VDB Attorneys-at-law, together with specialists Bert Schaareman and Bas van den Broek from Aeternus, have described several common mistakes made by advisors in mergers and acquisitions. Below is part 2 of the blog series on this topic.
Duty of Care for Advisors in Mergers and Acquisitions
In this article, we highlight three cases in which advisors were accused of failing to exercise the care expected of a competent contractor during an acquisition process. Failure to meet this duty of care can result in the advisor (or the firm they work for) being held liable for damages to the client. Advisors, particularly in an acquisition process, face significant liability risks.
In our first article, we outlined the importance of a proper engagement letter. You can find that article [here].
In this article, we discuss three practical examples where a breach of duty of care played a role, providing a practical tip for each case.
Case Study 1: Incorrect Advice
Party A sold the shares it held in the Target company to Party B (the buyer). Party B had an outstanding debt to Target, which was documented in a loan agreement drafted by the advisor in question, a tax advisor. The advisor represented Party A and the Target company. According to the loan agreement, the managing director (DGA) of Party B was personally liable for repayment of the loan. It was also intended that the DGA would provide a personal guarantee. However, because the DGA's spouse had not signed the guarantee (as required by Article 1:88(1)(c) of the Dutch Civil Code), the guarantee was voidable.
Party B failed to repay the loan and was liquidated. Target was unable to successfully enforce the guarantee. Target and Party A blamed the advisor for failing to notice the spousal co-signature requirement. A liability claim followed.
The advisor was held accountable for failing to act with the care of a competent contractor, as he did not act as a reasonably competent and prudent advisor. The client argued that the advisor should have been aware of the legal requirements for guarantees. After all, advising in the context of an acquisition requires a certain level of expertise, including related agreements. The client believed that the advisor should have had this knowledge himself or, if not, should have raised the issue and involved a specialist.
Tip: The lesson here is "stick to your expertise." Drafting documents outside the advisor's knowledge can lead to critical mistakes. Ensure documents are reviewed by the right specialist or identify early when expert input is needed.
Case Study 2: Financial Position of the Buyer
In this case, two business partners (party X and party Y) jointly held half of the shares in several companies. Party X wished to buy out Party Y. Based on financial statements, they agreed on a purchase price of €350,000. Party X needed external financing to fund the purchase. The advisor recommended having the purchase price evaluated by an appraiser.
The valuation report provided several assessments, including one that suggested a significantly lower purchase price of €100,000. However, this lower valuation was ignored. Party X secured external financing, and the transaction proceeded. Party X later struggled to repay the loan and blamed the advisor, citing the lower valuation in the report as evidence of excessive financial strain.
The advisor was accused of failing to warn Party X about potential financing risks based on the valuation report findings. Party X argued that the advisor should have referred him to an accountant to reassess his financial capacity.
Tip: The duty to warn is a common pitfall for advisors. When should you warn a client? How far does this duty extend? These questions are not easily answered in practice. It is difficult to provide a general rule, but this case shows that it is better to warn once too often than not enough from a professional liability perspective.
Case Study 3: Inadequate Valuation Report
This case is based on a recent ruling by the Amsterdam Court of Appeal dated July 23, 2024 (ECLI:NL:GHAMS:2024:2081). A consulting firm prepared an (indicative) valuation report related to the exit of a minority shareholder. According to the client(s), the consulting firm made both procedural and substantive errors. Allegations included:
- Providing an inaccurate valuation;
- Failing to comply with professional standards;
- Adjusting the report under pressure; and
- Arbitrary normalization of legal expenses and wrongful elimination of personnel costs.
These allegations were primarily linked to the guidelines of the Dutch Institute for Register Valuators (NiRV). A key consideration of the court was:
"The NiRV guidelines are recommendations and not binding rules for Registered Valuators (RVs). It is not these guidelines but the agreement between the RV and the client that governs the execution of the assignment."
In this case, the court found no violation of the agreed terms. Regarding substantive errors, the court stated that "indicative valuation is not an exact science. Such valuations involve subjective assessments and choices made by the valuator. The key issue is whether the valuator's decisions were reasonable. If so, they complied with their duty of care."
Based on this reasoning, the clients' claims were entirely dismissed. Thus, the consulting firm successfully defended itself.
Tip: The ruling of the Amsterdam Court of Appeal highlights the importance of carefully documenting the assignment when its execution is questioned. The principle "do what you say and say what you do" is very applicable here and serves as a useful practice tip.