The recent spread of COVID-19 around the world and unprecedented lock down measures have frozen M&A activity around the world, resurrecting the ghosts of 2008 after many golden years. The present crisis is however of a different nature. It is too early to draw conclusions on all its consequences on the economy and financing systems for now. The French state has taken strong short term measures to support companies and workers with a freeze on tax and social charges and by providing emergency loans to companies through the French State controlled BPI bank. The French banking federation has also instructed its members to grant automatic freezes for a 6 month period on all existing credit facilities, which seems to be effective based on the first returns. However, M&A activity will only resume when health and safety measures are abandoned, volatility on prices stop and financing is available.
Many questions have arisen as to the consequences of COVID-19 on French M&A and Private Equity on the short term regarding existing transactions. Purchasers have inquired about the possibility to terminate transactions that have not closed yet. On the other side, sellers want to ensure that the deal will close. This crisis will also certainly have an impact on the long term in terms of how transactions are negotiated.
How secure is a transaction that has not closed yet?
There are basically three tools that could be used try to terminate a transaction that has not closed yet: conditions precedent relating to financing, material adverse change clauses and force majeure. If there is no possibility to terminate the contract, is there any possibility to renegotiate on the basis of hardship?
- Financing conditions
The dynamics of the French M&A and PE market other the past years associated with low interest rates and strong appetite from lenders resulted in fewer and fewer share purchase agreements containing financing conditions precedent. The market standard was the so called “certain funds” provisions in the financing agreements providing for certainty of debt financing. Even for the share purchase agreements containing such conditions, the principle was usually limited to the availability of the funds on the closing date. In the current circumstances, there is no market disruption that could justify the unavailability of funds. Specific attention should in any case be paid to the exact wording and conditions provided in the transaction documentation.
- Material Adverse Change (MAC)
Another tool that could be used to terminate a transaction could be material adverse change provisions. While these types of provisions are very common in the US or UK, they are less used in France. MAC clauses used in France are usually limited to events or circumstances attributable to the target itself such as industrial accident, for instance (fire, explosion of sites, etc.). French MAC clauses usually do not cover epidemics which are considered events occurring outside the target. MAC clauses should of course be carefully reviewed to determine whether COVID-19 could be successfully invoked. In any case, this type of provisions is purely contractual and judges will base their analysis on the wording of the provision itself as well as on the intents of the parties.
- Force Majeure
The question of force majeure under French law arises in the current circumstances. The French Minister for the Economy has even announced that for public procurement contracts, the notion of force majeure would be applicable. Could this be the case for a private agreement, in particular a share purchase agreement ? The answer is likely to be no on the basis of current case law. If there is no contractual definition of force majeure in the share purchase agreement, the provisions of Article 1218 of the Civil code will apply: “There is force majeure in contractual matters when an event beyond the control of the debtor, which could not have been reasonably foreseen at the conclusion of the contract and whose effects cannot be avoided by appropriate measures, prevents the performance of its obligation by the debtor”. When it comes to the transfer of shares against payment of the related purchase price, the cases when the performance is not possible can be related to the unavailability of the payment system, which is not the case for now. French case law is rather stringent when it comes to payment obligations. The mere fact that an obligation is rendered more onerous as a result of outside circumstances does not exonerate the debtor from their payment obligations on the basis of force majeure. It cannot however completely be ruled out that case law will evolve in the future to take into account the extreme situation we are facing. For now, an extension of the interim period between the signing and closing of the share purchase agreement could be envisaged to enable the parties to take appropriate measures so that they are in a position to close.
Even though French law is rather robust in terms of binding nature of private agreements, what about possibilities to renegotiate the share purchase agreement in case of occurrence of unforeseen change in circumstances that render its enforcement excessively onerous for one party? French law offers this possibility in Article 1195 of the Civil code. However, this article is not applicable for share transfers and is therefore of no use in the case at hand, except of course if the parties have expressly contractually agreed to have recourse to this mechanism. Obviously, if the current crisis prevents the seller from satisfying some conditions precedent or providing some closing deliveries, the purchaser may bargain its waiver on such missing conditions precedents or closing deliveries against a purchase price reduction or earn out payments.
What’s next for M&A?
We have seen above that French law is favourable to sellers in the current environment, especially as regards deal certainty and value. Buyers will want to increase their coverage for their future transactions. Hence a probable shift in negotiations and an evolution of market practice as alongside longer and more complex discussions can be anticipated. Until the market recovers and deal flow returns to normal, there may be some points of attention for the next transactions which are highlighted below.
- Due Diligence
The scope of due diligence may now include business continuation plans in case of epidemics with specific procedures in terms of health and safety as well as working arrangements. Commercial due diligence may now also cover specific contractual provisions both from customer and supplier contracts on force majeure provisions assessing the risks for the target in such events. From a business perspective, supply chain matters will also have to be carefully reviewed, including in terms of geographical scope in case certain areas or countries account for most of/all supply sources.
- MAC provisions
Due to the fact that force majeure and hardship principles provided by French law are of limited help in French M&A transactions, MAC provisions are likely to be increasingly discussed. The general principles of such provisions may not change in the sense that they usually exclude pandemics, but specific circumstances or deal dynamics may cause the parties to specifically consider and discuss the allocation of risks among them in such cases. This will be particularly pertinent when there is a significant period of time between signing and closing due to the regulatory authorizations to be obtained.
- Price mechanics
The choice between locked box mechanics and price adjustment is likely to be carefully considered by purchasers. While the seller friendly market made of competitive bids left no place for price adjustments, the new market trends may well put price adjustments back on the table again as a protection for purchasers in case of serious market events between signing and closing.
- Representations & Warranties
Reiteration of representations & warranties as of closing will prove more and more difficult in a world of uncertainties. Discussions were already sometimes difficult around the update of disclosure schedule between signing and closing. These types of discussions are likely to become more difficult in the future where purchasers will want to be reassured on closing.
- Interim covenants
Other provisions of share purchase agreements may have to be considered in light of the COVID-19. In particular, interim covenants may be more scrutinized by potential purchasers. The tendency other the past years was to have lighter interim covenant provisions to avoid gun jumping issues. Bearing this risk in mind, purchasers may want to have reinforced rights in case of material events such as outbreak of epidemics or pandemics. Finally, information obligations shall be reinforced between signing and closing.
- Regulatory Approvals
Timing between signing and closing may also have to be adapted to take into account the fact that regulatory authorities may take more time to review the filings considering the change in working environment. Currently the French merger control authority has not closed down but they have more limited capacity due to the lock out measures which will lead to delays in the review process. Although the Authority is bound to issue a decision within a certain timeframe (25 working days for a phase I decision), the clock only starts ticking upon the filing of a complete merger notification file. If the authority cannot cope with the stream of notifications, which is however expected to decrease significantly, it is expected that they will declare the files incomplete and make additional information requests which will slow down the review process.
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