Navigating the impact of COVID-19
How to manage M&A risk
The COVID-19 outbreak is having a major impact on the global economy and the financial performance of market participants.
Companies may have entered into major transactions at valuations that have since deteriorated due to the crisis, leading to moves to terminate the transaction or reduce the purchase price.
As a first step, the parties will need to determine the extent of the impact of the outbreak on the target company itself, but there will also be work to be done in assessing the impact upon the M&A process more generally.
Where a target company is severely impacted, some parties will inevitably assess the possibility of walking away from the deal.
The same could be true for buyers affected by the crisis and who no longer find themselves in a position to proceed with an acquisition.
Acquisition and joint venture agreements sometimes contain material adverse change (MAC) or material adverse effect (MAE) clauses, which permit a party to decline to close the transaction and/or to terminate the contract – these are more common in some jurisdictions (such as the US) than others (eg Europe).
Whether the COVID-19 outbreak would be covered by any MAC/MAE clause depends on the drafting – but matters that affect the broader market or industry in which the target operates, without a need to show a specific material effect on the target itself, are fairly rare across all jurisdictions.
Aside from material adverse change clauses, some purchasers in a strong bargaining position may have negotiated rights to terminate in the event of a material breach of contract or breach of warranty in the gap between signing and closing.
Conditions to closing could possibly also be used by a party to engineer a walk away right.
Transactions requiring complex antitrust or other regulatory clearances which involve cooperation and information sharing are particularly vulnerable if the SPA does not contain sufficient certainty as to each party’s obligations and the timeframe for fulfilment.
Similarly, the need for shareholder approval could provide an opportunity for a party to walk away from the deal. A seller that remains committed to the transaction should ensure that it observes its contractual obligations to avoid giving a reluctant buyer an opening to terminate.
Although there may be implied rights in law to rescind or terminate an agreement that could be relied upon, we would expect most acquisition agreements to exclude any such rights which are not expressly provided for.
Possible avenues to explore might be the doctrine of frustration (where a contract has become radically different or impossible to perform), or termination rights arising because of the other party’s fundamental or repudiatory breach.
However, there is likely to be a high threshold to meet to enable these rights to be exercised.
Purchase price adjustment mechanisms
Depending on the pricing mechanism, the economic disruption caused by the crisis may create an obvious opportunity for acquirers to adjust the price they are willing to pay for the target company/assets.
This may result in valuation disputes – these are always fact specific but they will now need to address and account for the added levels of uncertainty posed by the outbreak.
Where the parties remain committed to their deal, the overall process is likely to take longer.
Those M&A deals that are subject to merger control review or require other regulatory clearances are likely to find that the process is disrupted, with a reduced prospect of early clearance even in ‘no issues’ cases under review. More complex cases may be delayed or suspended.
Parties should review long-stop dates in their documents and communicate hard deadlines to the relevant authorities.
Practical obstacles might also be encountered when dealing with other pre-closing matters, such as legal or operational reorganisations or securing consents from third parties. Parties should review their obligations and consider whether they can be achieved in the existing contractual framework.
Assuming that in these scenarios the parties remain committed to the deal, it may be necessary to renegotiate long stop dates to avoid the transaction automatically terminating.
Acquisition agreements usually contain pre-closing covenants by sellers that they will operate the target business in the ordinary course, as well as observing restrictions on certain activities.
Although it is common for a seller to negotiate a carve-out to allow it to react appropriately to emergencies, these provisions should be checked and monitored carefully.
Sellers may need to seek purchaser consent to certain actions (eg drawing on liquidity sources), and will not want an inadvertent breach to provide an opportunity for the buyer to terminate or renegotiate.
Bring-down of warranties
Warranties are made as of a particular moment in time (eg as of signing of the transaction).
Acquisition agreements sometimes deem certain or all of the warranties to be repeated on a later date, eg as of closing (so-called ‘bring-down’) – this is more common in some jurisdictions (such as the US) than in others (Europe).
If due to unforeseen circumstances particular warranties are no longer true as of closing, the seller might - depending on the provisions of the relevant contract – face damages claims or even a termination right of the purchaser.
Some of the points mentioned above will be relevant to transitional services, where the parties may be finding performance in the current climate difficult or impossible due to staff or supply shortage.
Concepts of force majeure or frustration may be more likely to be applicable in this context, and there may also be express clauses dealing with failure to comply with contractual obligations.
For deals under negotiation, the key hurdle to overcome will be valuation.
Due diligence will clearly be focussed on the ability of the target to continue its business operations in this fast changing environment.
Otherwise, the issues described above will be equally relevant and must be addressed during negotiation in order to increase deal certainty or allow flexibility to walk away from the deal, depending on your perspective.
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If you would like to discuss these issues in more detail, please speak to your usual Freshfields contact or one of the lawyers listed below who can direct your query.