Board should create a process to ensure settlements are appropriate and fair.
Imagine this scenario: over the last 12 months, your firm has both completed an M&A deal and settled a long-standing legal dispute. Both transactions involved the same significant amount of money, but although the M&A underwent a lengthy – and public – review before being approved, the dispute settlement was quickly negotiated and approved by a small circle of executives, and executed swiftly and quietly.
Why the lack of due diligence on the dispute settlement? Your reasons are probably varied. You’re not legally required to carry out due diligence on such settlements, for one – for another, corporate stakeholders rarely sue executives for signing them. These settlements are also complex and difficult to analyze given the ‘You had to be there’ nature of the negotiations. Plus, if the settlement is between private parties, it may never need to be disclosed.
Whatever the reason, you’re not alone. Many organizations lack a process for determining if settlements are reasonable, yet the stakes are high. Your dispute settlements can cost you as much or even considerably more than your M&A transactions, but whereas in M&A negotiations management and the board solicit opinions from investment bankers and the market, perhaps even in the form of ‘fairness opinions’, such diligence is rarely applied to dispute settlements with similar rigor.
Settlement strategies
Given the potential risks and returns, it is advisable for boards, senior management and other stakeholders to put a process in place that helps them decide if the amount in a settlement is appropriate and fair. It is also recommended that this be done no matter which side of the dispute your organization happens to be on, and that the process, at least for major disputes, employ at least one of the following four strategies.
• Involve a broad range of stakeholders in settlement negotiations. For a variety of reasons – including financial, political and organizational – stakeholders outside of the dispute settlement team may be reluctant to criticize a pending deal. They may suffer from you-had-to-be-there syndrome, in which the details and dynamics of the deal were so complex that they’d be difficult to recreate for someone new to the situation. Outsiders to the process may thus feel they simply don’t have sufficient knowledge to question a settlement. This ‘closed circle’ approach to settling disputes can be risky, however – at the very least, well-respected members of the internal legal and finance teams should be involved, and no major settlement should be signed without the oversight and involvement of the board.
• Get a settlement fairness assessment. You face increased investor and regulatory scrutiny across your business, and your board is already well advised to use due care when executing its fiduciary duties. One increasingly common way that boards can help demonstrate fulfillment of their duties when approving a transaction is to seek a ‘fairness assessment’ from a trusted and independent adviser. A settlement fairness assessment is a highly specialized judgment about the fairness of a proposed settlement from a financial point of view. Not unlike a fairness opinion that you may seek for a financial transaction, a settlement fairness assessment helps managers, shareholders and other stakeholders review the steps that management has taken to determine that a given dispute settlement is appropriate and fair.
• Perform a capacity-to-pay (CAPAY) analysis. CAPAY is exactly what it sounds like: you make an estimate of an organization’s ability to actually pay a settlement. After all, in those disputes in which you hope to collect funds, you don’t want to embark upon a long process of arguing legal points and calculating damages only to find that the other firm cannot pay what you consider fair. In disputes where you will be the payer, you may want to perform a CAPAY analysis so you can proactively negotiate a settlement that won’t cripple your operations. You should perform a CAPAY analysis if you are going to be on the receiving end in cases where the potential payment is significant, or potentially beyond a company’s ability to pay from its readily available means.
• Bring in a third party for an independent evaluation. For the same reason that you should include more internal stakeholders in settlement negotiation, it’s a good idea to bring in an independent third party to vet the deal. This approach offers three advantages. First, an outside organization will have access to specialized resources – legal, financial, and investigative specialists, as well as experienced negotiators – that you may not have in-house. Second, by the nature of its business, a third-party settlement evaluator may bring a broader knowledge base about settlement negotiations than you would have accrued internally. Third, an independent third party is less likely to be encumbered by organizational biases or politics and should be able to evaluate the facts on their own merits.
By taking any or all of these steps, you increase the chances that you won’t overlook any important factors or variables that could lead to lawsuits or – more probably – leaving money on the table. The model situation would be to create a process as rigorous as the one you use to evaluate M&A transactions, and consistently apply it to settlement disputes with the same level of thoroughness and scrupulousness.
The time and cost of disputes
This table looks at the efficiency of contract enforcement by following the evolution of a sale of goods dispute and tracking the time, cost and number of procedures involved from the moment the plaintiff files the lawsuit until actual payment.
The data was collected as part of the International Finance Corporation(IFC)/World Bank Doing Business project, which measures and compares regulations relevant to the life cycle of a small to medium-sized domestic business in 183 economies. The most recent round of data collection for the project was completed in June 2011.
Source: International Finance Corporation/World Bank
Economy Time (days) Cost (% of claim) Procedures
East Asia & Pacific 519 47.8 37
Eastern Europe & Central Asia 412 27.3 37
Latin America & Caribbean 708 31.2 40
Middle East & North Africa 658 23.6 44
OECD high-income 518 19.7 31
South Asia 1,075 27.2 43
Sub-Saharan Africa 655 50.0 39
Canada 570 22.3 36
United Kingdom 399 24.8 28
United States 300 14.4 32
