We face an unprecedented business environment, given the scale and speed with which the coronavirus situation is developing.
Our clients face various challenges – from protecting and supporting employees and customers, facing material supply chain challenges, to preserving liquidity and adapting to new and to a large extent unknown operating conditions. Also, pending transactions that were signed pre-crisis and that now may or may not be closed, need to be efficiently handled. And despite the background of these current market conditions, we expect that both strategic investors and financial sponsors will, for various reasons, consider and pursue new transactions in the coming months.
To assist clients in navigating the M&A process in this unprecedented environment, here are the key points for the near future from our perspective:
Material adverse effect or material adverse change (MAE or MAC) clauses have only been seen very rarely prior to the hit of the Corona crisis in Germany. And even if a purchase agreement contains such an MAE/MAC clause, it might not cover a pandemic such as COVID-19. Therefore, most buyers may not be able to invoke the termination of a transaction based on a MAE/MAC clause at the moment.
As a consequence going forward, the parties of an M&A transaction need to negotiate explicit language to address COVID-19 risk-allocation in the context of an MAE/MAC provision. We have seen this practice followed in response to past crises.
Parties should pay extra attention to the seemingly routine “outside date” termination provisions since government approvals, particularly mandatory merger clearances, and further closing conditions might get delayed under the current conditions. The risks of delay need to balanced between the parties, and so do potential changes in the target’s financial results if the period prior to closing is particularly long.
In addition, it is now even more important to synchronize termination rights under the financing commitments on the one hand and the purchase agreement on the other hand.
Due diligence and reps & warranties
Extensive due diligence investigations to determine legal and financial risks and vulnerabilities become even more important – from reviewing supply chains to understand dependencies and potential shortfalls, analyzing key contracts to assess, inter alia, termination rights and force majeure provisions, to reviewing liquidity shortages and potential insolvency risks.
Moreover, specific representations (for example as to contingency planning, protocols, etc.) regarding the crisis may become more common in M&A deals in the coming months.
As COVID-19 is a known risk, insurers will most likely specifically exclude coronavirus-related losses from their policy coverage. In addition, an insured’s “knowledge” of a situation typically excludes that situation from policy coverage. For that reason, the scope of specific diligence regarding COVID-19, which would also apply to post-signing “updates” from a seller, and their effect on the insured party’s knowledge should be carefully addressed with legal counsel in the context of W&I insurances.
Interim operating covenants
In the interim period until closing, sellers normally operate the target’s business in the “ordinary course” to protect its value. However, given the current economic situation, ordinary course might very likely be counterproductive and might actually be the last thing a buyer wants a seller to do – the parties will therefore need to discuss and tailor “emergency” measures to put the seller, without obtaining prior consent of the buyer, in a position to preserve the target’s business in this time of crisis. This applies particularly to liquidity maintenance, debt refinancing and working capital management, but also to exceptions for changes required by law or regulation.
Now even more than before, transactions need to be structured insolvency proof, avoiding unpleasant surprises and later disputes with an insolvency administrator or the authorities in the interests of all parties. This relates to analyzing and mitigating the risks for (a) the seller in case of an insolvency of the target and/or the buyer and (b) the buyer in case of an insolvency of the seller.
Potential employment reorganisation features following closing should be addressed in the course of the transaction already – from adhering to essential employment-law procedures to negotiating the effects of potential post-closing reorganization issues on the purchase price.
Purchase price adjustments
Regarding the current uncertainties, we expect locked box mechanics will be rarely seen in the near future – in particular as the net debt and working capital of a target might significantly change in the interim period until closing. A balanced purchase price adjustment mechanism can therefore play an important role to provide for deal certainty.