Briefing

20 March 2020

How the COVID-19 pandemic is impacting M&A transactions

The COVID-19 pandemic and the resulting concerns about a global downturn are also having an impact on the European and worldwide M&A market: valuations of businesses have become more difficult, auction processes are delayed or postponed, and prospective sellers and purchasers need to identify the specific challenges stemming from the crisis in order to adequately reflect them in the transaction documents. This being said, the current expectation is that M&A activity will not come to a complete standstill. On the one hand, it is highly uncertain of course whether normal deals in industries that are severely affected by the pandemic, such as the travel and leisure industry, will still take place in the foreseeable future and buyers may also seek to avoid closing transactions that have already been signed. On the other hand, businesses in other industries, e.g. healthcare, will certainly benefit from the crisis. Moreover, reduced stock prices can also create new M&A opportunities and M&A may also be an option for businesses facing financial trouble or even insolvency as result of the crisis.

Here are some initial observations on how the crisis is likely to affect M&A processes and points to consider in due diligence and negotiating M&A contracts. Naturally, this is only a high-level overview – more detailed information on legal implications of COVID-19 is available on our coronavirus alert hub, which is being expanded and updated on an ongoing basis.

M&A transactions will take longer and become less predictable

Due to the pandemic and steps taken by governments in many countries:

• Negotiations, management presentations and site visits will become more difficult or even not possible at all due to strict travel restrictions as widely applicable throughout Europe or strict internal policies of companies.
• It may become significantly harder or even impossible for a certain period to secure debt financing of the purchase price.
• Purchase price discussions might be re-opened even late in the process due to negative (or indeed positive, probably always unpredictable) effects of the pandemic on the target’s results due to closure of production sites, decrease in sales etc., resulting in transaction uncertainty for both sides.
• Workstreams that need to be completed between signing and closing, i.e. the carve-out of the target business might take longer due to capacity restraints in the business.
• Clearances, consents or approvals from governmental authorities to be obtained between signing and closing might take longer and delay the closing. We are seeing already that national competition authorities worldwide need significantly more time than usual to grant merger clearance (for further detail see Impact of COVID-19 – merger review and deal timelines).
• Parties may seek to invoke material adverse change clauses or other termination rights in existing SPAs. MAC clauses allow the purchaser to walk away from the transaction in case the target is impaired by certain, contractually defined force majeure events. What qualifies as a material adverse change, however, depends very much on the drafting of the individual clause. Most MAC clauses, which have in any event been rarely seen in European deals recently, explicitly exclude events that affect the global economy in general (so-called “market MAC”) rather than the target specifically (so-called “business MAC”) or contain other significant carve outs, so that it remains a question of individual interpretation of the clause and other elements in the SPA whether the Purchaser can indeed invoke a walk-away right under the MAC clause.

Impact on Due Diligence

The following COVID-19-related questions could be relevant in connection with the due diligence of the target:

• With regard to employees:
  
  
  
  • Are there viable and sufficient options to use alternative working methods (home office, virtual meetings etc.) and what are the consequences from an operational perspective if not? (for further detail (German law) see Coronavirus: Immer mehr Arbeitnehmer arbeiten im Home Office. Was Arbeitgeber jetzt berücksichtigen sollten and Home-Office wegen COVID-19 – und dann? Was gilt für Aufwendungen, Arbeitszeit und wie kann der Betriebsrat arbeiten?)
  • Is short-term work a possibility and have the appropriate steps been taken (including required interaction with employee representatives and authorities) (for further detail see Short-Time work and short-time allowances in Germany)
  • Is the target able to comply with all (new) regulatory requirements regarding employee safety?
  • Is the target GDPR-compliant when handling employees that may have contracted the virus?
    o Has the target complied with all other obligations as an employer around COVID-19 (i.e. information, transparency etc.)
      

• With regard to corporate governance:
  
  • Is the target business set up in a way that allows its different corporate bodies (management board, supervisory board, shareholders’ meeting) to be fully functional despite the Corona-related restrictions?
  • Did management act in accordance with its statutory duties when taking crisis-related decisions? (for AGMs see The Playbook for Switching to a Virtual Annual Meeting: A Review of SEC Guidance, State Considerations, Technical Administration and the View of Investors and Advisors (US), UK AGMs and COVID-19 and Hauptversammlung und Corona (Germany))
  • Domiciliation requirements might also become an issue, if the current travel restrictions continue to stay in place. (for more detail see Will COVID-19 travel restrictions affect corporate tax residence?)
    
    

• With regard to material contracts:
  
  
  
  • Is there a risk of covenant breaches being triggered in financing agreements, and how much exposure does this create for the target business in a worst case scenario?
  • Are contracts with customers and suppliers “Corona-proof”, i.e. is compliance with contractual obligations still possible in the light of the current restrictions on public life, border closures etc.? Are certain customers or suppliers entitled to terminate their contract due to the crisis? Could the target face damages claims as a result? Also, price adjustment clauses could become relevant. (for further detail see Coronavirus: implications for English law contracts and Coronavirus: implications for Dutch law contracts)
  • Do existing insurance policies cover any losses that have already occurred or are likely to occur as a result of the crisis (e.g. losses due to mandatory closures, losses in production due to problems in the supply chain or losses due to the inability to fulfil own contractual obligations etc.)?
    
    

• With regard to emergency government funding and tax relief
  
  
  • Has the target already made use of such emergency funding and if so under which terms & conditions?
  • If not, is the target eligible to receive emergency funding?

In addition to the above and going forward, scanning the regulatory horizon for limitations and risks stemming from potential governmental measures in the future will be key. As a starting point, it may be useful to take into account the measures already taken in other affected regions and countries.

Key issues when negotiating M&A contracts

The following areas are likely to become relevant in negotiating new M&A contracts in the near future:

• From a purchaser perspective, the crisis is an obvious negotiation tool to try to renegotiate the purchase price and to contractually shift the risk of a negative development of the target’s business towards the seller (e.g. by means of purchase price adjustment mechanisms, indemnities, earn-out concepts etc.). Sellers, on the other hand, will argue that the crisis will not have a lasting impact on the business model and, thus the value of the target. As seen in the aftermath of prior crises, this insecurity may trigger a renaissance of earn-out and earn-in clauses to cater for the unpredictability of future success of the target business.
• With regard to MAC clauses, sellers are likely to insist that the consequences of the Corona pandemic – broadly defined - are explicitly excluded (if they are willing to accept a MAC clause at all), but there may be an increased use of bespoke definitions of what the parties regard as a MAC in the given circumstances.
• Regarding closing conditions (merger clearance and other regulatory approvals, pre-completion carve-outs, or consent of important suppliers or customers), the parties will need to take into account the potential for delays resulting from the crisis described above. Long stop dates will have to be set carefully. The same is true for the timelines for pre- and post-closing integration plans.
• The seller’s warranties and indemnities should of course reflect any specific COVID-19-related issues that the due diligence has brought up.
• From a seller’s perspective, particular care is required with regard to interim operating covenants. Also, bring-down obligations regarding representations and warranties at closing may be impacted (i.e. where warranties given at an earlier point in time are deemed to be repeated as of closing).
• In the light of current restrictions, newly negotiated transitional services agreements need to be drafted carefully. In particular, the risk of default (e.g. due to staff or supply shortage) needs to be properly allocated.
• To avoid the risk that the purchaser is obliged to close the deal without necessary financing in place, the contractual provisions in debt financing agreements protecting the lenders against negative developments resulting from the pandemic (e.g. covenants, MAC clauses, termination rights etc.) should be mirrored in the SPA.
  
  

For more information about the legal implications of COVID-19, please visit our coronavirus alert hub.