Transaction disputes

With cross-border transactions increasing and the inherent complexities involved so are the number of disputes. The latest London Centre for International Arbitration report noted that 15% of arbitrations related to Shareholders’ / Share Purchase or Joint Venture disputes in 2023 compared with 10% in 2022.

In this article we specifically consider the calculation of damages in post-transaction disputes and in particular the calculation of purchase price or fair market value. With the increase in complex international transactions, it is not unusual to see adjustments from breach of warranty or fraudulent misrepresentation claims that result in adjusted purchase prices or fair market values that results in nil or negative values.

Whilst there might be some legal and factual implications for each individual case. This article explores whether you can have a negative value.

The commercial rationale for a transaction

In a straightforward transaction, you have a buyer and a seller, the buyer provides positive consideration (normally monetary) in exchange for an asset (normally an operating business).

It is very rare that you hear of a deal for negative consideration, that being the seller of an asset or business provides the buyer with the asset or business as well as a sum of money to take the business. This is because there can be other more commercial options for the owners of the assets, including for example, to liquidate the business and sell the net assets.

Therefore, most deals are concluded for a positive consideration. However, if information is not complete or full you might find a scenario in which positive consideration is paid for an asset or business, whereas an alternative scenario for example, liquidating the business would have been more appropriate.

An example might be a division of a larger business that is carved out and sold, whilst it can operate on its own, certain assumptions would need to be made to understand the likely revenue and profit of operating as a standalone operation, particularly where overhead costs are shared. If this information is incomplete or wrong the basis of the purchase price or valuation is likely to be wrong.

The role of international arbitration

This is why many sale purchase agreements have specific dispute clauses that protect the buyer and why you often see post-transaction disputes either: 

1. through error (for example where financial statements are warranted and later found to be misstated) 
2. fraudulent misrepresentation (an intentional or reckless deceit to induce buyers).

If this misstatement or fraudulent misrepresentation is significant enough or the margin of the business is sensitive enough, a valuation on a going concern or operating basis may quickly become negative. This alternative may mean the business was not a viable or a going concern when purchased.

Liability aside, this would give cause for a claim for the losses suffered by the claimant. However, would it be fair and equitable for any claimant to really get back more than they paid?

This would depend on the business’ highest and best use, which is defined by the International Valuation Standards Council as “the use of an asset that maximises its potential and that is possible, legally permissible and financially feasible.”

The highest and best use may be to continue with an asset’s existing use or for some alternative use. Therefore, whilst an asset could have a negative value on an operating basis or going concern there may be an alternative valuation approach that results in a higher value.

Calculating the alternative value

This alternative value could be assessed by looking at the net asset value or liquidation value, effectively what residual value remains after the operations are ceased and all the assets and liabilities are settled. For example, on an operating basis the value might be negative £5 million, however, the liquidation value is positive £5 million. Therefore, the highest and best use would be to liquidate the assets. Assuming the buyers paid £10 million for the assets, the damages might be £5 million, being the difference between the purchase price and the highest and best use value of £5 million.

However, there are scenarios where a negative value is still the best outcome and continuing to operate the business returns the highest and best value. This is particularly so for entities with large infrastructure or legal obligations, an example being an upstream oil and gas entity.

A significant portion of value in an oil and gas transaction may be impacted by decommissioning liabilities. The operating value may be £150 million and decommissioning costs £100 million, equating to a value of £50 million.

Considering a scenario where the oil production was overstated, and decommissioning was understated in a fraudulent misrepresentation claim. The revised values might be an operating value of £115 million and decommissioning costs of £120 million, equating to a value of negative £5 million.

Due to potential legal obligations, regardless of the method of valuation, the entity is going to be required to carry out the decommissioning now estimated at a cost of £120 million. Therefore, the highest and best use is likely to be to continue to operate the assets to minimise the total losses.

In a simple calculation, the damages here would be £55 million, therefore, more than the initial purchase price and it is possible that a scenario exists where you get back more than you paid.

In considering the title of the article, it might seem unusual to get back more than you paid in a transaction dispute. In comparison to a normal commercial transaction, why should a dispute mechanism allow you to retain an asset or business and receive more than you initially paid for such asset or business.

Whilst not common there are scenarios where the information provided induces a buyer to pay a positive sum for an asset or business that is a liability, being that the best course of action is that the buyer will need to inject more than the purchase price to close or maintain that asset or business.

When considering the correct approach to damages, careful consideration will need to be given to the right valuation approach and depending on the legal and factual background, one that provides the highest and best use. There may also be factual evidence to consider, particularly as transactions at a negative value are rare and therefore the buyers might have made a different decision had they had full and complete information.

How Crowe can help

The Crowe Forensic Team work on a significant number of forensic cases, of varying sizes; we are always happy to have an initial no obligation discussion on any matters where we can add value and advice. For more information, please contact Alex Houston or your usual Crowe contact.

This article was first published in Expert Witness July 2024.