Post Deal Liabilities with Nicola Lancaster

Speaker A: Welcome to the Mergers and Acquisitions podcast. As you will have noticed, in this series I'm trying to get you informed about as many aspects of MA as possible and where we focused last episode on integration or what happens after the signing of the deal. This time we look even further beyond and our focus is on what happens after the deal is done and dusted. During the deal negotiation process, the buyer and the seller will have agreed on all kind of things, including of course, the price and the allocation of all sorts of risk. Now what happens later when these risks play out and materialize? Then buyer and seller must get the sale and purchase agreement out of the drawer and do what's provided for in the spa. Right. Life's not that simple. As we shall learn in the next half hour or so, I have the perfect guest to explore this important topic and I'm very happy to welcome Nicola Lancaster. Nicola is lead counsel for Shell where we work together and she's responsible for managing post deal liabilities. And note, this can mean both post deal expense and post deal income. Nicola trained and qualified in the City, which is the deal making heart of London, and started out in commercial property before moving on to Shel's real estate team. Her experience on complex environmental situations, especially with soil and groundwater, drew her into the deal space. And when Shell created a, uh, dedicated team for post deal liabilities back in 2012, Nikola was one of the first to join. Welcome to the studio, Nikola. Thank you for joining us.

Speaker B: Thanks for inviting me, Hus. Really pleased to be here, Nikola.

Speaker A: Working for a company that has such a long history as Shell has must be both a, uh, blessing and a challenge. If you're the person looking at all its past deals and associated liabilities, potentially they go back 100 years. What interests you so much to work in this space?

Speaker B: Well, I certainly like variety in my practice, Huss. I'm very much a problem solver. I like to sort things out. I like to work practically as well as on complex legal issues and in the deal making space. I get to start from the very beginning and see things right through to the end. So I see lots of different perspectives on a transaction. That's what really makes it interesting for me.

Speaker A: I remember vividly having pcro, that's the name of the team when I was leading the M and A practice. And, uh, the most frequently heard sentence from that team was, you can't believe this story that we're going through right now. So the variety was indeed very interesting with different sorts of cases, historic liabilities coming in all the time. And also a sense that, uh, the more proactive you can be, the better you can keep control of those things.

Speaker B: I would certainly agree with that. The idea, as you say, that you put the spa in the cupboard and only take it out when a problem arises is not how we try and tackle it.

Speaker A: So if you have experience handling so many claims afterwards, that must be knowledge that you can bring back to the people who are doing the deal today.

Speaker B: I certainly hope so. We try to bring back the learning. So the things that work well, we can feed those in and say, this is a great idea, follow this path. The things which didn't quite pan out how we hoped they would, where we were caught unawares, perhaps, or where things didn't. Yes, quite go to plan. We can also feed that back to the deal teams, that's both the lawyers, the finance teams, the deal makers, so that we can really sort of recycle those learnings right into the active deals.

Speaker A: So can you say a bit more on how that's, uh, working and is organized in Shell?

Speaker B: Sure. Well within our deal making function, which of course, that's where we first met. Um, we do have a dedicated line of business, the PCRO line of business, and they will work on the commercial side of things. We have financial specialists and they'll bring in other technical specialists as needs. We'll work with our insurance colleagues, tax colleagues, HR colleagues, soil and groundwater colleagues, etc. Really depending on what the individual claims involved or indeed the rights. So we may have claims against others. And I think one of the benefits that this brings in Shell is having that line of business, and I'm the lawyer that supports that line of business, is we can really see the deal from end to end. So we're not just looking at the money that we make on a sale or the price that we pay on the acquisition. We can really see the total end to end value. So how much of that value did we give up? Whether it's by not receiving what we think we should have received, or money that we've had to pay out for claims, or under the other conscious agreements that we've made to cover certain post credit completion liabilities for our buyers?

Speaker A: Yeah, because I guess it's a human quality to just assume for the best and not to expect that you actually have to pay out the warranties or indemnities that you signed in the sba.

Speaker B: Yes. Sometimes people are very optimistic about the likely scope of post deal claims. Sometimes we have to take that optimism down, and sometimes it's the opposite. Right People think that something is going to be a big problem. We'll see a lot of claims coming through, and in fact, we see very little.

Speaker A: Okay, so information management must be an important aspect of doing this well, because you want to know that you have all the underlying documentation. So how do you manage that?

Speaker B: Information management is always a challenge. And you can imagine the amount of information that we manage as part of a deal, one deal, let alone all of the deals that we've looked at. So, first and foremost, you do need to know where your contracts are. Frequently there's a number of different agreements that go together to make up one particular transaction. You need to keep your data rim so you know what you've disclosed, what you've shared with the buyers, and therefore what information we had and the assumptions that we were making. And within Shell, we have our own process as we close the deals or we get towards deal closing, of making sure that we fully reviewed the transaction to understand what we've agreed to, what we believe the liabilities are, uh, and we can start to sort of build a plan to manage them. But yes, we need to keep the information that is relevant. So if, for example, we've agreed to stay involved with a piece of litigation, let's keep what we need of the files so we understand who's doing what, what's the case about, etc. Etc. So, yeah, plenty of information to be managed.

Speaker A: So I would, uh, think that you then also have a good idea when the deal's actually being prepared and, uh, people are doing due diligence, that you would say, okay, well, do this and that because I really want to understand the liabilities and also find out about the ones that haven't been disclosed.

Speaker B: It can be very challenging to find out what hasn't been disclosed when you're trying to sell. Indeed, for a seller preparing due diligence, and I know you've spoken about this before on the podcast hus, my personal preference is that this is done side by side with the legal drafting. In particular, when we start talking about warranties and indemnities, if there is a gap between the scope of the due diligence exercise that you've kicked off and the way that you're approaching your legal drafting, then there is a high chance that you will have undisclosed liabilities arising because you haven't done that exercise of looking for the information. It can always be challenging to get information, of course, out of assets, out of local companies, et cetera. And then, of course, you need to follow through that principle into the Negotiation process. So if you are under a lot of pressure to expand the scope of warranties that you're given, give more indemnities, then you do need to go back and double check that, uh, do you need to expand the due diligence? Do you need to go and ask more questions, understand the issue better? If you're buying, then I think the starting point is getting clear on what it is you're expecting to buy and what are your key value drivers for this particular business asset company, and then looking for the gaps. So what is not warranted in your spa, because that will indicate that your seller hasn't maybe looked for that information. So maybe it's missing from the data room that can drive your investigation process. Typically, you should have a good understanding of where the danger zones lie for a particular, um, asset or business. For me, I typically look at things like permits, I look at real estate, I look at litigation, I look at soil and groundwater issues and other problems with the business, et cetera, that may need to be disclosed, may need to be understood, may need to be shared.

Speaker A: So does that mean that AI is making life easier in this field currently?

Speaker B: I'd say so. We're obviously still at a learning stage in terms of how it can best be deployed in deal making. I'm sure everybody is approaching it in various ways. We're certainly looking at using tools to understand the scope of the documents that are being disclosed, harvesting key information so that we can understand exactly what those documents mean. And actually, from the legacy management perspective, you know, can we go back and look at what we've agreed in the past, where we've given indemnities warranties, where we've, um, preserved rights? Can we take those examples, make sure we're managing them actively, and indeed, can we use them again for learning in future deals? So maybe we've agreed a particular type of arrangement with a particular buyer. Let's go and look at that and see. Did it work? Did it not work? How can we replicate it in a future transaction?

Speaker A: Yeah, useful. So now thinking of the outcome of the due diligence, you identified a certain liability with your experience of, uh, looking from the back, uh, what do you think are the best strategies for buyers and sellers to deal with such a liability in a way that doesn't create a lot of cost?

Speaker B: If we're looking at cost, I think it's much more than just the price. If I'm going to address that question, um, it's much more than just the financial number attached to the liability, whether That's a price chip or some kind of potential claim cost to the deal can also be in deal doability. So upfront mindful disclosure understanding of the risks associated with that particular liability as a seller demonstrates that you've thought through the liabilities associated with what you're selling. Uh, you're coming to the table, prepared to manage them responsibly in the course of the transaction. Even if that is saying over to you, I need you to take this on. A well managed liability has a lower risk and therefore a lower cost in the deal because it doesn't become a matter of uncertainty or fear if you like. So hopefully that should flow through to negotiations becoming more streamlined. Both parties are prepared to have an open discussion and manage the issue. And for the seller, if the due diligence has been rushed or disconnected, there is a risk of non disclosure or breach claim. So again, that upfront thought about what exactly it is that we need to disclose, I think really can flow through into a good running transaction. Once we've identified the issue and we need to accommodate it in some way. There's obviously a number of tools in the box available to a deal team. I'll try not to get too legalistic here, but I mean, you know, the obvious thing is a price chip. I'm just going to take this money off the purchase price. I'm not going to pay you for that particular liability. That I think is going to come through quick and simple. But it's not always easy to land if the parties are very apart on value. And quite often these issues, these liabilities are not precise and there can be a valuation gap between buyer and seller. So in which case we'll start looking at other remedies that are available. And uh, if you've dealt with lawyers, you'll hear them talk all the time about warranties and indemnities. I'm talking here as an English lawyer, of course, and people don't always focus on what exactly those particular tools do in the context of a transaction. So a warranty is pretty much a statement that a certain state of affairs exists, that you can price your bid for my asset, for my business on the basis that that statement is true. If it's wrong, you then get to come back and say I've overpaid for the business. So that's a valuation issue in the sort of the heart of the deal. An indemnity tends to be a dollar for dollar reimbursement for a particular incident happens if I lose this case, you can come back and Claim the value. And people don't always understand the distinction between the two of them. Some things will work better than others. If you're talking about preserving operational interests, you know, maybe neither really works for you, let's be honest. And maybe you're better off looking for an undertaking to sort a particular issue out. So if we are talking about litigation, indemnities, for example, you then need to think about things like, is it just a case of paying when the final judgment comes through? Do you want to have influence over the handling of the case? Do you want to be involved? Maybe the buyer doesn't actually want to be involved at all in handling that particular litigation. And once we get into environmental matters, it gets even more complicated. Yet again, there are lots of different ways that we can deal with things when they come up. Do you want to have a clear plan on how a particular issue will be remediated? Do you want to be involved in that? Do you want to stay responsible for managing a particular case because then you'll have the satisfaction that something will be done to a standard that you require? Or are you happy that the buyer takes it over and you've agreed a certain financial contribution to that in the other way? One thing I will say that I do see, when people are looking at these tools, they get very focused on the warranties and indemnities and they don't look at the less exciting bit of the spa, the boilerplate. And you can really lose the benefit of the protections that you negotiate if you don't get the boilerplate right. And sometimes it's around limitations on time claims, formats of time claims, etc. But on the whole, people get very excited about warranties and indemnities. Believe it or not, people tend to think indemnities are the best solution because you have this dollar for dollar reimbursement, um, so to speak. But any of the lawyers listening will know that we very recently had a report of a case where actually it was the warranty claim that the buyer brought, the impact on the value of the business of the particular item that wasn't disclosed was higher, much higher than the value of the indemnity that was agreed to cover the outcome of a particular circumstance. So you really do need to look at it in the round and decide what's the right protection for the situation.

Speaker A: Yeah, I remember that. From a seller perspective, a clean break was sometimes, uh, deemed very attractive, which means that all the risks pass to the buyer. And maybe you accept the price chip because of it. But then my Reflection was always that the buyer undertaking a risk with less information to them than the one the seller who managed that risk in the past. So possibly needs a bigger price concession than what it's really worth because they don't have all the information. And then there's also a risk that maybe some of the liability comes back to the seller anyway. So you would have paid twice. Uh, so a clean break was always something that sounds better on paper than, uh, is in practice.

Speaker B: I would agree with that. Plenty of people get very fixed on achieving a clean break without really thinking about whether it truly is a clean break or not. As you say, Hus, there are some things you simply can't hand over. And you can have a contractual clean break, but not a legal clean break, in which case you're potentially taking your price chip but keeping your liability, trying to mitigate it as best you can, but you're not getting what you think you're getting.

Speaker A: So the other thing I picked up so far was having a clear accountability of who deals with these post, uh, deal issues is important. And uh, what you've managed in Shell is to pool the resources and the experts who deal with that, pull them together and feedback that knowledge and learning also to the people who are doing the deals today. So with that, Nicolas, thank you. Uh, have a sip of water while we take a short break to get reacquainted with our sponsor, Pilco.

Speaker C: Pilco and Associates is the leading advisor to deal leaders and senior executives on operational EHS and ESG risks and liabilities in the global chemical and energy industries. With 45 years of experience, the firm UM has advised on more than $600 billion worth of transactions involving facilities in 80 countries, including some of the highest profile deals spanning those five decades. Ilco's advisors have an average of 38 years of relevant professional experience in operational and executive roles with major energy and chemical companies. For more information, go to pilco.com

Speaker A: you're back in the MA podcast with our guest Nicola Lancaster, who's the lead counsel managing all of Shell's post deal rights and obligations. Okay, so we've spoken about obligations already. All these historic deals and claims that are generated from these. Now what's your experience, Nicola? With sellers rights, can earn outs or other constructs be beneficial in getting to a deal and then afterwards, are they practical to administer?

Speaker B: Absolutely deferred or contingent considerations and pass throughs, for example, can certainly be a way to bridge a value gap, but they do need to be carefully thought through. There needs to be the right balance of control so the seller can be satisfied that the terms are being met. They uh, do need to be practical. Don't make your pass throughs, your payments dependent on, for example information that doesn't exist or circumstances that can be manipulated. And then the seller does need to be well organised in order to monitor the payment and ensure that it is collected. So the more complicated the structure that you choose, the greater the risk that there is an argument later. So one case may involve achieving a planning permission or investment decision for a new project that can trigger an additional payment to the seller. But you have to define that very carefully. In a cyclical business, higher trading margins could trigger a payout. But then the buyer would want to make sure that, for example that was during a period where they were actually operating and they'll try and negotiate exceptions for downtime. You may end up in an argument where the planned maintenance is part of downtime, whether it's simply things out of the buyer's control, for example. And then you do have to think through that the dynamics will change. Certainly in our way of practice the people around the table are uh, frequently not the people running the business in the future. And there may be a willingness to compromise while you're getting the deal done and negotiating. But post deal this may well have moved uh, around.

Speaker A: So in a way uh, these contracts come from an inability to agree on the price. And you're going to say well we will agree on the price later and part of the consideration is deferred depending on uh, how the world turns out. So if we would hypothetically be negotiating the mooted purchase of the mining company Anglo American, which was potentially going to be bought by Rio Tinto. And note we have nothing to do with this and no way are we linked to it. But you could then uh, say, ok, we have an earnout linked to the future price of copper. And then you would probably get into an argument, as you said Nicolas, on whether the mines were actually working over the period in question. Yes or no?

Speaker B: That's definitely a possibility. And then indeed you do have to be ready to follow it up, administer the terms of the contract that you've agreed, check the information is right, sometimes chase and uh, make sure the money comes in as anticipated.

Speaker A: So have you had situations where there were disputes on the working or meaning of an SBA and what was a good uh, way of resolving them?

Speaker B: Well we certainly always try to resolve our uh, disagreements commercially and amicably. And I would say most of the time we do manage to do that. Occasionally we have in my experience, ended up in informal dispute resolution. But on the whole, we really do try to resolve things commercially. I don't think anyone wins but the lawyers. In those situations, disputes can be varied. They can be very mechanical about the process that needs to be followed. We can have very technical legal debates about the meaning of the word reasonable or the meaning of the word material in a particular warranty, has it been breached. But I think it's worth remembering, when we are talking about disputes arising, quite often, it's not even so much about the deal that was negotiated. It's about the fact that once you hand over control of a business, a target, you also hand over control of the matter concerned. And just because the selling organization takes a certain approach to managing certain liabilities, it doesn't mean that the buying organization is going to take the same approach. And you can end up with sort of differences of opinion, differences of views on how things should matter, which then sort of move back into the original contract. People think something is not as expected. And that's where, you know, we do sometimes see unexpected claims arising or proving harder to resolve because the parties have very different opinions on what the right way forward is.

Speaker A: So you're dealing, of course, with spas that you didn't write yourself. But with that information going back, what would be your top tips to the people writing the spas now to make it easier to use them later?

Speaker B: Get a good night's sleep. I do appreciate that, uh, these deals are often agreed, uh, very late at night when people are tired. There's a last point that we can't quite resolve, and we have to come up with some kind of way to bridge that gap. But my top tip is always, wherever possible, have a peer review. It's very easy to become word blind and assume that you understand the meaning of the clause or you've missed some unintended consequence of that. As I mentioned earlier, check the boilerplate, check the structural parts of the spa. These less exciting and less focused areas of the contract can make or break a claim in some cases.

Speaker A: Thanks. That will be helpful indeed. So now we're going to think about buying a company, uh, that has a lot of historic liabilities themselves. So what would you then look for in that company as an indication that these liabilities are being well managed?

Speaker B: Well, if we're talking about deal liabilities, um, I would be trying to establish that the target treats these like any other business activity. I have seen acquisitions being considered or reviewed, and the target is perhaps subject to, uh, ongoing litigation. And the report Is, this is fine, don't have to worry about it. Uh, the company has an indemnity from the person that they in turn bought from, but then nobody's thinking about what is the scope of that indemnity, how is that indemnity being managed, how is that case being managed? And without that information, I, uh, can't make a judgment on how well those liabilities are being managed and how likely they are to result in financial consequences. So a well thought out, proactive approach to case management, opposed to, as we said, putting the SBA in a cupboard and hoping nothing happens, is really the best way to make sure that things don't escalate, blow out of proportion. You don't get any nasty surprises because once the damage is done, once the money is spent, the incentives change and it's harder to resolve issues.

Speaker A: Okay, so what I'm starting to understand is that overall, this P0 post closing rights and obligations mindset is a real practical one. You're trying to make sure that all the things that look good on paper, as you expect them in reality also turn out, and you need to manage them, um, just like you're managing any other contract. But then the additional complication is that, uh, people's loyalties will change, so the businesses won't behave necessarily as you expect them to. They're not charities. And since different people are now in charge, uh, they may look, uh, at the same bit of information in a completely different way with different management practices and even different ethics. So I've got one last question to you, Nicolas. If we go back to this hypothetical case of Rio Tinto buying Anglo American. Suppose you are on the board of Rio Tinto and you're going to review the deal proposal. So you've got all this experience of what can happen after the deal is done, especially in a company with a very long and rich operations history. Now, what are you going to ask the deal team to assess the quality of the deal?

Speaker B: Well, we'll start with, what are we buying? Do we understand what we're buying? Are there any particular areas of doubt or uncertainty that came up as we were negotiating to buy that company? And have we procured any protections, any warranties, any indemnities, any financial protections to cover those issues that the deal team, um, identified. And how are we going to manage those particular protections? How are we going to make sure we get the benefit of them? But then I will also go further and try to understand what are we not proactively buying? What might we be picking up that we haven't actually thought of. What's the history? What liability might that company have associated with past operations? Have they sold a business but remain legally liable for whatever that business did? Have they sold a business? Do they remain legally liable to the person that bought that business? What are the things that are not front and center? Uh, in terms of current operations, do we understand them? Have we checked for any upsides? Are we leaving money on the table that we can go back and collect? And are we ready to manage them so that we take full value and we defend our position as best we can? And so, yeah, I'd be looking for things like list of provisions for liabilities. Any particularly material provisions in the books. I'd be looking for the assessments. Who made that assessment? What's the basis of it? Are we content that it's still right? Do we need to look into it more? Do we need to be more proactive about those matters? And then I'd probably ask to look whether there's a list of provisions in the company. What are those provisions for? If they're potential historic liabilities, how were the assessments made? Do we need to revisit them? Are we confident in them? Do we have a plan to manage them?

Speaker A: Thanks, Nicola. Uh, that's actually a, uh, pretty comprehensive list of questions to ask. And I hope that anybody involved in a deal listening to this podcast is now convinced that the value associated with these post deal liabilities can be really very significant and that it takes a holistic view to manage these in the best way possible. Thanks again. It was great to have you on the show.

Speaker B: Thanks for inviting me. It's been good fun.

Speaker A: And that concludes the M and A podcast for today. For more information you can visit the website of our sponsor@pilco.com and for feedback, please use LinkedIn where I provide notice of each forthcoming podcast. Thank you for listening.