FUTURE OF M&A PRICING MECHANISM:
A LOCKED BOX AND COMPLETION ACCOUNT HYBRID?
There are two ways by which the buyer and seller of an M&A deal agree on the purchase price: lock in on a price early on and leave it untouched through completion—the locked box—or leave the price undecided till a final account has been drawn up after the deal is completed—the completion account.
Yet, there might be an alternative, a mechanism combining elements of both and which is more appropriate for certain transactions.
Locked box vs completion account
The need for these two divergent approaches results from the potentially expansive temporal span of an M&A deal. As the underlying fundamentals of the company being acquired change, its actual value at the earliest stages of the deal is likely different from that at closing. The beginning and the end are the two natural timestamps to determine the price.
When visualized this way, the essential difference between the two pricing mechanisms is timing. In a locked-box transaction, both parties agree on a price tag before due diligence and negotiations regarding the most recently audited balance sheet. Concerning a completion account, the deal value is calculated by drawing up a special account after the buyer gains control of the company.
The locked box mechanism is simple and relatively inexpensive. Still, the buyer risks (or benefits from) unpredictable changes to the business, and more preparation is needed upfront to determine the price. Because of the certainty of receiving a determined amount, the mechanism is seller-friendly.
The completion account mechanism promises the buyer to ‘get what it pays for’ (as such, it is buyer-friendly), but drafting the completion account is time-consuming and costly, and post-deal disagreements about the purchase price sometimes result in litigation.
Lawyers typically assist with defining the terms specific to each pricing mechanism. In a locked-box transaction, negotiations likely involve defining the conditions under which the seller can withdraw capital from the business, known as ‘permitted leakage’ (and any ‘unpermitted’ leakage will be reimbursed to the buyer).
In a completion-account transaction, negotiations turn on how the final account will be drawn and specifically on the definitions of cash, debt and working capital, from which the final value will be derived.
In the UK, both mechanisms are used. According to Osborne Clarke, in the economic uncertainty of 2021, buyers preferred completion accounts. But in 2022, the UK saw an uptick in locked boxes, thanks to the improved confidence in financial data.
The hybrid pricing mechanism
But imagine the following scenario, as found in a Greenberg Traurig article: Company X is looking to acquire company Y, and it has been ten months since company Y had its financials audited.
On the one hand, company X may have insufficient confidence in the recent accounts provided by company Y’s management, but on the other hand, the audited financial data do not accurately reflect company Y’s current state. Moreover, both companies find that contractual terms of leakage and reimbursement do not adequately protect them. In such a case (and in others), Greenberg Traurig suggests that prospective buyers and sellers consider a hybrid mechanism.
By the hybrid mechanism, parties agree to use future audited financial accounts which are yet unavailable and proceed with standard negotiations. For a locked box, parties agree to use the most recently audited accounts (albeit in the future). Concerning a completion account, the final purchase price is determined after closing the deal (though not determined via a completion account).
The advantage of this approach is that parties can proceed to extensive negotiations without recently audited accounts and rely on expensive completion accounts.
Impact on law firms
The availability of the hybrid mechanism could mean more deal activity. Where the locked box and completion account mechanisms are less applicable, law firms could recommend the hybrid mechanism, reviving a transaction that would otherwise be prematurely aborted.
As such, in addition to having a new toolkit at their disposal and offering fresh advice to their clients, law firms know about the hybrid mechanism benefitting financially from legal fees.
However, law firms should note that considering the hybrid mechanism may entail unforeseen complications. New terms need defining, negotiations run at a different pace, and the careful collaboration of lawyers, accountants, and management from both sides is essential.
A law firm may find that, while it does not possess the experience or resources to execute the hybrid mechanism, its clients may be unwilling to commit to this unfamiliar way of pricing the deal. As such, law firms interested in the hybrid mechanism could consider building expertise and a track record of successfully executing hybrid-priced agreements.
Article written by David Zheng
HUMAN INTELLIGENCE vs COMPUTER INTELLIGENCE: HOW AI IS CHANGING THE WORLD
AI: ‘Can Machines Think?’
Alan Turing, a mathematician most famously known for breaking the Nazi code machine Enigma, posed the critical question, ‘can machines think?’
With such a simple question, we similarly expect a simple answer. Woefully, only after decades was this question proven affirmative. With difficulties defining AI, it is plausible to deem artificial intelligence as a tool mimicking human intelligence and cognitive activity.
AI is being used across industries, from finance to healthcare. Therefore, it is contended that AI manufactures a future fuelled by endless opportunities.
Regardless of the different sectors of the economy, we are all influenced by AI. For example, many would be guilty of using AI-developed technology such as Siri and Alexa. This demonstrates that our society is steadily becoming accustomed to AI; it is embedded into our daily lives. Whether that is from using AI-based technology at work or in our homes.
What makes a machine intelligent?
Controversy circulates over the above question. However, some certainty can be provided by a 2019 research paper, ‘On the Measure of Intelligence’, where the writer (a Google engineer) argues that intelligence is the rate at which a learner turns their experience and prior skills into new skills at valuable tasks that involve uncertainty and adaptation. With this definition in mind, it would mean that displaying such intelligence requires these machines to possess the ability to work with the comparatively scarce information they are programmed with and guess the potential outcomes successfully.
This proposed solution seems to have already made its debut in contemporary society; for instance, in the music industry David Guetta, a music producer, believes that the future of music is in AI. Using technology to add a vocal mimicking another artist, Guetta used two AI sites to create lyrics and rap for a live show. Guetta believes that AI can be used to create new sounds as it unlocks new musical styles.
AI allows the music industry to flourish where machines and software rely on the initial, limited knowledge this tech was installed with. In fact, fans of massive artists are using the AI generator to create their tracks in the style of their chosen artists.
The effects on the legal world
AI’s versatility is demonstrated through its features from the music industry to the legal sector. For example, a newfound piece of technology created the world’s first AI-powered lawyer.
It was the first of its kind to defend a party against a traffic ticketing offence in court. The robot listens to court arguments and formulates accurate responses for development. It was devised to tell the defendant what to say in real-time through headphones. However, this idea was discarded as the inventor was threatened with the risk of spending six months in jail.
The above example, however, indicates that advancements in AI technology can also threaten the legal job market; if similar future projects are successful, perhaps the legal sector will also see declining trends in job opportunities as they slowly become replaced by AI-powered machinery.
Furthermore, law firms use AI solutions to assess risk and predict outcomes in litigious matters. By utilising such methods, law firms can quickly identify patterns and avoid potential risks in current cases. AI also allows lawyers to delegate tedious tasks to computers that are perhaps executed more accurately by technology, meaning lawyers can use their time more efficiently.
A law firm’s proposal
As mentioned earlier, the lack of a sufficient definition of AI means lawyers are not readily equipped to compete with the fast-paced nature of AI development, as AI unlocks a new area that is a relatively foreign concept to law firms.
Many lawyers seem to be therefore slandering the ambiguities found within defining what AI consists of. For example, the lack of certainty in the definition of AI in the EU draft legislation demonstrates this. It suggests that lawyers have little to work with, especially where current computer-generated work may threaten intellectual property laws. For example, some questions circulating among law firms are whether the current copyright legislation can accurately protect computer-generated work.
In conclusion, AI is an ever-increasing part of society. Perhaps consolidating a more accurate definition of AI is a path law firms must navigate to advise their clients appropriately. Additionally, lawyers must adopt a forward-thinking strategy to predict future AI trends to ensure law firms can adopt appropriate regimes that coincide with AI changes.
Article written by Shruti Viththiananthan
A PROBLEM WITH LIDL’S LOGO?
Lidl owns two similar trademarks and has made claims that Tesco’s sign infringes on them. Lidl’s primary argument is that many customers believe that Tesco’s logo is the Lidl logo, and Tesco is benefiting from an association with Lidl’s reputation for ‘high-quality goods sold at a low price’.
The arguments
Tesco argues that Lidl had trademarked the symbol (with no letters) in bad faith because Lidl had never used it. Tesco has accused Lidl of ‘evergreening’, which is applying to re-register a trademark or a logo without any text included. This is to avoid the need to prove genuine commercial use of the trademark.
In June 2022, the High Court granted Lidl’s strike-out application, stopping Tesco from obtaining a declaration of invalidity based on bad faith. The court held that Tesco did not produce enough evidence of the alleged bad faith to shift the evidential burden to Lidl. The court proposed that a lack of intention to use the trademark alone does not indicate bad faith.
In addition, Lidl also requested permission to rely on survey evidence it had collected to highlight the distinctiveness of its trademarks. The court granted Lidl permission, suggesting it would add value in answering whether Lidl’s trademark was distinctive.
In November 2022, the Court of Appeal declared Tesco’s bad faith claim has a solid basis and, therefore, a fair prospect of success. The court also allowed Tesco to proceed with its accusation of ‘evergreening’, citing Hasbro v EUIPO in which ‘evergreening’ had amounted to bad faith.
Lidl’s lawsuit and Tesco’s counterclaims will be heard by the High Court this week. Lawyers representing Lidl argued Tesco’s actions ‘must involve some form of deception’ and the use of the logo was ‘not accidental’. Benet Brandreth KC, representing Lidl, claimed that ‘Tesco deliberately copied Lidl’s branding to achieve precisely the transfer of reputation for good value that is occurring’. Tesco countered that the trademark was intended as a ‘weapon in legal proceedings’.
Lidl must prove damage which means customers have been misled into what supermarket they are going in and have ended up in Tesco by mistake due to deception. Interestingly, in September 2022, Lidl was embroiled in another IP issue regarding Lindt’s iconic chocolate bunny. Switzerland’s highest court ruled in favour of Lindt after it submitted a survey demonstrating that the public was likely to be confused between Lindt and Lidl’s gold bunnies. Although there were some differences between the two products, the court ordered Lidl to destroy its stock.
What this means for law firms
It seems IP issues amongst Britain’s leading supermarkets are not stopping soon. For example, we have witnessed lawsuits being bought for IP infringement over cakes and bottles of gin between Marks and Spencer and Aldi. As the cost-of-living crisis deepens, it could be the case that supermarkets and businesses will be looking for ways to bring in more customers than their competitors.
IP law plays a prominent role in protecting assets, ideas and human creativity, which is essential for businesses to run with the confidence of knowing their ideas will not be used; therefore, the expertise of IP law firms will continue to be in high demand.
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