1 April 2020

The impact of COVID-19 on M&A transactions

COVID-19 has suddenly burst into the daily lives of billions of people and its effect on the economy is being felt in every region of the world.

Many M&A transactions have already been suspended. On the other hand, a number of M&A deals have their timetables considerably accelerated as a result of the pressure from parties anxious to avoid a freezing of the deal that may occur at any moment. While many projects have now been, at least temporarily, set aside, this new set of circumstances is also creating opportunities which can generate new transactions (e.g. low equity valuation, governmental COVID-19 measures aimed at stimulating the private sector, or changes in consumer behaviour).

We are well aware of the hyperinflation of information generated by COVID-19 and have therefore limited our analysis to a few points of interests, based on our observations over the past few weeks.

In a nutshell:

  • DD phase: extension of timeline and specific points of focus
  • Implementation and negotiation of MAC clauses
  • Managing the interim period between signing and closing
  • Impact on R&Ws
  • Impact on price clauses

1. Due Diligence Phase

a. Providing an extended timeline for due diligence:

  • populating the data room is more complex when employees are confined;
  • more detailed financial due diligence is needed in order to anticipate the possible effects of COVID-19 (stock adequacy, ability to recover receivable, cash flow, "Best Practices" adjustments, etc.);
  • operational due diligence should cover the target’s ability to continue operating with employees working remotely;
  • specific legal due diligence should be carried out on key contracts and insurance policies (see below).

b. Points of focus when reviewing key contracts:

  • Hardship and force majeure clauses: may the effects of COVID-19 constitute a case of force majeure or hardship allowing the target or its co-contractor to suspend performance of the contract, or even terminate it?
  • Improper performance: do the current circumstances or the new regulations related to COVID-19 hinder the proper performance of the target’s, or its co-contractors’, obligations?
  • Relationships with the co-contractors: did any of the target's suppliers or customers request an amendment to their contract(s) or announce that meeting its obligations might be difficult/impossible due to COVID-19?
  • Financing: Is the target bound by any agreement with possible claims based on force majeure or termination clauses? Does the target benefit from COVID-19 emergency measures that facilitate funding or otherwise help the operation of its business, such as Switzerland’s recently enacted state guaranteed lending scheme (the requirements imposed by such measures should also be part of the due diligence).
  • Insurance policies: do the target’s insurance policies cover the effects of COVID-19?

2. Material Adverse Change Clauses (MAC clauses)

Binding offers, as well as share purchase agreements where signing and closing are not simultaneous, generally provide that the buyer has the option of not carrying out the transaction if a material adverse event occurs before closing (such a clause is usually referred to as a “Material Adverse Change” clause, or MAC).

MAC clauses negotiated prior to COVID-19 rarely address epidemic situations explicitly. A few MAC clauses cover force majeure cases, but it usually not obvious that the force majeure qualification can be retained for COVID-19, particularly when the MAC clause was negotiated at a time when the parties were already aware of the beginning of the spread of the virus.

MAC clauses generally exclude events that cause a general deterioration of the target's sector or the activity of its competitors, but the COVID-19 usually has a negative effect not only on the target, but on all companies in the target’s sector.

For projects that are currently being negotiated, the buyer would therefore be well advised to provide a MAC clause that specifically addresses COVID-19 (or, more generally, epidemic situations) and the seller would be well advised to only accept this MAC clause if its scope is limited to situations where the target company suffers a "disproportionate" impact compared to similar companies in the same sector.

3. Management of the Interim Period between Signing and Closing

Where there is an interim period between signing and closing, the seller is standardly contractually obliged to (i) refrain from taking any decision at the target level outside of the normal course of business or that is not in accordance with its usual past practices and (ii) often, meet a number of pre-closing requirements (regularizations, reorganization, obtaining authorizations, etc).

It would be in the parties’ interest to introduce some added flexibility in the way that the intermediary period may be managed. The parties may, therefore, want to clarify the following:

  1. What is the "normal course of business" in the context of COVID-19?
  2. What is the standard for the “normal-course-of-business” obligation? Best efforts or only commercially reasonable efforts? How would the performance of such an obligation be assessed?
  3. Does the target need to obtain the consent of the buyer before adopting exceptional protection measures that companies may adopt pursuant to the relevant jurisdiction’s COVID-19 emergency regulations (for example: the possibility to resort to partial unemployment, defer the payment of taxes, etc.)?
  4. Does the failure to abide by the pre-closing commitments suspend the completion of the transaction (i.e. condition precedent) or does such failure merely give rise to damages (or post-closing obligations)?
  5. If the buyer manages to impose very strict conditions on how the interim period is to be managed, such buyer might run the risk of being considered a de facto manager of the target. In such case, the buyer may be forced to bear financial consequences in the event that the target ends up filing for bankruptcy.

Whilst organizations are continuing to operate 'business as usual' as far as possible via remote working and reallocation of resources, there is a possibility that timetables may be impacted and extensions granted to statutory timeframes where necessary. Parties may hence consider adapting the deadlines (i.e. long-stop date) in which the conditions precedent must be fulfilled, in particular entering into an ad-hoc variation agreement that either sets a new long-stop date or defines certain events that trigger possible delays (or even bring forward) the due date according to or upon their occurrence.

4. Seller’s Representations and Warranties

It would be in the buyer’s best interest to adjust some of the seller's usual representations as well as to insert a few new ones in order to take into account the possible impact of COVID-19.

Some examples of statements to be added or reinforced are:

  1. adequate emergency procedures are in place to ensure the continuity of the target's activity;
  2. the number of employees will remain stable;
  3. the target has secure tools and information systems that allow for remote work;
  4. the target and its customers/suppliers have the ability to honour all important contracts;
  5. no payments have been suspended;
  6. the target has the ability to maintain/renew funding;
  7. there is sufficient inventory to overcome future supply shortages;
  8. the target is not bound by restrictive obligations linked to COVID-19 emergency measures, such as Switzerland’s recently enacted state guaranteed lending scheme.

The parties must also carefully consider any bring-down certificate of the representations and warranties (i.e. confirmation by the Seller that all the representations and warranties set out in the agreement of purchase and sale are true and correct on the closing date).

The buyer may want to ask for such a certificate, even in the case of a locked-box transaction (where such certificates are usually less common). It would be in the seller's interest to negotiate for the possibility to update its statement for events related to COVID-19, without such update triggering the MAC clause (and thus putting the transaction in jeopardy), a price adjustment, or the payment of a financial compensation. This could be achieved by attaching a COVID-oriented disclosure letter.

5. Effects on the Price

Without the benefit of hindsight, it is difficult for the parties to anticipate the effects that COVID-19 might have on the target’s medium or long-term valuation.

This gives buyers an incentive to move away from locked-box mechanisms and more towards conventional price adjustment methods based on net debt and normative working capital requirement (with the obvious difficulty being how to define this normative working capital requirement when taking into account the effects of COVID-19).

In order to avoid the suspension of an operation due to the impossibility of predicting the magnitude of the pandemic's long-term effects, the parties could resort more systematically to using post-closing earn outs. The short term effects of COVID-19 could be smoothed by increasing the length of the reference period used as a basis for the calculation of the earn-out. We have also seen price formulas that rely on indexation based on the length of the confinement period imposed in the applicable jurisdiction.

On the seller’s side, there is an interest to ensure that the buyer has the financing to pay for the price, as COVID-19 could have a negative impact on the buyer’s cash or access to external financing.

Categories: Corporate and Commercial

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