Following a period of pandemic-enforced turbulence, private equity deals have rebounded strongly, with disputes likely to grow as a result
The private equity (PE) scene in Asia-Pacific is thriving again after pandemic-fuelled turbulence. We consider the implications of recent developments for disputes in this sector, including: private equity trends in the region; the nature of PE disputes we have seen; and the key features of arbitration that make it suitable for resolving PE disputes.
Trends in Asia-Pacific
What have we seen?
Before the Covid-19 pandemic, the PE industry enjoyed sustained growth in APAC. Between 2015 and 2019.1
- the average size of PE funds in APAC grew from $210 million to $630 million;
- assets under management for APAC-focused funds grew 31% (compared to a 12% increase for funds focused on North America and Europe); and
- the region’s share of the global PE industry increased from 17% to 28%.
Different trends can be seen in pockets across the APAC region. For example:
- In Australia and New Zealand, pension and super funds have begun transitioning towards a more active role with direct PE investments. This trend is reflected in Australian Super and BGH Capital's $1.5 billion takeover of education group Navitas in 2019.
- In comparison, corporate venture capital funds have been more active across Asia (eg China and Japan), with a focus on investment into start-ups and high-growth companies. In mainland China, this has been spurred by a new Foreign Investment Law, which harmonises previous legislation and signals renewed commitment to inbound investment.
Despite turbulent macroeconomic conditions resulting from pandemic-related disruptions, PE returns in APAC continued to perform strongly, rising to a decade high 14.2% median net internal rate of return in 2021.2 This growth reflects the abundant investment opportunities that have arisen after the Covid-19 pandemic. The acceleration of social trends including e-commerce and demand for remote working, health services and digital platforms has provided new opportunities for PE funds.
The emergence of increasingly sophisticated markets in places like Singapore, Malaysia and Thailand, and early-stage opportunities in markets such as Cambodia and Laos, have spurred this regional progress.
What is to come?
PE transactional activity rebounded strongly from pandemic-fuelled turbulence in 2020-2021. There are some indications this will continue, with high deal volume, increasing industry competition, and strong returns driven by PE firms creating value, delivering top-line growth and reducing cost bases to increase margins.
However, despite the industry in APAC having overcome the worst of pandemic-induced volatility, there are headwinds in the short-to-medium term:
- The ongoing conflict in Ukraine (including the volley of sanctions against Russia, and Russia cutting gas supply to some European countries), the consequential threat to commodity flows and price pressures;
- China's response to the spread of new Covid-19 strains; and
- widespread inflationary pressures.
Where is arbitration in APAC region?
Arbitration is on the rise in APAC across a range of sectors, including private equity. Data published by the major arbitral institutions reveals that parties consistently prefer to resolve disputes by arbitration:
- According to preliminary statistics, 13.6% of ICC filings in 2021 came from South/East Asia, and another 12.5% from Central/West Asia.
- Singapore remained Asia's most popular arbitral seat in 2021, followed by Hong Kong (Queen Mary University White & Case Survey 2021)
- Arbitration is on the rise elsewhere in the region including in Australia, China, South Korea, Japan, Indonesia, Malaysia, and Thailand.
What kind of disputes does PE generate?
While no two PE disputes are alike, there are common categories:
Disagreements over purchase price, where the price is tied to completion accounts, performance milestones, leakage in relation to the locked box regime or exercise of termination rights.
Post-closing disputes most often arise in the context of a contractual warranties regime, where breaches of a warranty are discovered after closing. Examples include warranties relating to financial information, undisclosed liabilities and the condition of material assets. Disputes also arise in relation to earn-out arrangements.
A variety of exit disputes arise, depending on the transaction structure and the exit options available to investors. Parties disagree about the exercise of put/call options, including the enforceability of the mechanism; whether conditions have been met; and the buyout price (or how it should be calculated).
Disputes also arise where a minority investor is squeezed out.
These include confidentiality and conflict of interest issues, and myriad disputes concerning the valuation of the underlying investment (eg calculation of fair value and the application of minority discounts).
We also see disputes over governance, indemnification or enforcement of non-competition agreements.
Why arbitration for PE disputes?
PE transactions are often international and fast paced, with investors facing increased competition in bidding for high-quality deals.
Arbitration has a few key features which give it an edge on other forms of dispute resolution for PE cases.
Benefit for APAC PE disputes
Worldwide enforcement regime
Given the typical cross-border nature of PE transactions involving multiple international parties, the ability to enforce arbitral awards in 170 jurisdictions under the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards is a key advantage. In contrast, enforcing court judgements across borders in the region is challenging.
Arbitration, therefore, offers an element of convenience and finality for parties in the PE space, and also allows them to resolve disputes in a single forum – preventing conflicting court decisions.
|Ability to select arbitrators
The complexity of international PE transactions makes disputes arising in relation to PE contractual instruments particularly amenable to resolution by tribunals with relevant expertise (as judges or juries are likely to be less familiar with PE disputes).
In arbitration, parties can help select the individuals who will decide their dispute. This enables them to appoint people who have heard PE disputes before and are familiar with the sector and its issues.
|Privacy and confidentiality
The relative confidentiality and privacy of arbitration is especially appealing to players in the PE space, who typically wish to avoid public court proceedings.
Although there are perceived limitations or pitfalls to arbitration, these can be mitigated with various tailored solutions, as outlined below:
It can take 18-24 months from the commencement of the dispute to the final hearing, and months more for the delivery of an award.
In the context of PE disputes, this timeframe may be too long, with fundraising, deployment, and realisation stages typically taking place in short time frames. If a dispute arises, the parties want to resolve it and move on.
Under most rules, parties can agree on a fast-track or expedited arbitration process.
Most arbitral rules also include an "emergency arbitration" procedure for parties who need urgent interim relief before the tribunal has been formed.
|Scope for remedies
|Remedies in arbitration are predominantly monetary. In certain scenarios, PE players may need more urgent relief in the form of freezing orders or injunctions. Arbitrators can make such orders but have limited powers to sanction non-compliance.
|Most courts in APAC can order interim relief in support of arbitration and have extensive power to punish parties who do not comply.
The fundamentals of the PE industry look strong despite the emergence of new risks in 2022. As the volume of deals remains robust, we anticipate a commensurate growth in PE disputes. Statistics indicate most of these disputes will go to arbitration.
In particular, we expect the trend of growth in offshore investment to continue. In recent times, large funds based in the US, Europe and Asia have shown increased interest in assets across APAC, including in Australia. Australia remains a relatively stable and attractive investment market compared to more unsettled markets in Europe and elsewhere. The cross-border component of these offshore investments suggests arbitration of PE disputes will continue to thrive in the region.
1. Boston Consulting Group, The Promise for Private Equity in Asia-Pacific (August 2020), available here