Mona Patel Partner
COVID-19 – Potential impact on M&A transactions
Both Buyers and Sellers will need to be mindful of the potential impact of COVID-19 on new and ongoing M&A transactions. There are a number of issues that the parties might consider addressing at various stages of the transaction to protect themselves and provide an agreeable approach where risk is identified.
Should we consider COVID-19 when negotiating new or reviewing existing heads of terms and other preliminary agreements?
Yes - you may want to contemplate the following:
- Exclusivity Periods: consider longer exclusivity periods to allow sufficient time to assess the impact of COVID-19. If the parties are delaying existing transactions where heads of terms have already been signed, diarise any existing exclusivity period and decide whether this should be extended in good time.
- Deal Structure: while typically non-binding, where parties are in the process of negotiating heads of terms or memorandums of understanding, endeavour to address the parties’ position on matters such as deal conditionality, due diligence, warranties and the other items considered in this Q&A. These are issues that are likely to drive the most discussion between the parties. If the parties’ expectations are set and agreed (in principle at least) early on, this is likely to avoid protracted negotiations at the later stages.
Is there any additional due diligence we might consider in light of COVID-19?
In addition to the usual due diligence which would be undertaken on a potential Target, Buyers should assess COVID-19’s impact on:
- Financial Diligence: what impact could COVID-19 have on any financial projections, revenue and profit? Is this quantifiable at this stage of the outbreak? Is the Target’s solvency likely to be impacted in the aftermath of the outbreak (especially if the Target is in vulnerable sectors such as retail, hospitality, aviation etc.)?
- Supply Chain & Contractual Relationships: how will the Target maintain its trading relationships and what is the potential effect on its existing supply and customer contracts?
- how will the Target deal with insolvency of key counterparties?
- do the Target’s contracts contain any onerous delivery obligations including liquidated damages for delay?
- are there any ongoing renegotiation of terms with counterparties?
- have any contracts already been terminated?
Please see our article ‘COVID-19: Impact on Supply Chain’ here for a more detailed look at the implications of COVD-19 on the supply chain.
- Physical Trading: to what extent does the Target rely on physical trading? If the Target is already trading online, is its website/sales platform able to cope with increased demand?
- Insurance: does the Target have any insurance policies in place which may respond to COVID-19 related losses? Please consider our article ‘Coronavirus: Insurance’ here for a more detailed look at the the general impact of COVID-19 on insurance.
- Business Continuity Plans: does the Target have any meaningful business continuity plans? How are those plans being implemented and are they operating successfully?
- Laws: monitor changes in law expected to arise as a result of the outbreak such as changes to work place leave policies and how this will impact the operations of the Target and compliance.
What are some of the additional COVID-19 related protections we should consider building into the transaction documents?
- Deal Conditionality: where there is a gap between exchange and completion, there is a risk that the Target’s operations could be significantly affected by COVID-19 during the interim period. Buyers may wish to consider negotiating COVID-19 specific conditions precedent, termination rights and/or “material adverse change” (MAC) clauses. When negotiating provisions of this type, being clear and specific with the triggers is key. Examples of conditions precedent requested by a Buyer may include: (i) retention of key named employees; (ii) material supplier and/or customer agreements remaining in place; and/or (iii) conditions tied to specified financial metrics.
- Material Adverse Change: while every clause will depend on its wording, generic MAC clauses are unlikely to respond to the COVID-19 outbreak as they typically contain exclusions relating to general economic conditions and market events. Anyone trying to rely on a generic MAC clause entered into in the current climate will also have a more difficult burden to overcome given how widely COVID-19 has been reported. As such, MAC clauses should be drafted with clear and specific trigger events which should include COVID-19 related triggers if the parties agree.
- Termination Compensation: as a compromise for the Seller accepting conditionality, and the inclusion of a COVID-19 MAC clause, the parties could agree a termination fee (payable by the Buyer to the Seller) in the event the Buyer were to walk away from the transaction. The amount is usually subject to negotiation but often the compensation will represent the Seller’s legal spend and management time.
- Creditworthiness: Buyers should consider the potential longer term impact of COVID-19 on the creditworthiness of the Seller for example with regards to any indemnity and warranty protection being offered. A Buyer can seek extra security such as a parent company guarantee, retention of a portion of the consideration and/or escrow arrangements. Sellers might also consider seeking protection against default of the Buyer’s payment obligation, particularly where: (i) there are long periods between signing and completion; (ii) there is deferred consideration; and/or (iii) the Buyer is reliant on third party financing or investment to fund the acquisition.
- Consideration & Earn-Out Mechanics: review the provisions relating to any price adjustment and/or earn-out mechanisms carefully. Could a significant impact on the Target’s business lead to an unexpected drop in the purchase price? A Seller can mitigate this risk by agreeing a minimum consideration amount.
How might COVID-19 affect other typical provisions in transaction documents?
- Interim Period Obligations: in non-simultaneous sign and close transactions, it is common practice for the Seller to give certain promises to the Buyer that it will continue to run the business in the way it had been prior to exchange. Typical obligations on a Seller include procuring that the Target’s business is run in the “ordinary course” and to “maintain trade relationships”. Certain key decisions will also be subject to the Buyer’s consent (e.g. entering into or modifying material contracts).
Each obligation will need to be assessed carefully by the Seller e.g. will it be able to continue to implement its contingency plan and react to changing economic conditions without having to go back to the Buyer throughout the interim period?
Where a Seller has a detailed contingency plan in place for the Target, a compromise position could be for actions relating to the plan to be approved in advance by the Buyer. Reasonableness or strict time limits for the Buyer’s consent could also be introduced. This will allow the Target to manage the impact of the outbreak during the interim period.
- Longstop Dates: where completion is subject to certain conditions, consider what the realistic timeframes for satisfying those conditions might be when agreeing Longstop Dates. Where some form of regulatory approval is required, bear in mind that the relevant authority may not be in a position to operate within its usual timelines. E.g. the EU Commission has published a notice regarding special measures due to COVID-19, which is encouraging certain merger filings to be delayed.
- Warranties & Disclosure: Sellers are likely to see Buyers requesting enhanced warranty protection for COVID-19 related risks (e.g. the impact on suppliers/customer contracts), which will place a greater burden on the Seller’s disclosure exercise. Sellers will also need to be mindful of the impact of COVID-19 on warranties which are to be repeated at (or daily until) completion. If accepted, the Seller should ensure it retains the right to update its disclosure letter.
Alternatively, a Seller in a stronger negotiating position may seek to ring-fence COVID-19 related liability by carving-out any breaches arising from it or excluding COVID-19 related breaches from certain general warranties (such as accounting).
Given the current change in working practices and lack of physical meetings, how will we conduct the execution of transaction documents?
Given the travel restrictions and lockdowns in place in certain jurisdictions, it is unlikely that all signatories will be able to convene and hold a physical closing meeting. Regard will need to be had as to how this will be managed and by agreeing the process and protocol in advance. Please consider our article ‘COVID-19: Can we sign documents electronically’ here for a more detailed look atexecution formalities where documents are being signed electronically.
Parties should also check the Buyer’s and Seller’s constitutional documents to ensure there are no restrictions on electronic signings, especially where the parties are incorporated in jurisdictions outside of the UK.
The above does not constitute legal advice nor does it consider a complete list of corporate M&A issues to consider in the context of COVID-19. Should you have any queries, please do not hesitate to contact the authors of this article or your usual corporate department contact at Ince.