, adding that he still hoped that the parties might make a deal in the future.
On May 27, Seller notified Minute that Seller was willing to sell 55 Sites on revised deal terms. On May 30, Sweeney, on behalf of Minute, emailed Brown proposing a transaction. The email listed five terms:
- “$140 million for 55 Sites.
- Execution of an APA on or before June 15, 2014.
- Closing on or before August 1, 2014.
- Non-compete by Seller for three years within five miles of any Site being sold.
- APA similar to what we recently submitted but modified to reflect the above terms.”
Sweeney’s email added that the above terms were “final and non-negotiable” and gave Seller until 5 PM on May 31 to confirm its acceptance. The email neither referenced the bidding procedures nor did it include a request for exclusivity. Seller’s board, meeting by telephone, voted to accept Minute’s terms. Before Sweeney’s deadline, Brown emailed him to say that Seller was “on board to sell Minute the 55 Sites subject to a mutually agreeable APA” and that Seller’s counsel “would be turning a revised APA tonight to respond to your last draft.”
On June 1, Seller’s counsel sent Minute’s counsel a revised draft APA together with initial drafts of exhibits, including an escrow agreement and a non-competition agreement. Seller, Minute and their respective counsel worked toward finalizing the transaction documents over the next several days. Meanwhile, Quick presented Seller with a new offer to purchase 70 Sites for $180 million. Seller’s board determined Quick’s offer to be superior to Minute’s. On June 10, Seller and Quick finalized and executed an APA.
The Parties’ Positions
Upon learning of Seller’s deal with Quick, Sweeney demanded that Seller honor the deal reflected in the May 30-31 email exchange. Seller refused relying on the terms of the Confidentiality Agreement providing that no contract for a sale of the Sites would exist until the parties signed a definitive agreement. Minute argued that the termination of negotiations for the sale of 100 Sites ended the initial bidding process, that Seller’s subsequent offer to sell 55 Sites initiated a new sale effort that was not governed by the bidding procedures, including the “no obligation” provisions of the Confidentiality Agreement, and that the parties’ May 30-31 email exchange was a sufficiently definite expression of offer and acceptance to result in a contract for the sale of 55 Sites on the terms described in Minute’s email. Minute consulted its outside counsel who advised that case law in the jurisdiction was not fully settled but that Minute had a “good shot” at winning in a lawsuit.
The Dispute is Outsourced and Resolved
Although the above description of the dispute deviates from the facts of the actual case in certain respects, the following description of how the parties resolved the dispute is fully consistent with publicly available information.
Soon after the closing of the sale to Quick, Minute sued Seller for breach of contract and also sued Quick for tortious interference. Seller counterclaimed for damages alleging that Minute had breached the Confidentiality Agreement. Minute settled with Quick but continued its litigation against Seller. Approximately three years after the closing of the sale to Quick, the trial court granted Seller’s motion for summary judgment on the basis that a definitive APA was a condition to the formation of a contract and dismissed Seller’s counterclaims. Minute appealed to the state’s intermediate appellate court, and approximately two years later the appellate court reversed and remanded, holding that the question of whether Seller and Minute intended to form a contract by their exchange of emails was a question of fact that was not appropriate for summary judgment. Seller in turn appealed and approximately three years later the state supreme court reversed the decision of the intermediate appellate court and entered judgment for Seller. The litigation was widely reported in the trade and legal press.
Understanding How Mediation Can Maximize Value
The value destroying consequences of this outsourced dispute resolution process are obvious – eight years of litigation resulting in significant diversion of management time, the attendant negative publicity and almost certainly millions of dollars spent in legal fees and other litigation expenses. Seller and Quick had their deal (although Seller sold 30 Sites fewer than it originally hoped to sell) but at significant additional expense and after years of uncertainty, and Minute ended up with a goose egg, a black eye and a big legal bill. There must be a better way.
Mediation allows the parties to an M&A-based dispute to maximize value in two ways: first by avoiding many of the value destroying aspects of outsourced dispute resolution and second by enabling the parties to use their deal making talents to devise solutions that are more creative and more valuable than a judge or arbitrator could impose.
Although one can list a number of ways in which mediation differs from litigation and arbitration, there is one cornerstone distinction from which flow all the others: unlike the traditional forms of outsourced dispute resolution in which (if the tribunal has jurisdiction) participation is compulsory, participation in mediation is voluntary. There are a few exceptions, for example parties may have contractually committed to mediation as an initial dispute resolution step or a judge might order parties to give mediation a try before coming back to court. However, in the vast majority of cases, disputants participate in mediation only if and for as long as they choose to do so. This basic difference has several consequences.
First, any party at any time can exit from mediation if that party no longer feels that the process is productive. Not so with litigation or arbitration which, once commenced, must run its course unless all parties (and in some cases the tribunal) agree. Like the Hotel California, once entered there is no getting out of an arbitration or lawsuit, unless one is willing to surrender. Parties to outsourced dispute resolution are along for the ride for as long as it takes, even as value continues to vaporize before their eyes. Disputants lose nothing by beginning with mediation because any party at any time can call off the process and opt to litigate.
Second, because participation in mediation is voluntary, the parties can select the neutral with whom they want to work. Contrast this with litigation where legal rules limit the available fora and in any given forum the disputants have almost no ability to influence the selection of the judge. Ability to select the neutral makes value maximization much more likely. This is especially so in the M&A context where a mediator’s experience in deal making can be enormously helpful. With the few exceptions of the Delaware Court of Chancery and the specialized business litigation sessions that exist in some states, a judge hearing an M&A dispute is unlikely to be familiar with the type of transaction that gave rise to the dispute. Even if the judge does have some acquaintance with M&A, she or he is likely to be a litigator by prior experience rather than a transactional lawyer. Disputants can select a mediator who actually knows what they are arguing about and how to make deals.
Third, in mediation the parties and the mediator have complete freedom to design their process. Not so with litigation, which is governed by procedural rules that mandate the elements, sequence and timing of the process. While there is some limited ability for the parties and the judge to expedite and streamline, almost inevitably the rules of civil procedure (including discovery) make litigation time consuming and expensive. The eight-year ordeal that ensued from the decision to litigate the relatively simple M&A dispute described above puts an exclamation mark on this observation. This durational reality of litigation leads to uncertainty over eventual outcome, distraction of management and other personnel from running the business and significant out of pocket expenses, all of which destroy value. Disputants who choose to arbitrate in theory have somewhat greater flexibility than do litigants to shape their process, but in practice arbitration has become increasingly more formal, effectively often becoming “litigation lite”.
In contrast, by retaining control of their dispute parties who mediate, with the guidance of a skilled mediator, can design an efficient, businesslike process that gets to a conclusion much more quickly and inexpensively. For example, disputants and the mediator can discuss and agree on the extent to which the parties will exchange information, who will (and must) attend mediation sessions, the written and oral submissions that each party will make, and a timetable. Other process matters that the parties should discuss include whether to mediate in joint session and/or by means of separate caucuses with the mediator, whether the disputants prefer that the mediator take an evaluative or a facilitative approach and whether the parties want the mediator to offer a non-binding recommended resolution if the parties get stuck. As a result, the duration of the typical mediation of a business dispute is measured in weeks, or perhaps months, rather than years, resulting in far less value destruction than litigation or arbitration.
Fourth, disputants who choose to mediate almost always include confidentiality as an element of their agreed upon process. By contrast, litigation necessarily occurs in a fishbowl. Confidential mediation avoids the value destruction that often accompanies the public airing of an M&A dispute. Our example above illustrates this point in a number of ways. Both Seller and Minute were owned by private equity funds. The sponsors of those funds are likely to be frequent fliers in the M&A world for whom reputation would be an important interest. Seller’s sponsor would probably not want to be known for backing out of deals. Minute’s sponsor would not want to be known for inability to seal a deal – in this case not requesting exclusivity as part of its May 30 offer may look from the outside like a rookie mistake. Perhaps to a lesser extent the spotlight did neither Quick nor I-Banker any favors. Had this dispute been resolved in mediation, the parties would have retained control over the public message.
To be fair, some of the value conserving advantages of mediation over litigation (such as confidentiality and the ability to select the neutral and proceed more quickly) are available in arbitration. However, there is one advantage to mediation that is unique and even more significant: mediation provides the disputants with the opportunity to shape their own resolution in ways that are more inventive and more value creating than a judge or arbitrator could impose.
Judges and arbitrators can rule that one party or the other is entitled to money, and judges who sit in courts of equity have some ability to order that parties behave or refrain from behaving in certain ways. In essence judges and arbitrators decide which party “wins” and by how much. However, neither judges nor arbitrators have the authority to make a new deal for the parties. Only the parties themselves by retaining control over the process can fashion a new deal to resolve their dispute. A skilled mediator can play an important role in helping the parties get to a happy landing.
Mediators facilitate creative dispute resolution in the first instance by encouraging the parties to think beyond the positions they are taking and to focus instead on their underlying interests. Recognizing the difference between position and interest is critical. A disputant’s position is that for which the disputant is asking to satisfy its claim. By contrast an interest is that which motivates a disputant to take a particular position. A mediator encourages the parties to look behind their positions and articulate their interests by asking “why?”. The distinction between position and interest and the usefulness of appreciating that distinction in negotiations has long been part of the mediator’s canon, dating at least from the 1981 groundbreaking book, Getting to Yes: Negotiating Agreement Without Giving In, by Roger Fisher and William Ury.
Returning to the example above, the parties’ positions are easy to discern. Minute’s position is that it has the right to purchase 55 specific Sites from Seller for $140 million. Seller’s position is that it has the right to sell those Sites (as part of a larger package consisting of 70 Sites) to Quick for $180 million with no liability to Minute. Quick’s position is that it is entitled to purchase 70 Sites from Seller for $180 million (including the 55 claimed by Minute) with no liability to Minute. But what is each party’s interest – why are the parties taking their respective positions? It is impossible to know without asking “why?”. The “why” question is one of the most powerful tools in a mediator’s box.
One cannot discern the parties’ interests from the published reports of the dispute that inspired our hypothetical, so the following is pure speculation, but nonetheless entirely plausible.
Seller was a portfolio company of a private equity fund. If asked about its interest, Seller may have explained that its sponsor was interested in generating liquidity because the fund was nearing its end date and the sponsor would soon be required to make distributions to the fund’s investors. Seller would have preferred to sell all 100 Sites originally offered, but selling some Sites was better than selling none and selling 70 to Quick was better than selling 55 to Minute.
Minute too was a portfolio company of a private equity fund. Its sponsor may have had an interest in deploying capital because its investors were growing impatient with the sponsor’s slow track record in making investments. Indeed, if that were its interest Minute may have preferred to have made an even larger investment in convenience store/gas stations if there were an attractive opportunity to do so.
If asked, Quick may have explained that its interest was in the geographical diversification of its operations beyond the Southeast. The Midwest was not an area of unique strategic importance to Quick, but Seller’s sale efforts provided an opportunity for Quick to move its eggs into a second basket.
Of course, each party may well have different or additional interests. Typically, the mediator will probe each party’s interest in separate caucuses under a promise to hold the information confidential unless the disclosing party authorizes the mediator to share the information with other parties, although the parties might decide to share their interests openly in joint session if that seems a promising path to resolving their dispute more quickly.
The premise of this technique is that there is likely more than one outcome that would meet the interests of the various parties, if not completely, then at least is a manner better than the alternative to a negotiated agreement. Armed with an understanding of the parties’ interests, a mediator would then encourage the parties to “brainstorm” possibilities that would meet those interests and to consider whether any of those possibilities could form the basis for an attractive resolution.
Returning to the hypothetical, Seller’s interest in liquidity might be met if it could sell Sites in addition to those sold to Quick, including Sites located in other parts of the country. Feeling pressure to deploy capital, Minute might be a buyer for some of those stores, having no particular affinity for any of the 55 Sites (and perhaps even preferring not to double down on the upper Midwest where it already operates stores) but feeling more strongly the need to invest promptly in attractive assets. Being interested in geographical diversification, Quick may also be interested in buying Sites owned by Seller in parts of the country other than the Southeast and perhaps in buying additional stores in the Midwest owned by Minute (which may in turn generate additional cash permitting Minute and Seller to do an even bigger deal). How much better for all parties to consummate and announce a value-creating three-way deal that no judge or arbitrator could impose than to slog through the courts for years to an uncertain destination.
The foregoing discussion springs from a case in which certain facts are unknown, so one cannot know for sure if the possibilities suggested above were in fact available to the parties. Nonetheless the discussion illustrates the potential of mediation as a superior process for maximizing value, especially in the context of controversies arising from M&A deals. Not every fact pattern will present as many opportunities for such creativity – there are disputes that seem on their face to be only about money. But even in such situations there are always other interests in play, such as reputation, relationships, other business opportunities and timing, and therefore almost always ways to make deals.
Indeed, while disputes may seem to be unwelcome, every dispute presents the opportunity to make a new deal. When a dispute arises in the context of M&A, the parties can use mediation to retain control and do what they do best – imagine and make value-maximizing deals.