Before The Deal Honeymoon Ends

January 24, 2010

First published on TheDeal.com

Even as deal activity begins to pick up, corporate decision makers remain understandably risk averse. Dealmakers must balance their need to get a deal done with the goal of avoiding costly or unnecessary mistakes.

While much has been written about effective post-closing integration practices, not nearly enough attention has been paid to effective conflict management. Given the potential for the rupture of important relationships and the prospect for costly and distracting litigation battles after completing the deal, focusing on the structure for the resolution of potential disputes while a deal is being negotiated — and relationships are still in the honeymoon phase — should result in enormous benefits later.

Post-closing conflicts and contract disputes are simply a fact of deal life. Notwithstanding all sincere attempts to understand another company’s practices and to clarify the structure of the arrangements, misunderstandings happen. While dealmakers refine their approach and seek to deal with every contingency, they rarely change their approach to improving conflict resolution. Or they haven’t changed it enough to keep pace with today’s sophisticated alternative dispute resolution tools and techniques.

Today, when long-term cost control is more imperative than ever, dealmakers should rethink their attitudes about disputes and conflict resolution. They should build a more proactive and structural approach to dispute resolution before disputes arrive. Here are a few concepts that every dealmaker — lawyer and nonlawyer — should keep in mind.

First, build in incentives to identify and resolve conflict very early in the process. Deal negotiators are generally familiar with a “step clause” that requires managers to negotiate first and, failing resolution, deploy a series of escalating steps to either the courthouse or selection of an arbitral tribunal. This approach doesn’t create enough incentive on the business managers to fix the problem.

Litigation and arbitration should be the last resort. Adopting a series of business escalations encourages managers to work even harder to find innovative solutions before the matter goes to separate legal camps. When senior-level managers cannot fix the problem, require the CEO or chairman to meet before the matter goes down an adversarial path.

This creates tremendous pressure on managers to solve the problem through conciliatory processes — negotiation or mediation — rather than court or tribunal.

Second, don’t relegate the discussion and negotiation of these issues to the legal team, and treat the dispute clause simply as part of the boilerplate language. Typically, dealmakers have assumed their lawyers are better equipped to decide the right dispute-resolution mechanism. Litigation lawyers are usually consulted late in the process to design a clause. Deal negotiations generally focus on the legal and technical details like choice of law, situs, arbitral rules and so on.

Today the deal team should demand creative options. Business people who are directly involved in designing a conflict system will buy into concepts that fit their culture. Dealmakers should consider some successful practices developed by industries that simply can’t afford the disruption of litigation. In many long-term construction projects, for example, the project is kept on schedule by experts engaged throughout the development — called standing neutrals or dispute review boards — to decide technical, financial or other issues within tight time frames. In government and university settings, employment disputes have been reduced by creating an impartial and neutral ombudsperson or office.

These practices work because they build in and accept the use of third-party neutrals to de-escalate and resolve disputes as early as possible.

Finally, structure the deal with the future relationships foremost in mind. While negotiators naturally want the best deal possible on all points, aggressive risk allocation can backfire in protracted battles downstream. Construction industry studies have time and again demonstrated that realistic risk allocation and promoting teamwork reduces costs, with fewer disputes during and after the project.

Dealmakers should recognize that conflicts are not only possible, but may even be inevitable in most transactions. Whether or not inevitable, the destroyed relationships, delays and high litigation or arbitration costs are not inevitable.

Using a few basic themes, dealmakers can creatively craft a dispute management system or process that meets the parties’ business goals while avoiding disputes that tarnish the benefits of the deal.