Merger Guide for the Perplexed

On the heels of launching its new merger rule on contingent losses, FASB slaps on a "Band-Aid" that raises questions with lawyers.

For example, “the first fork in the road” with respect to FAS 141(R) requires companies to make a judgment call regarding whether the contingent liability is contractual or noncontractual in nature. A potential contractual obligation must be recognized at fair value on the acquisition date. More testing is needed before a potential noncontractual liability is recognized, however. According to FAS 141(R), a fair value estimate is required of a noncontractual liability if it is “more likely than not” that the company would lose the suit or settle, and therefore incur a loss.

But most companies, auditors and lawyers had a hard time understanding the criteria laid out in FAS 141(R) to determine whether a liability was contractual or not. What’s more, even if companies got passed the categorization debate, the second fork in the FAS 141(R) road was to estimate the liability. To do that, attorneys had to release what they considered “prejudicial” information about the suit, and they flat out refused to comply fearing the release of the information would put defendants at a disadvantage.

Despite its good intentions, FAS 141(R)-a, which will be out for public review until Jan. 15, 2009, is likely to attract comments on the disparity between the proposal and its international counterpart, IFRS 3. To be sure, FASB and international standards setters have been working together since 2002 to converge the two sets of standards into one volume of rules that apply globally. FAS 141(R)-a could be a sticking point in that process.

The main problem is that current international accounting rules require companies to fair value contingent losses in all cases. So in theory, companies operating outside of the United States are making the fair value estimates, says Hanson.

But American lawyers argue that the U.S. is too litigious to make a rule like IFRS 3 practical, because they are not about to put their clients at a disadvantage by disclosing lawsuit information that would be damaging. Such information could include loss estimates and associated data that could be used by plaintiffs to determine monetary awards or guilt. Further, sharing data with third-party valuation experts could be seen as a breach of attorney-client privilege, which would open up the information to full discovery.

More puzzling, says Hanson, is that foreign companies that acquire lawsuit-laden U.S. subsidiaries claim that they are complying with the fair value rules in IFRS 3. Meanwhile, American attorneys insist that there are no U.S. companies — parent or subsidiary — that could comply with the international rule in the litigation area.

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