The current COVID-19 pandemic continues to affect every aspect of society, disrupting the global economy and devastating both small and large business alike. With regard to volatile economic environment in which businesses are now operating, any decision, whether seemingly inconsequential or not, could have a potential adverse outcome and should be considered carefully.
Whilst some businesses will be focused on merely weathering the storm and keeping themselves and their employees afloat in these tempestuous waters, there may be other businesses with strong cashflows seeking opportunity and being ready to utilise this uncertain landscape to strengthen their competitive position. It is accordingly anticipated that we may see an increase in business restructuring through, amongst other means, mergers and acquisitions. Whilst there are various considerations that businesses should consider when negotiating and implementing such transactions, specifically within the context of this pandemic, we highlight five below which we believe are of particular importance.
Most M&A agreements will contain a material adverse effect clause which essentially allows a buyer to simply walk away from an agreement in the event of a drastic change of circumstance in the target company (whether operational, economic or financial). The careful formulation and inclusion of such a clause in the negotiation and drafting of agreements are therefore critical. In ordinary circumstances, buyers could analyse a target company’s past performance and find comfort in assuming the target’s future performance. Unfortunately, the COVID-19 pandemic and the uncertainly created as a result thereof makes such analyses much less reliable or comfortable.
For agreements signed but yet to be implemented, whether or not the pandemic will constitute a material adverse effect will be dependent on the wording of such a clause in that specific M&A agreement. Where M&A agreements are entirely devoid of these clauses, parties may have to turn to the common law defence of supervening impossibility (see COVID-19: Force Majeure and the Actions of Responsible Corporate Citizens dated 17 April 2020) in order to ascertain whether they remain bound by their performance obligations under the agreement despite the change of circumstances brought about by COVID-19.
For agreements yet to be signed, the inclusion of only the generic warranty and indemnity clauses will no longer suffice. What is now called for, arguably more so from a buyer’s perspective, is to fully investigate the specific risks of the target company, unique to the COVID-19 pandemic, and tailor the warranty and indemnity clauses according to these identified risks. For example, a buyer may now want to insist on a broad range of warranties pertaining to health and safety and / or customer, supplier and vendor relationships.
On the other hand, a target company may wish to limit certain warranties and indemnities, for example, to specific periods such as for the period prior to or at signing. This will guard target companies against falling foul of any warranties and indemnities, particularly in light of the fluidity of the COVID-19 pandemic and the consistent changes to the economic environment.
For those agreements signed prior to the COVID-19 outbreak, but before closure, parties would be well advised to carefully consider the agreed upon warranties and indemnities and the effects that the pandemic has had thereon. It is likely that the position of both parties has changed drastically since signing and accordingly some representations and warranties may now need to be downgraded.
In February 2020, valuations and markets had soared to an all-time high however just one month later we saw them plummet as the COVID-19 pandemic wreaked unprecedented havoc on the financial world. This kind of market volatility only further inflames the uncertainty surrounding a target company’s future position.
It would therefore seem prudent that where transactions are still in the negotiating phase, parties agree on the inclusion of a price adjustment clause. Whilst such a clause often results in valuation disputes, it affords both parties the comfort of being able to renegotiate the purchase price and adjust the purchase price where there has been a substantial change in the circumstances of the target company.
The approach of parties to the conclusion of any restructuring deal during COVID-19 will likely be found on polar ends of the spectrum. Target companies will likely push buyers to close deals whereas buyers will likely move slowly through each stage, checking and double checking all everything. Any buyer would however be well advised to ensure that such a cautioned approach is maintained, especially insofar as due diligence investigations are concerned.
An in-depth and thorough due diligence investigation is crucial not only to a buyer’s ability to make informed decisions but also to avoid “buyer’s remorse” at the close of a transaction. The importance of heightened due diligence investigations, given the current market hostility, cannot be overstated. It is advisable that buyers employ a team of experts (lawyers, accountants, investigators and the like) to ensure the achievement of a holistic appreciation of all risks (whether operational, financial or contractual) that are associated with the target company.
In light of governments’ gradual and phased approach to restart the economy, when negotiating agreements, parties should take into account the likely delay such approach has had, and will continue to have, on applicable regulatory services, such as the Companies and Intellectual Property Commission and the Competition Commission.
Accordingly, M&A agreements still within the negotiation stage should accommodate for such delays and include appropriate deadlines for fulfilment where a party’s obligation is dependent on the cooperation of such regulatory services. Similarly, where agreements are in the implementation stage, parties should consider whether it will be necessary to provide for the extension of deadlines imposed before the COVID-19 pandemic.
It must be noted that the aforementioned list of considerations is in no way exhaustive and merely canvasses those which one may regard as primary given the current stage of the pandemic and the present global and national reaction thereto. Accordingly, as the pandemic continues to evolve, so too will its impact on the landscape of mergers and acquisitions, likely bringing certain additional considerations, now deemed less crucial, to the forefront. In this regard it is advisable that legal assistance is sought timeously when considering any M&A transactions and aspects of existing transactions are reconsidered having regard to the COVID-19 pandemic and potential effects resulting therefrom.