The COVID-19 (novel coronavirus) pandemic has caused uncertainty for individuals and businesses around the world. Those involved in M&A transactions need to consider the additional risks and, in some cases, opportunities which the pandemic may cause both for the short and long term. Derek Stroud, Alasdair Dunn and Christopher Miller discuss some of the key issues for parties to consider in the course of negotiations.
Sellers should anticipate that buyers will want to understand the impact of the pandemic on their businesses and attempt to address concerns early in any process. Both buyers and sellers will want to consider:
- Performance of Material Contracts: What is the impact on the business's material contracts? What are the consequences of a breach?
- Counterparties Performance: What rights do counterparties have under the contract to suspend performance in the event they are subject to business disruption? Are there any force majeure/frustration clauses allowing counterparties to walk away in the occurrence of an event outside their control?
- Commercial Renegotiation: Are there any clauses in the business's contracts permitting renegotiation of commercial points on the occurrence of certain events? Suppliers may look to renegotiate the price of goods as a result of increased demand or disruption further up the supply chain.
- Supply Chain: To what extent is the business's supply chain vulnerable to disruption as a result of COVID-19? What is the availability of alternative sources of supply in the event of disruption?
- Solvency: What is the impact on the business's banking arrangements and its cashflow position? How has the business performed in recent months and weeks?
- Change in law: Will there be an impact from travel restrictions or any other restrictions enacted by relevant governments?
- Insurance: Do the insurance policies provide adequate cover? The insurance industry has already flagged that business interruption insurance may not cover disruption caused by COVID-19.
- Rights of Employees: Is the business currently complying with its duty of care toward employees sick or at work? Is it providing a safe environment and facilities to work from home? If policies are in place allowing employees to work from home, have steps been taken to address the possible impact on data protection?
- Key Information: Could there be a delay in the delivery of key information such as audited accounts or financial projections?
Price and Consideration
Uncertainty and market disruption can pose a significant challenge in agreeing a valuation for the target business. As valuations are often based on current revenue or earning expectations of the business, the parties will have to consider the impact of COVID-19 on financial projections.
Buyers may attempt to make a portion of the price deferred or contingent upon the performance of the business post-closing.
Buyers could struggle to obtain acquisition financing with lenders unable to accurately assess the market conditions and future business performance of the target business. There may be additional working capital required by the target to cover short term cashflow issues.
Sellers should consider the financial viability of the buyer and its ability to meet post-closing obligations. The use of escrow arrangements or parent company guarantees may set off potential risks posed by the buyer defaulting on their payment obligations.
Material Adverse Change
If a split exchange and completion is proposed a buyer may seek to include a Material Adverse Change (MAC) clause to allocate the risk of any downturn in the target business between the buyer and seller post-closing. MACs often give the buyer the right to walk away where the performance of a target business significantly worsens during the "gap" period.
It is in the buyer's interest to negotiate a MAC clause which allocates the risk of any COVID-19 downturn to the seller. A seller will most likely point to the public nature of the virus and seek to place risk solely on the buyer.
Warranties and Indemnities
It is usual practice for a buyer to insist on a series of warranties and indemnities from the seller in respect of the target business. Buyers may wish to include specific warranties regarding the business continuity plans, emergency protocols, status of material contracts, and the adequacy of its supply chain so that the sellers are obliged to provide a clear picture of the position for the buyer and its advisors to assess.
Sellers should ensure any warranty requested is met with an appropriate disclosure and resist subjective or forward-looking warranties.
If specific and significant risks have been identified, then the buyer should seek to negotiate an indemnity or price adjustment to mitigate against any future loss.
Warranty and Indemnity Insurance
If either party intends to take out warranty and indemnity insurance, that policy should be reviewed carefully in order to understand any exclusions on claims relating to matters connected with COVID-19.
To discuss the impact COVID-19 may have on your transaction, or to talk through any of the key considerations detailed above, please get in touch with your usual Brodies contact.