What is the impact of COVID-19 on M&A transactions?

As the coronavirus (COVID-19) continues to headline the global news, with stock markets suffering severe hits and governments implementing draconic measures to contain the spread of the novel virus, the impact on global M&A activity will undoubtedly be significant. In this newsletter, we address the potential legal impact of COVID-19 on M&A transactions.

1. Transaction logistics

With quarantines and travel restrictions in place, the practical disruption of COVID-19 cannot be underestimated. Although electronic conferences can replace most physical meetings, on-site visits and investor road shows for example simply cannot be replaced. As judicial and governmental officials are affected in the same manner, obtaining regulatory approvals might also require considerably more time. Moreover, the time and attention of transaction parties might be diverted away from any future transaction in an attempt to internally mitigate any potential impact first. These aspects themselves might already slow down or even frustrate deal-making processes.

2. Due diligence

Legal due diligence will increasingly be focused on assessing the impact of the virus on the target’s business, and whether the target has implemented any mitigation and/or contingency plans.

Additional consideration should be given to:

• the ability of the target, suppliers, customers and contractual counterparties to perform or suspend contractual obligations under material contracts or to unilaterally terminate such contracts;
• supply chain risks and the availability of alternative suppliers;
• insurance policies and coverage (e.g. business interruption policies);
• solvency risk and revenue; and
• compliance with laws as well as reasonably expected changes in law.

Should certain risks be identified, these might lead to the inclusion of conditions precedent, additional representations and warranties, specific indemnities or a revision of the purchase price mechanism. However, it is also not unlikely that transactions will temporarily be deferred, or even more radical, be aborted. In this light, parties should be reminded that they might expose themselves to precontractual liability (culpa in contrahendo) should they break off negotiations in bad faith or in an abrupt/untimely manner.

3. Purchase price

The impact of COVID-19 on the target might also be reflected in the allocation of the pricing risk between purchaser and seller. Taking into account the uncertain future development and economic impact of the pandemic, the purchaser might not be comfortable with fixed pricing or locked-box mechanisms, but rather have a preference for closing accounts and working capital adjustment provisions (potentially also incorporating specific adjustments relating to COVID-19) or deferred payments / earn-outs which are dependent on the achievement of certain milestones post-closing.

4. Financing and key dates

Delays in the delivery of key financial information such as audited financial statements as well as the current volatility in the financial markets might also delay or obstruct the availability of financing. Candidate purchasers with considerable cash available may have a competitive advantage over those who require a high amount of financial leverage (e.g. private equity funds).

As transaction logistics will be heavily impacted, many of the key dates should be reviewed in this context. Regulatory, financial or change of control approval requirements and long stop dates should be reviewed and adjusted if necessary.

5. Material adverse change clauses

Purchasers should heavily insist on including material adverse change (MAC) clauses which are broadly defined, thus also capturing risks relating to COVID-19. It is however expected that sellers will try to carve out as many events or circumstances as possible from such definition, in an attempt to prevent a shift of the transaction risk to their side. In any case, additional scrutiny is required when negotiating the exact wording of the MAC clause and the exceptions thereto.

Conclusion

COVID-19 will have an immediate and perhaps chilling impact on M&A transactions. Market participants should carefully review projected deal timelines and expectations and extend their due diligence review as to include matters which might be affected by the pandemic. Negotiations of the acquisition documentation should heavily focus on risk allocation between parties, for example through purchase price adjustment mechanisms, extension of key dates and MAC clauses.