Covid 19’s Impact on M&A Deals: Overhauling legal agreements
(A) Activity Fall in the M&A Market
Covid 19 has impacted the global M&A market activity dramatically. Most of the deals which were impacted by the Covid 19 spread has been put on hold while those in advanced stages have been reconsidered for many variables. Noteworthy are the statistics of M&A activity from the US which has been severely hit by the pandemic. Thus, M&A levels in the United States fell by more than 50% in the first quarter to $253 billion compared to 2019. Some of the largest deals have been put on hold. Just recently Xerox dropped its 34 billion USD offer of acquisition for HP refocusing on efforts to deal with coronavirus. By the same token Softbank terminated its 3 billion offer for WeWork shares. Investment bankers, men in finance are spreading rumors that new deals which are not in advanced stage are put in hold.
(B) What you should be thinking about the ongoing deals in advanced stage
Hopefully your heads of terms has not been binding in terms of the agreed price for the business and you may be able renegotiate the price based on the assumptions off future earnings and other fundamentals affected by the pandemic. Usually the purchase price would be formed from 2 components – fixed price and earn outs. While the earn-out would reflect the changed fundamentals, you should check if your heads of terms or intent letters give you possibility to renegotiate the price.
(b) Termination/Break up
If the purchase price is not possible to renegotiate or the impact of the pandemic on the business is so severe that this is likely to deteriorate the strategic considerations based on which the decision to purchase was made, one might as well consider walking away from the transaction. You should check the letter of intent to see if termination of break up is possible and under what conditions. Usually there would be break-up fees to be paid without further need to pay for any damages. Be careful in rushing to terminate the negotiations if your letter of intent is not legally binding. Depending on the applicable law, you may be caught under “culpa en contrahendo” or “negotiation in good faith” provisions of the applicable law. Good faith obligation implies that one cannot terminate without the consequences of making damages good if the negotiation was in such an advanced stage which gives the other party legitimate expectations under the possible contract. This obligation would likely be evident in most European legal systems as well as some U.S states. English law is silent on this point and instead is using the concept of estoppel.
(c) Material Adverse Change and Force Majeure
If the agreement is already signed, you should consider whether price renegotiation or termination is based on the customary Material Adverse Change (MAC) clauses. These are clauses which provide for either termination rights or renegotiation if material adverse effects occur. Due consideration has to be paid for the agreements in drafting stage to make sure that the MAC clause does not need to have the effect itself but the adverse change is enough. By the same token force majeure clauses if drafted accurately will give advantage to one or the other party with respect to performance of the obligations.
(d) Timelines and Delays
The quarantine and remote work has had an impact on all aspects of the work being done. Here are the key issues to avoid delays;
- If you have any permits to apply for, do it as soon as possible. For example, if you need to apply for permit for concentration from Anti-trust authorities you should do it now. The timelines are extended due to remote work and low efficiency;
- Same is true for corporate decisions and decision makers: apply for corporate approvals now or if there is anything to agree upon with the decision makers, do it now;
It is highly likely that the buyer you are selling your business to will be impacted by the current economic situations and may face problems of liquidity or solvency to pay the purchase price or the earn-out if deferred payment is provided for in accordance with the agreement. You should consider security or escrow (although questionable in case of bankruptcy) for securing the payment of the purchase price. Likewise, the buyers should consider some form of security to secure the performance of the warranty and indemnity provisions in the agreement if the agreement is signed.
(f) Due Diligence Issues
Here are the key takeaways for the DD process;
- Financial situation should be monitored closely at least on the basis of the management accounts so as to check compliance or potential breach of the financial covenants;
- Due consideration shall be given to the employment issues of the target: did it manage to shift to the online regime or not? Was it done in compliance with the applicable laws and whether the employees can be held responsible under the same labor laws without any regulatory flaws or vacuum?
- It is of utmost importance to check if the material contracts of the target has MAC clauses or financial covenants which can be triggered to the detriment of the target.
- In capital heavy industries or industries which deal with sensitive issues worth value, it is important to check if the insurance policies cover the pandemics, force-majeure instances etc.
- Last but not least, since all the work and communication is moving online, GDPR compliance issues, trade secret protection systems should be in the center of attention.
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This material is produced by Legelata LLC. The material contained in this newsletter is provided for general information purposes only and does not contain a comprehensive analysis of each item described. Before taking (or not taking) any action, readers should seek professional advice specific to their situation. No liability is accepted for acts or omissions taken in reliance upon the contents of this material.
Legelata LLC, 2020