Big mergers aren't always all they're cracked up to be. Regulatory pressures can keep deals from ever getting off the ground, with the largest tie-ups attracting special scrutiny. Even when they are consummated, the failure rate can top 60% based on share price, according to some studies.

Recent disappointments include the 2015 merger of Kraft/Heinz/3G Capital, whose shares have lost half their value; Verizon's 2017 acquisition of Yahoo and its earlier buy of AOL, which resulted in a huge write-down last year; and Bayer's 2016 acquisition of Round-Up-maker Monsanto, which is fighting multimillion dollar verdicts in the U.S. over alleged links to cancer in users. Other deals fell through entirely, such as Rite Aid's proposed $24 billion merger with Albertsons last year.

But while the law firms advising on big deals are happy to trumpet their involvement, no one interviewed for this article knew of an instance where a firm had been blamed for a failed merger. Boards of directors and their financial advisers are mainly responsible for putting together deals, and—legal malpractice claims aside—they are the ones held to account by shareholders for mistakes.

In the end, only so much of the deal is under the lawyers' control, said professor Stephen Bainbridge of UCLA School of Law in Los Angeles. “There is not much a lawyer can do when they are fighting about whether Steve Ross gets to be the CEO five years from now,” Bainbridge said. “Maybe Marty Lipton could step in, but there aren't a lot of lawyers with that kind of weight to throw around.” 

David Weiss of Reed Smith. (Courtesy photo)

Despite trade troubles with Brexit and China cutting the number of cross-border deals, U.S. M&A deal value increased in the first half of 2019, led primarily by several megadeals, according to data from Refinitiv. But according to a Bloomberg Law analysis of second quarter results, the share of deals that didn't complete after parties entered into a definitive agreement ranged from 16.5% to 2.1%, with the highest figure for deals valued at $10 billion or more.

Even if the lawyers aren't to blame for deals that flop, Bainbridge said there's a lot they can do to maximize the chances that a transaction will succeed.

“Our expertise is not working a deal and saying, 'the numbers don't work, and you are not going to get the operational synergies you want,'” Bainbridge said. “But you can try to protect your clients through careful due diligence. We can assist the client on doing things that reduce litigation risk. We can walk the client through the decision-making process that courts expect; or do you need to shop the deal before signing a merger agreement? We can advise the client that courts are increasingly skeptical of fairness opinions from investment bankers with skin in the deal. (And) there is a lot more that we can do in an acquisition of a privately held company than a publicly traded one.”

Here are three major areas where deal lawyers can help:

Due Diligence

“One thing lawyers can do is not accept what is put in front of them as the entire set of facts they need to know,” said Thomas Waldman, a shareholder in corporate practice at Stradling Yocca Carlson & Rauth in Santa Monica, California. “They need to be able to understand the industry and ask the right questions.” 

For instance, several lawyers noted that since the 2017 Verizon/Yahoo merger, more companies are aggressively probing acquisition targets' cybersecurity as part of due diligence and considering those concerns as part of valuation, especially in the technology sector. When massive data theft from cyberattacks at Yahoo came to light amid Verizon's bid to acquire the company, Verizon's lawyers used the information to reduce the purchase price by $350 million, once the two sides reached a liability-sharing agreement that Verizon insisted upon. But the merger is still largely viewed as a bust, because divisions lost so much value.

Marriott International faces class-action lawsuits and a potential $124 million fine from UK privacy regulators for customer data breaches, including unencrypted passport data, that allegedly were hacked from Starwood Hotels prior to its being bought by the company in 2016 and right up until 2018, when the the breach was discovered. The UK data protection regulator's investigation found Marriott failed to do proper due diligence. (Marriott has contested the findings.)

Stephen Bainbridge, UCLA school of Law (Courtesy photo)

Potential liabilities from drugs or chemicals or environmental hazards linked to illness are harder to uncover in due diligence, however. “Minimizing that sort of product liability risk is particularly difficult because of the long tail,” said Bainbridge, who holds a master's degree in chemistry and was an associate at Arnold & Porter in Washington, D.C., early in his career.

Aside from poring over records for signs of fraud, mismanagement, liabilities and executive misconduct, lawyers should spend time with decision-makers and talk through any red flags, Waldman said. The way law firms staff transactional matters doesn't always lend itself to that kind of scrutiny, however.

“It is unfortunate that the law firms put the youngest and least experienced lawyers on due diligence when it is really one of the most important roles,” said UCLA School of Law professor Iman Anabtawi, who has written extensively on corporate law. She said that, in order to better prepare junior associates to spot problems or potential problems with a deal, their firms could provide them with relevant training or assign more experienced associates to due diligence teams.

Contracts Are Key

“Lawyers can use contracts to protect clients from risks a deal is going to go sour,” Bainbridge said. “In a private deal, especially, we can figure out how big of an escrow holdback to have for indemnification claims, how long of an escrow period to have, what kind of an agreement to use, what are the key things you have to have to make the deal successful and key ways of drafting closing conditions to achieve that.”

Robust indemnification clauses, termination and break-up fees and clauses that address regulatory or market upheaval can be inserted when lawyers anticipate obstacles.

Predicting regulatory hurdles is increasingly important. Last year, Broadcom Ltd.'s attempted $117 billion hostile bid for Qualcomm was thwarted when President Donald Trump vetoed the deal after the Committee on Foreign Investment in the U.S. gave it a thumbs-down. The CFIUS review had been requested by Qualcomm in an apparent strategic move by the company's lawyers at Paul, Weiss, Rifkind, Wharton & Garrison and Covington & Burling to defeat the takeover. 

Global regulatory risks are a bigger threat than in the past, said Eric Talley, a corporate law professor at Columbia University Law School. “Antitrust and tax authorities have been very energized over scrutinizing acquisitions for almost a decade. And more recently, national security concerns have attracted government scrutiny in both the U.S. and abroad, many times unwinding even closed deals,” he said.

“It is not just that the DOJ and FTC are becoming more worried about mergers in general,”  Talley said. Regulators in the EU, China and Australia are also more active. “It is coming from so many directions compared with 15 or 20 years ago,” he said.

Insuring Against Failure

Representations and warranties insurance has been around for about 20 years, but it has become increasingly popular within the past five, according to Sean Griffith, a professor of corporate and securities law at Fordham University School of Law, who has studied and written about its use. In the United Kingdom and Australia, where the policies were first introduced, it is called warranty and indemnity insurance. 

“It really takes off in 2015 and has been used aggressively in the private deal market in the last five years, with targets that are nonpublic companies,” Griffith said. Buyers in private deals and take-private deals used RWI policies in 30% to 50% of deals last year, he found, but less often in deals involving publicly traded companies, where information about companies is more readily available.

More than 20 insurers provided coverage insuring deals from $50 million to over $1 billion, according to Griffith's research. AIG, AXA XL, Beazley and QBE are some insurers issuing the policies.

Buyers use RWI policies to insure against losses caused by a breach of representation by a seller about the condition of the business or about a liability or an obligation and to reduce the amount of escrow the seller has to put up against a misrepresentation. Insurance also can extend the time period a buyer has to discover problems with the business. As for sellers, they also may be more inclined to disclose more if they're backed by insurance, instead of having to put up their own funds or stock in escrow.

The insurer charges a premium of about 2% to 3% of the coverage limit, which is often split between buyer and seller. The coverage limit is often about 10% of the deal price. The policy term is often three to six years, and as in most insurance there are deductibles and exclusions.

“We believe that the advent of this insurance product has been useful in M&A transactions,” said David Weiss, a partner in Reed Smith's global insurance recovery group in San Francisco. “It typically covers unknown problems, so that is where it can help getting deals done.”

For Stradling Yocca's Waldman, it boils down to the combination of care and judgment that lawyers can provide. 

“A lot of times, lawyers can't control the outcome of M&A, but lawyers can add value through their experience with multiple transactions and just through planning and process,” he said. “The legend of some deal-makers is that they sketch it out on a napkin. But the reality is more complicated.”