As COVID-19 continues to spread across the nation, companies and transaction participants are struggling with increased risk and uncertainty posed by the virus. For businesses, challenges range from protecting and supporting employees and customers, to contributing to evolving efforts to battle COVID-19 and adapting to new and dramatically different operating conditions. Understandably, the outlook for M&A activity is highly uncertain. Nevertheless, both companies and financial institutions will continue to address pending transactions and even consider, and where appropriate pursue, various new transactions. With that in mind, this release aims to provide particular risk considerations businesses should consider when engaging in a transaction during this unprecedented time.
Deal Risk Considerations
Material Adverse Change Clause
– While many customary acquisition agreement terms will be subject to greater scrutiny and negotiation considering the COVID-19 crisis, the definition of “Material Adverse Change” (“MAC”) will likely be of interest and focus. At this time, because it is difficult to predict the lasting impact of the COVID-19 outbreak for any particular company or industry, there is no standard analysis as to whether the impacts of COVID-19 on a particular business would justify a party’s refusal to close on a deal under a MAC. However, MAC definitions in purchase agreements are beginning to include specific events such as COVID-19, in order to specifically address this current pandemic and other events that may arise in relation thereto. The risk-shifting between sellers and buyers as to which party will bear the risk of the COVID-19 outbreak will remain a negotiated and highly fact-specific point, and the parties’ leverage might shift as the situation develops.
Due Diligence and Representations & Warranties
For transactions that are at the due diligence stage, COVID-19 related concerns will be front and center. Parties will likely face logistical challenges in addressing typical due diligence needs of buyers (especially on-site and/or in-person visits), which may result in a delay of the overall transaction. Furthermore, buyers may feel compelled to recommission previously completed due diligence reports (relating to market assessment or the integrity of revenues and earnings of the target) to reflect the post COVID-19 reality.
In connection with due diligence concerns, COVID-19-specific representations may help inject a greater degree of certainty and promote additional information-sharing. Buyers may consider additional situation-specific representations and warranties about the target’s business relating to the impact of COVID-19 (including inventory on hand, absence of anticipated supply chain failure, etc.). And on the opposite side, sellers will likely attempt to maximize inclusion in the disclosure schedules of references to the potential impacts of COVID-19 or qualify the representations and warranties, as to minimize the possibility of the buyers claiming that the outbreak resulted in a breach of a more general representation and warranty.
Interim Operating Covenants
– Between the signing and closing of a transaction, buyers generally want sellers to operate the target business in the “ordinary course” to protect the value of the business they have agreed to purchase. As a result of COVID-19, parties should be spending more time before the signing discussing and negotiating key provisions, actions and consideration that may need to be taken into account between the signing and the bifurcated closing. Parties should greatly consider drafting with specificity if they want to have additional COVID-19 protections.
Purchase Price Adjustments
– The impact of the COVID-19 crisis may necessitate a deviation from the customary approach to purchase price adjustments and potentially purchase price hold backs. Pricing mechanisms were already heavily negotiated prior to the virus and now they are under even more scrutiny. Sellers may seek to pursue a locked boxed pricing mechanism, which fixes the final purchase price based on the financial statements of the business on a set date before the signing and closing of the transaction. Conversely, buyers will likely seek a more traditional post-closing price adjustment mechanism that ensures the price is trued up to the state of the target business as of closing. Additionally, buyers may decide that it is prudent to hold back and retain a portion of the purchase price to protect them during any potential COVID-19 related downturn which may impact the business of the seller. Thus, it is important for buyers and sellers to evaluate their purchase price adjustments and account for flexibility as a result of COVID-19, including the possibility of a hold back of funds for COVID-19 related purposes.
The impact of COVID-19 on mergers and acquisitions transactions and the deal marketplace in general is rapidly evolving as dealmakers adjust in real time to the changing circumstances. Transaction processes are continuing to progress and develop as parties press to reallocate uncertainty and risk. Accordingly, both buyers and sellers should continue to think through the different ways that COVID-19 may impact their respective businesses and future deal transactions.
Allocating Risk in the COVID-19 Deal Environment
April 16, 2020
By: William Mullen and Reese Dollins