Plus ça change? What continuation deals mean for private equity disputes

As highlighted in recent articles in the New York Times and the FT, continuation deals have moved rapidly from the periphery to the mainstream of private equity transactions. 

There are several reasons why these deals have grown increasingly common. In a slower environment for external exits, they offer sponsors the ability to establish valuations and realise profits on assets that they may have been invested in for some time. Capital and liquidity can be returned to existing investors as seasoned funds mature. And they also allow sponsors to hold on to assets that they want to keep in their portfolios.

Recent commentary has understandably focused on the increased volume of these transactions and on the inherent conflicts they present, particularly around transparency, disclosure and valuation. Those risks are real, but from a litigation perspective, they seem likely to be overstated in the abstract. A sponsor that is effectively both the seller and the buyer will clearly be subject to conflicts. However, as a matter of market practice, continuation deals are structured on the basis that existing LPs must give informed consent following a contractually prescribed process. New LPs will also independently evaluate the commercial merits of the transaction, take their own legal and financial advice, and conduct appropriate due diligence at arms-length. It is only where they conclude after taking those steps that the transaction is attractive that it will move forward. 

It follows that where LP consent is properly obtained and the sales process otherwise complies with established norms, the fact that the sponsor happens to be on both sides seems unlikely, in itself, to be problematic (or to precipitate a meaningful number of claims).

Of course, where there are actual or alleged failures in disclosure or process in obtaining required consents, that likely will give rise to disputes (as recent arbitration proceedings filed in the US by ADIC and others against Energy & Minerals Group demonstrate). But for the most part, while continuation deals may be relatively novel, the essential nature of the disputes they generate are unlikely to be. Instead, over time, what I believe those involved in this area will see is that disputes gravitate quickly towards familiar private equity and M&A litigation fault lines.   

Take disputes around closing conditions or MAC provisions as an example. Compared to a conventional private equity transaction, the conditions to closing in a continuation deal may be more complicated. That in turn may heighten the risk of a pre-closing dispute arising. In volatile markets, questions will also almost always arise as to whether a material adverse change has occurred between signing and closing. But the essential questions of, e.g., what a condition precedent or MAC requires on its proper interpretation, and whether the condition or MAC has been triggered as a matter of fact, will be very familiar.

The position seems likely to be similar in relation to deferred consideration provisions. Where value is delivered through, say, an earn-out, disputes often arise as to whether applicable performance conditions have been met, or whether one party has acted in a way that improperly frustrates or accelerates payment. These issues are, again, well-trodden ground in private equity litigation; and save that (in effect) the GP will presumably have an ongoing (but pre-approved) role in seeking to ensure that the relevant performance conditions are met, the continuation deal overlay seems unlikely to make much difference. Likewise also in those cases where breaches of warranty, misrepresentation, fraud, or negligence on the part of professional advisers may have occurred.

With those observations made, there is one point which stakeholders in such deals should still consider carefully. Even if the inherent nature of any disputes which arise from continuation deals is likely to be familiar, the additional complexity of these deals does increase their risk profile. That in turn is likely to make it even more important for sponsors, LPs and other stakeholders to involve litigation counsel at an early stage, and ideally well before any dispute has actually crystallised. Early input from a litigator will allow deal and in-house teams to stress-test the key contractual provisions through the lens of how they would be examined by a court or tribunal if matters unravel. 

As we have also previously explained, relying exclusively on deal counsel to navigate and mitigate the risks may warrant caution. Deal lawyers are essential to executing complex transactions efficiently and commercially. But advising on disputes (actual or potential) requires a different mindset—one focused on how an issue is objectively likely to play out before a court or tribunal. 

To conclude, in most cases, it seems unlikely that continuation deals will create new litigation risks, but they do seem likely to repackage (and possibly amplify) them. Planning for and seeking to mitigate the way in which familiar M&A litigation risks may manifest is therefore likely to remain the most effective way to ensure that a continuation deal does not become a continuation dispute.