Mid-Year Trends in Global M&A Litigation: Digital assets, AI and ESG in the Crosshairs

As of mid-year 2023, clear trends in M&A disputes have emerged globally, with disputes involving disruptive technologies and services – like digital assets and AI – and environmental, social and governance (ESG) commitments, leading the way, according to the BRG Mid-Year M&A Disputes Report.

These disputes are increasing against a backdrop of ongoing market volatility and geopolitical instability and are likely to intensify, as mainstream awareness and regulatory scrutiny of these emerging technologies and ESG-related concerns grow.

Dealmakers globally – especially acquirers and venders of tech companies – would be wise to consider the impact of these new legal risks on their deals, projections and risk assessments.

Catalysts for M&A activity may also fuel M&A disputes

The BRG Report surveyed 162 leading M&A-focused lawyers, private equity professionals, and corporate finance advisors worldwide about which regions and sectors they believe to be disputes “hotspots.”  The Asia-Pacific (APAC) region is projected to lead M&A dispute activity this year, followed by the Europe, Middle East and Africa (EMEA) region, and the Americas.

Tech innovation, including advances in generative AI, digital assets and services, and gaming, is driving M&A activity globally.  In addition, for enterprises globally, ESG considerations are increasingly driving business-critical strategic and tactical decisions.  And both emerging tech and ESG have been identified as global disputes “hotspots.”

According to BRG Managing Director, Danial Ryan, areas of rapid growth and development may foster environments of uncertainty, which can lead to increases in M&A disputes.  In other words, catalysts for M&A activity may also fuel M&A disputes.

Digital assets and services disputes

According to the BRG Report, at mid-year, the digital assets and services sector is expected to be one of the leaders in dispute activity for 2023 driven by market volatility and regulatory scrutiny.

In the U.S., intensifying regulatory pressure, including enforcement, at both the federal and state levels have rocked the digital asset space, with many looking to Congress or the judiciary for clearer answers.

Notably, enforcement targets have begun to fight back, with a goal of testing regulators’ assertions in court. For example, after SEC filed a comprehensive enforcement action, levying a raft of securities-related allegations, against Coinbase, the popular, publicly traded digital asset trading platform has rebutted the SEC’s claims. It argues, among other things, that the relevant digital assets, and activities such as Coinbase’s staking service, do not involve securities and that, therefore, the SEC lacks jurisdiction.

This dispute is part of a broader effort by the SEC to exert jurisdiction over the digital asset industry, which many characterize as “regulating by enforcement.”  In the past year, the SEC has also introduced proposed rule changes that would expand the SEC’s reach over digital assets, including expanding the definition of “exchange” and extending the “custody rule” to a “safeguarding rule.” Yet the SEC has resisted comprehensive rulemaking requests (including from Coinbase), insisting that existing laws are sufficient to govern digital assets.

This month, in the Southern District of New York, Ripple achieved a partial victory over the SEC, yet it is too early to tell whether this will spark a trend that might lessen the SEC’s appetite for bringing similar enforcement actions, or if the decision may be overturned.  

In the ongoing Terraform Labs enforcement action in the same district, the SEC signaled a potential intention to appeal the Ripple decision.  And, in the Northern District of California, a securities class action against Ripple may retread some of the same questions decided in the SEC v. Ripple case.  The final answers – even in the Ripple case – could take years.

Although multiple digital asset-focused bills have been introduced, many believe that it is unlikely that the U.S. Congress will adopt digital asset-specific legislation this term. The result is likely to be ongoing uncertainty, which may also negatively affect valuations of digital asset-related businesses.

Artificial Intelligence disputes

The rapid adoption of AI tools, and growing questions about how they will be regulated, is fertile breeding ground for potential disputes. Although there are pre-existing laws that will apply to AI’s usage, new, AI-specific regulations are on the horizon. And with new rules come differing interpretations of what those rules mean and how they apply – setting the stage for increased M&A disputes.

For example, last year the White House published a Blueprint for An AI Bill of Rights for use in the development of new governmental policies. Since then, several U.S. regulators have signaled new changes to AI regulations, including the SEC, which announced its intention to propose rules requiring more robo-advisers or internet advisers to register with the SEC as money managers.

During the M&A due diligence process, difficulties in anticipating and interpreting new laws can lead to disputes.  This may especially be true in the AI context, where the processes underlying the AI typically operate as a “black box,” making it challenging to assess a target’s AI governance and legal compliance.  

While attempts are being made in AI-related M&A transactions to adapt deal documentation to account for rapidly changing legal and regulatory environments, it is difficult to anticipate every scenario that could crystallize over the next few years. For instance, as businesses increasingly adopt and integrate AI components into their day-to-day operations, new theories of liability could develop that would increase the likelihood of M&A-related disputes across industries. 

ESG disputes

Similar to AI, ESG considerations increasingly are impacting businesses globally, as investors, consumers, special interest groups, government agencies and other stakeholders continue to apply pressure on companies to improve their sustainability efforts, societal impact and internal governance.

In an increasingly transparent and socially conscious society, lack of attention to ESG considerations can lead to an increase in M&A-related disputes, including in the following ways:

• Complex ESG environment – Major developments in U.S. federal ESG legislation, such as the passing of the Inflation Reduction Act, coupled with an emerging anti-ESG movement amongst the U.S. states, has created a complex ESG environment. 
  
  Indeed, U.S. companies are caught between a veritable Scylla and Charybdis of diametrically opposed forces and requirements.  In addition, proposed SEC rules that would require companies to make climate-related disclosures in their public filings may lead to increased scrutiny of companies that fall behind in their sustainability efforts, or that embellish their ESG achievements. 
  
  While non-compliance with ESG-related requirements may lead to regulatory action, litigation and serious reputational harm, the current ESG regulatory framework lacks clarity and consistency, and this may drive disputes.
  
   
• Cross-border compliance – With the growing regulatory scrutiny of ESG metrics and commitments, multinational organizations engaged in cross-border M&A transactions must navigate compliance across all of the national regulatory regimes and reporting standards of the jurisdictions implicated by their deals, whose standards may conflict with one another. 
  
  They will also need to satisfy new global requirements where adopted, such as the International Sustainability Standards Board climate disclosure standard and general disclosure requirements. 
  
  Given the differing (and continually evolving) approaches to ESG regulation across jurisdictions and globally, acquirers and vendors will be forced to allocate and assess a (relatively) new set of risks, which may increase disputes.
  
   
• Prioritizing ESG due diligence – An ESG-related oversight could result in regulatory investigation or enforcement, shareholder activism and even litigation. As a relatively new topic, courts worldwide are still grappling with ESG issues, leading to some degree of unpredictability in judicial decisions.  
  
  Acquirers should conduct extensive ESG-specific due diligence to ensure that the target and its assets aren’t subject to increased risks, such as greenwashing enforcement actions, and to ensure that targets have implemented proper ESG governance structures.

Looking ahead - the role of good governance

The common thread running through this increase in M&A disputes regarding digital assets, AI, and ESG considerations is uncertainty.  Not only are all three areas continuing to grow and develop, they each also present new legal risks, which are only increasing as the regulatory matrices governing these areas evolve and increase in complexity.

Given the potentially significant societal impacts of AI, digital assets and ESG, regulatory scrutiny understandably is intensifying, increasing the risks of regulatory investigations or enforcement and exposure to serious penalties and reputational risks. And the global nature of digital asset-, AI- and ESG-related activities are likely to implicate multiple regulators and jurisdictions, as well as other stakeholders seeking to influence the development of relevant legal frameworks.  

While there is no one-size-fits-all solution, good governance is one of the factors that can mitigate these new legal risks. When engaging in M&A, acquirers would be well-advised, during the due diligence phase, to seek evidence that potential targets have established good governance around technological innovation, ESG and post-acquisition, to double-down on implementing good governance. Read more in our previous post Tackling the AI revolution with policy and governance.