Post-Merger Disputes for NFPs: Due Diligence Failures & Hidden Liabilities

Introduction

After a merger or acquisition, not-for-profit organisations can face unexpected post-acquisition disputes when hidden liabilities or discrepancies surface that were missed during due diligence. These issues can disrupt operations, create financial strain, and lead to complex dispute resolution processes involving the buyer, seller, and sometimes shareholders.

Addressing post-acquisition disputes requires a clear understanding of the legal and financial risks unique to mergers and acquisitions, as well as the importance of seeking advice from a not-for-profit lawyer. This guide is designed to help not-for-profits navigate the challenges of post-closing disputes and find effective paths to resolution.

The Post-Merger Nightmare: Uncovering Hidden Liabilities

Undisclosed Employee Entitlements & Obligations

After a merger is finalised, historical liabilities related to employees can become a significant source of post-acquisition disputes if they were not properly accounted for during due diligence. The Fair Work Act 2009 (Cth) provides a framework that protects certain employee entitlements during a transfer of business, ensuring that service with the old employer is recognised by the new one.

Several key entitlements are protected, meaning an employee’s prior service continues to count. These include:

• Personal and carer’s leave: Accrued leave balances transfer to the new employer.
• Unpaid parental leave: Eligibility is based on the total period of service with both employers.
• Notice of termination: The length of the notice period is determined by the employee’s continuous service.

However, disputes often arise from entitlements where the new employer has a choice. For annual leave and redundancy pay, the new organisation can elect not to recognise an employee’s prior service. If this occurs, the former employer is obligated to pay out these entitlements. A failure to clearly address this in the merger agreement can leave the buyer facing unexpected financial obligations, sparking a post-acquisition dispute that requires expert advice on NFP employment and workplace law.

Financial Misrepresentations & Accounting Discrepancies

Many post-acquisition disputes emerge when the buyer discovers financial inconsistencies or misrepresentations after the deal has closed. These conflicts often originate from ambiguous language and a lack of clarity in the Sale and Purchase Agreement (SPA), creating fertile ground for differing interpretations and expectations between the parties.

Common areas where accounting discrepancies lead to disputes include:

• Ambiguous Accounting Policies: The SPA may fail to specify the exact accounting standards and practices to be used in preparing completion accounts. This can lead to disagreements over issues like inventory valuation methods, exposing the buyer to “price chipping.”
• Working Capital Calculations: The calculation of working capital and subsequent price adjustments is a frequent point of contention. Disputes can arise over the treatment of various items, such as prepayments to suppliers or tax payables.
• Undefined Financial Terms: The lack of standard definitions for metrics like EBIT or EBITDA can cause confusion. For example, parties may disagree on whether to include government grants or supplier rebates in these calculations, impacting earn-out clauses or deferred consideration.
• Vague Financial Records: Relying on “management accounts” without attaching complete, audited financial statements can create loopholes, as these records may not adhere to official accounting standards or include necessary year-end adjustments.

Undisclosed Pending Litigation & Other Liabilities

One of the most serious risks in any merger is the possibility of inheriting unforeseen legal battles or other significant liabilities that were not disclosed during the due diligence process. A thorough investigation is designed to uncover such risks, including debts owed to the Australian Taxation Office (ATO) or involvement in existing litigation that the merged entity could inherit.

When these liabilities are not revealed by the seller, the buyer can be caught unprepared after the acquisition is complete. Consider a scenario where a not-for-profit merges with another organisation, only to discover later that it is now responsible for a costly, ongoing lawsuit it was never told about.

These hidden issues frequently become the basis for a post-acquisition dispute investigation, as the buyer seeks to recover losses from liabilities it did not knowingly agree to assume. While indemnities can be used to allocate specific, known risks like tax matters or product liability, undisclosed problems fall outside this protection and often lead to conflict.

Understanding the Legal Frameworks for Your Merger Dispute

Disputes in NSW State-Based Amalgamations

When not-for-profit organisations amalgamate under the laws of a specific state, the governing legislation dictates how assets and liabilities are handled. In New South Wales, the amalgamation of two or more incorporated associations results in the formation of a single new entity.

Under this framework, the new association automatically assumes all assets, liabilities, rights, and responsibilities of the former organisations. This transfer includes any pending legal proceedings that may have been initiated against any of the original associations.

Consequently, if a hidden liability emerges after the merger, the dispute is handled with the understanding that the new, amalgamated entity is legally responsible.

Disputes in Mergers Under the Corporations Act

For mergers and acquisitions governed by the Commonwealth Corporations Act 2001 (Cth), a framework impacted by The Treasury Laws Amendment (Mergers and Acquisitions Reform) Act 2024 (Cth), the allocation of liability is typically determined by contractual agreements rather than by automatic statutory transfer.

The principle of caveat emptor, or “buyer beware,” often applies, placing the responsibility on the buyer to conduct thorough due diligence. In these transactions, the SPA becomes the central document outlining how risks are distributed.

Liability for unforeseen issues is managed through specific contractual terms, such as:

• warranties
• indemnities

Therefore, a post-acquisition dispute will usually centre on whether there has been a breach of these negotiated terms, making the resolution process a matter of contractual interpretation and enforcement.

Legal Avenues for Your NFP After a Flawed Merger Acquisition

Pursuing a Breach of Warranty Claim

A warranty is a statement of fact made by the seller to the buyer within the merger agreement, covering matters such as profitability or performance. These statements are based on information disclosed during due diligence and are considered true at the time they are given.

A breach of warranty claim, a common form of commercial litigation, is a legal action following mergers and acquisitions. It aims to place the buyer in the financial position they would have enjoyed had the warranty been accurate, although litigating the value of the acquired organisation can be complex.

In practice, damages can be approached from two competing perspectives:

• The buyer may argue that the “as warranted” value equals the purchase price, so any shortfall should be recoverable.
• The seller may contend that the buyer overpaid for the business, thereby trying to reduce the damages owed.

Making an Indemnity Claim for Specific Risks

An indemnity is a promise within the merger agreement where one party agrees to cover the cost of a specific, known liability. Unlike warranties, indemnities allocate risk for particular issues that fall outside the buyer’s responsibility.

These specific risks can include a range of potential problems identified during the acquisition process. Common examples include: 

• Environmental risks associated with a property 
• Product liability that might arise from past sales 
• Outstanding or anticipated tax matters

Making an indemnity claim offers a more direct path to compensation than a warranty claim. An indemnity provides dollar-for-dollar compensation for the identified loss, allowing the buyer to pursue the claim as a debt rather than a breach of contract.

This structure can avoid many of the difficulties associated with litigating a breach of warranty, making it a more straightforward dispute-resolution process.

Strategically Resolving Your Post-Acquisition Dispute

The Critical Role of Dispute Resolution Clauses in Your Merger Agreement

Including clear, tailor-made dispute resolution provisions in your SPA is essential for managing post-acquisition conflicts. These clauses are key to ensuring that any dispute that arises after the merger is addressed in a timely and appropriate manner.

When drafted effectively, these provisions create a structured plan of action for both the buyer and seller. This clarity helps prevent disagreements from escalating into costly and time-consuming litigation.

By pre-empting potential issues and outlining specific procedural rules, both parties can approach the resolution process with a clear understanding of their rights and duties.

Common Resolution Methods from Negotiation to Arbitration

Merger agreements typically specify a sequence of methods for resolving a post-acquisition dispute. The goal is to find the most appropriate pathway for the specific issue at hand, starting with less formal options before moving to more binding procedures.

Commonly used resolution methods include:

• Initial Negotiation: This is often the first step, where parties attempt to reach an amicable agreement within a defined period.
• Expert Determination: For disputes of a technical nature, such as accounting disagreements, an independent expert may be appointed to make a binding decision on the matter.
• Court Proceedings: For domestic acquisitions, litigation through the court system is often the default form of dispute resolution if initial negotiations fail.
• Arbitration: This method is frequently used for international mergers and acquisitions, as it offers a confidential and flexible alternative to court, with awards that are enforceable across borders.

The Importance of a NFP Lawyer in Post-Merger Disputes

When a post-acquisition dispute arises after a merger, the issues are often too complex for a not-for-profit board to handle without understanding the risks and responsibilities for a director. Engaging competent and experienced legal counsel is critical for navigating the intricate financial and contractual disagreements that can emerge. A lawyer with expertise in mergers and acquisitions can interpret the SPA, identify potential breaches, and provide a clear strategy for dispute resolution.

A not-for-profit lawyer plays a crucial role in building a robust case, whether the issue involves a breach of warranty, an indemnity claim, or an accounting discrepancy. Their involvement is essential for investigating the dispute, gathering the necessary evidence, and developing a legal strategy to support your organisation’s position.

This outside expertise is vital for understanding the nuances of the SPA and ensuring all claims are properly substantiated. Furthermore, legal advisers guide the organisation through the formal dispute resolution process outlined in the merger agreement.

This may involve:

• Initial negotiations to attempt an early resolution
• Expert determination for technical financial matters
• Formal proceedings such as arbitration or court litigation

By approaching the dispute in a dispassionate and business-like manner, your lawyer can help manage the conflict effectively and work towards a favourable outcome.

Seeking advice from a lawyer who specialises in the not-for-profit sector ensures that any action taken aligns with your organisation’s unique regulatory obligations. They can help manage the complexities of the post-closing dispute investigation while considering the specific legal landscape governing charities and not-for-profits.

Conclusion

Post-merger disputes in the not-for-profit sector often arise from hidden liabilities, such as undisclosed employee entitlements or financial misrepresentations, that were missed during due diligence. Addressing these challenges requires understanding the governing legal framework and pursuing appropriate remedies, including breach of warranty or indemnity claims, as outlined in the merger agreement.

If your not-for-profit organisation is dealing with the complexities of a post-acquisition dispute, contact our experienced not-for-profit lawyers at LawBridge. Our team offers specialised legal services tailored to help your organisation manage these issues effectively and work towards a favourable resolution.

Frequently Asked Questions