COVID-19 – Impact on M&A
Attorney at Law (currently on maternity leave)
The COVID-19 crisis hit Europe in March 2020 and still has a significant impact on upcoming or ongoing M&A transactions. Over a year later, it has altered the way that parties structure M&A deals and negotiate agreements. Travel restrictions and lockdowns impede the necessary discussions as well as the completion of transactions. However, the risks arising from the crisis can be rectified by adequate preparation of the transaction processes and drafting of the transactional documentation, thus making the ongoing transactional activity possible.
Consequences for due diligence
Identifying risks within the target company is the main focus of due diligence. Buyers should consider the specific consequences of COVID-19 for the target company in the due diligence process to determine whether the target company is adequately protected against the negative impact caused by the virus. Disrupted supply chains, loss of production and decline in revenue, but also existing insurances, if any, measures ordered by public authorities, crisis management processes and consequences entailed by remote working, if applicable, should be taken into consideration. Further, conditions and compliance with possible governmental financial-support should be reviewed. Sellers, on the other hand, should approach this issue with particular sensitivity and proactively provide the corresponding information. The risks identified in this step will form the basis of further negotiations and the drafting of the agreement. In its practical handling, due diligence became a remote process since the outbreak of the virus. Management presentations, site visits and other meetings are often replaced by calls and video conferences.
Material adverse change (MAC) clauses native to Anglo-American transactions are agreed upon to cover any material changes of the subject matter of the agreement. They aim at providing for circumstances, which were not predictable and adversely affect the target company, appearing between the signing and the closing. The MAC clause allows for the buyer upon occurrence of an event defined therein (e.g. significant decline in revenue, loss of major customers or serious compliance violations) to rescind the agreement and/or to renegotiate its conditions without being liable for a breach of contract. In particular, new transactions require increased care when it comes to wording. Even if the extent of the pandemic cannot be estimated at the moment, it has become a known event by now. Nevertheless, it will certainly be possible to find an appropriate wording taking into account the specific COVID-19 risk. In this context, the parties should carefully weigh the risks (and how they are addressed in the wording) in each individual case.
MAC clauses often contain the so-called carve outs, i.e. a list of events that are not to be covered by the MAC clause. Some examples of these include changes in the industry-specific conditions or the economic situation, as well as force majeure, outbreak of wars, natural disasters or terrorist attacks. If, prior to the COVID-19 outbreak, an existing MAC clause had included a carve out that related to the outbreak of an epidemic, pandemic or similar medical event, then COVID-19 would clearly not trigger a MAC event for this transactions.
The omnipresence of COVID-19, however, led sellers to generally reject COVID-19 as MAC triggering event since COVID-19 is now a known risk that buyer could and should have duly considered when valuing the target. As of late parties are now negotiating if MAC definitions and carve outs should involve not only pandemics, but the government regulations and re-strictions promulgated in response to them (e.g., travel bans and lockdowns). Therefore, cautious wording is required, especially since the future course of the pandemic cannot be foreseen. It is, nevertheless, possible to find wording that takes into account the specific allocation of COVID-19 risks. In doing so, the parties should carefully consider the risks (and how they are allocated) on a case-by-case basis.
From the seller’s perspective, agreeing a break-up fee would be advisable. A break-up fee is a penalty determined in advance, which becomes due if a party withdraws from the deal. The purpose of the break-up fee is to reimburse the other party for the time and expenses it has invested in the deal. However, in particular from the buyer’s perspective, breakup fees will not be easy to negotiate due to the current uncertainty.
The unclear further development of the virus and its continuous economic consequences are a major factor of uncertainty, which entails major difficulties in the determination of a purchase price. Thus, from the perspective of the buyer, particularly locked box and fixed pricing concepts are not recommended. Rather, risks should be identified already in the due diligence phase and appropriately considered when drafting the agreement. This will of course not apply to the seller. The impacts of Covid-19 become apparent when it comes to the determination of the purchase prices. In the recent years Europe has been regarded as favouring the seller, but since the outbreak of the pandemic the market has returned to a ‘buyer-friendly’ environment. As a result, there is a decline in locked-box transactions.
Caution should also be used in the context of warranties and guarantees. Often, these are the subject of tough negotiations even under normal circumstances. As a result of the altered risks and concerns brought by the pandemic, new, more detailed representations and warranties are making their way into private M&A agreements. Buyers should keep a particularly good eye on those fields which are the most affected by the uncertainty caused by the virus. These include, for instance, the collectability of the target company’s claims, its financial projections and a possible breakdown of its supply chain. Well-advised buyers will also seek warranty as to that all laws and regulations related to the pandemic have been complied with, contingency plans have been developed to ensure business continuity and protective measure have been taken at all sites of the target. Further, representation relating to the reliance on Covid-19-related financial-support laws are often included in agreements. From the seller’s perspective, demands for more extensive warranties and guarantees can be counteracted by way of more transparency.
If the transaction has already been initiated, the question arises, whether the buyer can still exit the deal. In this respect, various possibilities could offer themselves. First of all, the written agreement is to be examined in great detail with regard to possibilities of termination and/or an adjustment of the purchase price. In many cases, agreements already include exit possibilities.
In particular international agreements often contain so-called force majeure clauses, which provide, in particular, for the (temporary) cancellation of performance obligations, for the exclusion of liability and for the right of withdrawal in case of an event of force majeure. But even without explicitly agreeing upon it, the remedy of force majeure may be applicable. However, this needs to be treated with caution. Even if epidemics and pandemics can generally be considered an event of force majeure, this does not necessarily mean that the parties of the agreement can actually invoke this circumstance successfully. Rather, it is necessary to specifically interpret the actual circumstances on a case-by-case basis.
A termination of concluded agreements or at least an adjustment can also be achieved on the basis of frustration of contract if certain prerequisites are met. For this to apply (in brief), the circumstances typical of this kind of transaction must have become the basis of the agreement and unforeseeably, material changes in circumstance must have occurred after conclusion of the agreement. Case law has allowed avoidance or rectification of contract due to frustration of contract only in exceptional cases so far. However, since COVID-19 has become to a known risk there is little reason for frustration of contract left.
In any case, a long stop date should be agreed upon for upcoming deals. This is a cut-off date by which the transaction must be completed. Typically, the long stop date lies weeks or months after the intended closing date. If the closing cannot take place by the long stop date due to unexpected obstacles (e.g. if official approvals cannot be obtained), the parties - or, depending on the structure, only one party – shall have the right to withdraw from the contract without being liable for frustrated transaction expenses.
Digitization of the transaction process
While due diligence was generally conducted digitally prior to COVID-19, personal contact was unavoidable at the latest at the completion of the transaction. After all, the necessity of the notarial certification and the drawing of the notarial act required the parties to appear in person before the notary.
This was remedied by the new Section 90a of the Notarial Code introduced as part of the COVID-19 legislation. Under such section, notarial certification and notarial acts can be executed and drawn-up completely on digital basis. For this purpose, a video conference is held with the notary, during which the documents can be discussed and subsequently digitally signed. Please find more information on the underlying process in the article "Covid-19: Consequences on notarial services". Originally, this amendment was only to apply until De-cember 31, 2020. Due to initiative from the business community, the digital execution of notarial acts has now turned to a permanent option.
Opportunities with respect to distressed M&A
As any other crisis, the COVID-19 crisis, too, offers possibilities for seasoned, crisis-resilient buyers and strategic financial investors to purchase the desired target company under favourable conditions. It is foreseeable that despite the national and European aid packages, many companies will come under economic pressure. Thus, even companies that have not been available for sale and/or have been offered at a much higher purchase price will enter the transaction market. According to our judgement, an increase in new distressed M&A deals is to be expected due to COVID-19 crisis.
The COVID-19 pandemic had a major impact on M&A transactions. In the wake of the pandemic the way that M&A processes are structured and agreements are negotiated has ir-revocably altered. Risks and concerns brought by the pandemic are concerned in the nego-tiation and drafting process of M&A deals.
The market will be a different one than it was before the crisis. Whereas in 2019 it was still possible to speak more of a seller's market, in which sellers were able to pick the suitable buyer from several interested parties, achieve high purchase prices and get through with seller-favorable provisions in the purchase agreements, there will be a turnaround - at least temporarily - towards a buyer's market. This may also be a reason for optimism. The correction of sale prices, which were overrated in 2019, will almost certainly lead to a boost in transaction activity.
Further, the last few months have shown ingenuity and great flexibility. Digitization has received an immense boost and now enables M&A transactions to run completely on digital basis.
Attorney at Law (currently on maternity leave)