Today’s M&A deal environment is uncertain. Whilst it is still relatively early days, at the time of writing, COVID-19 has already significantly impacted the basic logistics of running the sale process as countries close borders and ban employees from travelling.
Likewise, agreements between buyers and sellers and valuation will be difficult to reach when deal makers cannot make accurate predictions on future earnings. It will take all participants in the sale process (including advisers) time to adjust to this new reality. Buyers and sellers will need to take additional steps to negotiate and allocate deal completion risk.
In this article, we discuss a few common practices and provisions that buyers and sellers should consider in addressing and allocating legal risks from COVID-19.
We expect buyers to place more emphasis on earn-outs, indemnities, deferred consideration and sellers retaining equity to bridge the valuation gap.
Sellers on the other hand will not only have to structure the business to be “corona-proof” but also convince buyers of this and that COVID-19 would not have any lasting impacts.
If a deal does involve any such staggered consideration payments, sellers should consider adequate audit and information rights and post-closing covenants to ensure that the conduct post-completion by the buyer is optimally aligned with their interests.
In terms of deal certainty, we expect that sellers will favour cash consideration only deal structures over those that involve being issued shares in the buyer group since future share price performance is difficult to be assessed in the current environment.
In the Australian M&A market, lock box mechanisms are not common, since in a lock box scenario, the agreed date for the transfer of economic risk is prior to completion. In the current environment, we expect them to be even less common. Instead, we expect buyers to favour a completion adjustment mechanism which is likely to include a working capital price adjustment. This ensures that there is enough working capital to combat short-term COVID-19 impacts, such as the ability to service debt.
It will become increasingly difficult for buyers to conduct due diligence on the impact of COVID-19 on the target since certain types of due diligence may not be able to be completed (management meetings, factory tours, surveys, etc.) in the current environment. The facilitation of due diligence through technological means such as conferences through virtual platforms such as Zoom or Microsoft Teams and well managed virtual data rooms through external service providers will become even more important.
Further, more targeted COVID-19 related questions could be useful in connection with the due diligence of the target.
In relation to employees, this might involve asking whether there are alternative working methods and whether the target is able to handle all new compliance laws that relate to employee health and safety and risks of privacy breaches due to needing to work remotely.
In relation to corporate governance, this may require asking if the target business is set up to be fully functional despite the restrictions.
In relation to material contracts, buyers will need to investigate any supply chain issues. These may include compliance with contracts between customers and suppliers and impact of any force majeure clauses, termination or price adjustment provisions due to the crisis.
Most deals have a delay between signing up the deal and completing the acquisition whilst the parties seek to satisfy various conditions. This means that there is a possibility that buyers may discover new information after the price was agreed that might make buyers reconsider the value.
A material adverse change (MAC) clause gives buyers the ability to terminate the deal prior to completion if it can prove that circumstances occurred which had a material adverse effect on the target’s business. Sellers will usually want a carve-out to the MAC clause for matters which are outside its control and have nothing to do with how they run the business. Whilst there have always be carve-outs for general economic conditions, we expect there to be a trend for sellers to include a specific carve-out for COVID-19 in order to put the risk back on to the buyer. Equally, buyers relying on debt financing in accepting this risk would then need to ensure that their debt commitments have the same material adverse change clause as the acquisition agreement so the lenders can’t walk away unless the buyer can too.
Buyers and sellers should also carefully consider the impact of any long stop date in which conditions must be satisfied since deals may now take longer to complete due to delays in receiving regulatory approvals, third-party consents and financing.
Sellers should also be mindful to ensure that conduct of business restrictions in acquisition agreement allow them enough flexibility to take emergency actions to respond to time-sensitive issues without needing to go back to buyer for prior consent before taking such actions.
Several typical warranties will already cover issues stemming from COVID-19, such as compliance with law warranties. In the current environment, sellers should seek to ensure that they only give such warranties in relation to compliance with material laws and only to the best of their knowledge and be prepared to make specific disclosures against warranties that they do not think that they can comply with as a result of COVID-19.
Finally, we expect that in most current warranty and indemnity (W&I) insurance policies, losses related to COVID-19 would be excluded by insurers (although this may change over time). Consequently, buyers (especially in a private equity deal) may need to consider whether specific “clean up” warranties and indemnities for COVID-19 related issues should be sought in addition to any W&I insurance obtained. These include specific warranties and indemnities relating to the due diligence risks mentioned above. For example, a warranty that no counterparty is seeking to terminate a contract due to force majeure.
As highlighted above, there are various (and many more) tools available to buyers and sellers to allocate legal risks from COVID-19. We have sought to highlight some of the more common ones.
How can Rigby Cooke help?
Rigby Cooke currently advises buyers and sellers on a range of legal issues raised by this pandemic on M&A transactions. Please feel free to contact us if you have any questions or require any assistance.
|Disclaimer: This publication contains comments of a general nature only and is provided as an information service. It is not intended to be relied upon as, nor is it a substitute for specific professional advice. No responsibility can be accepted by Rigby Cooke Lawyers or the authors for loss occasioned to any person doing anything as a result of any material in this publication.
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