COVID-19 has impacted the lives of people around the globe and while we are all getting used to "the new normal", it is worth considering the impact of the pandemic on M&A transactions. This article is not exhaustive but sets out some of the key issues for parties to bear in mind while undertaking M&A activity in the current environment.
1. Virtual Dealmaking
There has been a clear slowdown in M&A activity with an increased number of transactions aborting or being put on hold as parties wait to see how target businesses are impacted by the pandemic and how quickly life returns to normal as lockdowns are gradually eased.
Parties may want to be realistic in any timetables they set. For example, it has become the norm to hold virtual negotiations but it can be more time consuming to undertake due diligence while working remotely and when site visits are not possible (or subject to social distancing requirements). Furthermore, obtaining governmental or third party approvals or consents may take longer than usual.
2. Due Diligence
At the best of times, buyers need to undertake due diligence to fully understand the target's business and the risks they are taking on before proceeding with an acquisition, but this is especially true in a difficult market.
For instance, buyers should consider the extent to which the target may have relied on any temporary government schemes and whether they have complied with all the requirements of such schemes. Any failures to do so could give rise to potential claims or liabilities to repay assistance. Buyers should also consider the impact of COVID-19 on other areas of the business, from contractual and financing arrangements, counterparty risk and insurance.
On a more practical note, buyers should consider whether social distancing means that physical inspections – such as property or environmental surveys – need to be undertaken in a different way.
3. Warranties & Disclosure
The warranty and disclosure process is fundamental to any acquisition. It enables buyers to learn about the business it is acquiring and gives a right to claim damages in the event any information about the business turns out to be false. For sellers it provides a way to disclose any issues against the warranties so that the buyer is fully aware of them, thereby minimizing the seller's potential liability for a breach of warranty.
We see buyers including additional warranties to learn about the measures a target has taken to manage all aspects of its business through the pandemic. Meanwhile, sellers are eager to avoid an excessive disclosure burden by including either COVID-19 exclusions to the drafting of the warranties or broad COVID-19 disclosures.
A few examples of particular issues which will need to be covered include:
- Financial position – the impact of the pandemic on the overall financial position of the target, especially where it has adversely changed since the last set of accounts were drawn up;
- Government schemes – any use of government schemes such as furlough schemes, tax deferrals, time-to-pay arrangements and temporary loans;
- Employment – redundancy programs and other changes to working conditions; and
- Contracts – the impact of the pandemic on a target's contractual arrangements, for example, whether counterparties are or will be unable to perform their contractual obligations, whether force majeure provisions have been triggered, whether contracts could be terminated by counterparties and whether there have been any extensions or other revisions to payment terms or increases in bad debts.
Given how quickly matters are evolving in the current environment, it will be important to ensure that the disclosure letter fully reflects the correct position at the time the warranties are given. And where there is a significant gap between signing and completion, we expect sellers to insist on a right to update the disclosure letter prior to completion.
4. MAC clauses
Material Adverse Change (or MAC) clauses – which give a buyer the option to terminate a share purchase agreement in the event that certain events occur between exchange and completion – have historically been much less common in Europe than in the US.
However, we are increasingly seeing MAC clauses being used as a way for buyers to manage risk. Where a MAC clause is used, it's important that the parties consider what events constitute a MAC. Buyers will want a MAC clause to cover as many scenarios as possible while a seller will want to minimize the scope of the MAC, so as reduce the risk that the buyer will invoke the MAC and walk away from a deal, for example by making clear that any worsening of the COVID-19 pandemic (such as a second wave) will not constitute a MAC.
5. W&I Insurance
Obtaining warranty and indemnity (W&I) insurance has become an increasingly common way of allowing the parties to manage the risk associated with warranties on M&A transactions, particularly where private equity funds are involved.
Premiums on W&I policies currently remain highly competitive due to the reduced number of deals in the market. However, policy terms require careful scrutiny as we are seeing some insurers attempt to include COVID-19 exclusions or cancellation rights between signing and closing (which they do not usually have following inception of a policy at signing). These sorts of terms should be resisted.
6. Completion Accounts versus Locked Box
Traditionally, most M&A transactions were undertaken on the basis of accounts drawn up after completion. However, in recent years there has been a significant shift to the "locked box" structure under which financial risk passes to a buyer as at the date of an agreed set of locked box accounts, often prepared months before the acquisition is subsequently completed.
Given that locked box structures put the risk of adverse changes in the business between the locked box date and completion on the buyer, we anticipate that the locked box will become less popular, at least in the short term. Where locked box structures are still used, buyers will be keen to ensure that the gap between the locked box date and completion is as short as possible.
Finally, completing M&A transactions will require more careful planning than normal. While the emergence of electronic signatures on platforms like DocuSign assists to some extent, special arrangements may need to be made for certain documents. Helpfully, many organisations like HMRC have modified their procedures to accept electronically signed stock transfer forms for stamping. However, nearly all M&A transactions involve the execution of deeds, and many practitioners have concerns around whether electronic signatures can be used to execute deeds – it will be interesting to see how both the law and practice develops in this area going forward.
Last reviewed: 14 May 2020