As the Coronavirus (COVID-19) outbreak continues to spread across the globe, merger and acquisition transaction participants need to consider the impact it is having on M&A transactions both in terms of process and timeline as well as in terms of substantive deal terms (including the need to build in automatic extensions of closing dates and other key dates due to pandemics, epidemics or disease outbreaks). In addition, as financial markets continue to be impacted by the pandemic, the impact on M&A transaction participants that rely heavily on debt to finance acquisitions cannot be overlooked. Those impacts include both the ability to utilize debt in the near term to finance acquisitions and the challenges in complying with financial and other covenants in their debt documents for borrowers that have utilized debt in recent transactions.
With respect to transactions currently under contract, the most immediate concern for buyers and sellers is the impact of the pandemic on their obligations to close. Buyers and sellers need to critically review the M&A transaction documentation for effects on the buyer’s obligation to close or right to terminate the acquisition agreement, whether resulting from the pandemic having a material adverse effect (MAE) on the seller’s business or the inability of the seller to “bring down” its representations and warranties at closing. Buyers and sellers also want to review the transaction documentation to determine their respective rights and obligations relating to potential breaches of the seller’s representations and warranties (as well as how interim breaches may impact any representations and warranties insurance that is bound in connection with the transaction). Finally, both buyers and sellers need to consider the impact COVID-19 is having on their ability to satisfy interim covenants, such as making Hart-Scott-Rodino (HSR) and other global antitrust filings in a timely manner or operating in the ordinary course of business.
This FAQ highlights several key questions that buyers and sellers have been and will continue asking as the world economy grapples with the COVID-19 fallout.
Q: How will COVID-19 impact deal process and timing?
- Auction Processes: Expect a slowdown or potential retraction in the process, especially in affected industries. Given the current dislocation in the market and the uncertainty regarding the financial impact on the overall economy and individual companies, it is not unreasonable to expect significantly fewer auction processes over the next several months. Sellers currently undertaking a process need to consider adjusting the timeline to account for increased logistical challenges as well as any delays caused by the inability of the federal government to function efficiently; in this regard, we note that the Federal Trade Commission (FTC) has provided guidance that they will not be considering early terminations in connection with HSR filings, and there is a possibility that the standard 30-day HSR waiting period may be extended. Buyers with cash on hand will certainly have a competitive advantage in an auction compared to those that require financing.
- Due Diligence: Buyers and sellers should prepare to experience a longer-than-usual diligence period. Sellers may experience difficulty in providing access to certain documents and materials because employees are working remotely. In-person management meetings and site visits will be difficult, if not impossible, to complete. Buyers should consider expanding the scope of diligence to focus on specific areas that may be particularly affected by COVID-19, including the target’s supply chain, IT systems, insurance coverage, response to COVID-19 for compliance with employment laws, business continuity plans, solvency risk, and ability to service its debt and comply with covenants under its debt documents, as well as the regulatory, licensing and data privacy implications as a result of remote working arrangements. Buyers also should evaluate force majeure clauses in the target’s key contracts and the termination rights of the target or its counterparties under key contracts.
- Governmental Approval: Buyers and sellers can count on longer response times from federal and state governments. Many federal, state, local and international governments are struggling with staffing (e.g., workforces are being required to work remotely and, in some cases, are facing the health issues caused by COVID-19), which may lead to meaningful delays. Governments are focusing on and directing resources to address the COVID-19 outbreak and are dedicating less attention and resources to less critical government functions, including in connection with the items noted above. Therefore, parties to transactions should consider allowing for extra time to prepare, file and complete any required filings and obtain any required consents. As of today’s date, California has instituted a “shelter in home” order, so any approvals needed from the California government (e.g., good-standing certificates, merger filings, approval to conduct environmental investigations) all are presumably impacted. At the federal level, the FTC has indicated that they will not be granting early termination of the HSR waiting period. Additionally, several proposals are being discussed in Congress to extend the HSR 30-day waiting period.
- Financing: Buyers should consider adjusting their timelines to obtain financing, as market uncertainty may increase the difficulty in obtaining committed financing and there may be delays in the availability of key information for lenders (e.g., audited or interim financial statements, financial models and projections). These difficulties could delay closings and decrease the certainty of closing for transactions in which a buyer requires financing.
- Covenants (e.g., deliveries, filings): Parties should consider whether any dates need to be reviewed and reconsidered (e.g., outside date, timeline for purchase price adjustments, HSR filings/regulatory approvals). Parties should expect that obtaining third-party consents and government and regulatory approvals will take longer than normal and should consider building in more time than usual to prepare and submit filings for government and regulatory approvals. Parties also should consider closing logistics earlier in the process in light of the logistical challenges (e.g., will any original documents like a deed be required at closing, or will signatories have the ability to sign documents if working remotely?).
- Purchase Price Negotiation: Negotiations on the purchase price may take longer than normal as the gap widens between a buyer’s and a seller’s valuation of the target in light of the COVID-19 outbreak’s likely negative effect on a target’s revenue and earnings forecasts. The outcome of negotiations will depend on several factors, including one party’s leverage vis-à-vis its counterparty and the scope, reach and duration of the COVID-19 outbreak. Buyers may insist on purchase price adjustment mechanics or deferred payments so that the purchase price reflects the value of the target at the closing, while sellers may insist that even though COVID-19 is a well-known risk, the risk is not specific to the seller’s underlying business and any risk should be borne by buyers.
Q: What provisions in an M&A acquisition agreement may be impacted?
- MAE:
- Pandemics, Epidemics and Public Health Emergencies. A seller should seek to exclude pandemics, epidemics or public health emergencies from the definition of an MAE in order to shift the risk of the occurrence of such events to the buyer, while the buyer should seek to include pandemics, epidemics or public health emergencies in the definition of MAE in order to shift the risk of the occurrence of such events to the seller. In negotiating the definition of MAE, buyers that are relying on third party debt to finance the acquisition should ensure that the definition of MAE in the acquisition agreement mirrors the definition of MAE in the financing documentation between the buyer and its lending sources in order to avoid any disconnect between the two definitions.
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Disproportionate Effect. If the parties agree the definition of MAE does include pandemics, epidemics or public health emergencies, the seller should attempt to qualify such events with a “disproportionate effect” qualifier (i.e., a pandemic, epidemic or public health emergency cannot be deemed to cause an MAE unless it disproportionately affects the seller), while buyers should seek to avoid any such qualifiers.
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Setting a Dollar Threshold as a Bootstrap Measure. Buyers should also consider adding a dollar threshold to cover any number of matters rather than specifically calling attention to pandemics, epidemics, or public health emergencies, including COVID-19. For instance, buyers should consider adding the following to the MAE definition:
“ . . . any change, effect, event, occurrence, state of facts or development that, individually or in the aggregate, would have an adverse impact on the Company’s business, operations, assets, condition (financial or otherwise), results of operations, or business prospects (including without limitation, the achievement or ability to achieve forecasts of revenue and/or earnings) in an amount in excess of [$________________].”
- Closing Conditions and Termination Rights: If a transaction is structured as a two-step or “delayed sign and close” transaction, the agreement will include certain “closing conditions” and termination provisions that allow the parties to terminate the agreement under certain circumstances. Buyers and sellers should carefully consider closing conditions that may specifically be impacted by COVID-19, including making governmental filings or obtaining government approvals within certain specified time frames and the materiality threshold (i.e., in all material respects or MAE) applicable to the seller’s obligation to “bring down” its representations and warranties at closing. Buyers and sellers also must consider the impact of COVID-19 on the “outside date” by which the transaction must be consummated. Buyers, particularly those that will require third-party financing, are well advised to seek a longer “outside date” under current circumstances.
- Representations and Warranties:
- Seller Disclosures. Sellers should consider including general disclosures regarding the impact of COVID-19 and its general impact as well as any specific required disclosures (e.g., in response to any number of representations, including those mentioned below that a buyer may require the seller to make).
- Situational Representations Benefiting Buyers. Buyers should consider requesting situational representations and warranties to specifically address the adverse impacts of COVID-19. For instance, a nonexhaustive list of typical representations and warranties that may be specifically tailored and/or expanded to address the impacts of COVID-19 include:
- Accounts Receivable – e.g., COVID-19 may cause meaningful A/R collectability concerns.
- Inventory – e.g., COVID-19 may cause material disruptions in supply chains, causing otherwise normal levels of inventory to be insufficient.
- Top Customers and Suppliers – e.g., COVID-19 may result in customers and/or suppliers reducing the level of business they conduct with the seller and/or there may be breaches or terminations of contractual provisions.
- Material Contracts – e.g., COVID-19 may result in the seller or their contractual counterparties breaching or terminating contracts or delaying/excusing their performance under such contracts by claiming a force majeure.
- Compliance With Laws – e.g., As a result of COVID-19, there may be local, state, federal or international laws, rules, regulations or government orders applicable to the seller’s business, including government orders limiting the extent of the seller’s business operations, forcing business closure, limiting import/export activities, etc.
- Labor and Employment – e.g., Due to the public health impact of COVID-19, mass quarantines (including government-imposed or self-imposed quarantines), school closures and other disruptions in the availability of a seller’s workforce, there may be labor shortages that adversely impact a seller’s business.
- Insurance – e.g., COVID-19 may cause material business interruptions, and a seller may not have business interruption insurance coverage. If they do have such insurance coverage, the buyer may want to include a representation that losses from pandemics, epidemics or other public health emergencies, including COVID-19, are covered, together with representations regarding applicable deductibles and policy limits, and that no claims have been denied or are being defended under a reservation of rights.
- Interim Operating Covenants: Buyers should consider including more robust interim operating covenants to deal with prospective changes in a seller’s business in order to deal with the effects of COVID-19. For instance, buyers may want to require a seller to obtain prior approval from the buyer before materially changing production volumes; writing off receivables or making other material accounting adjustments; reducing or otherwise materially modifying the makeup of the labor force; agreeing to settlements or waivers in connection with customer/supplier disputes or issues; entering into, terminating or otherwise modifying material contracts, etc. In addition to considering whether to include these specific covenants, the buyer should consider whether the seller will be able to comply with them, given the potential need to act swiftly to react to unpredictable and fluid situations.
- Deliveries/Filings: Parties to transactions need to consider allowing for extra time to prepare, file and complete any required filings and obtain any required consents.
Q: How will COVID-19 impact the representation and warranty (R&W) insurance market?
We expect R&W insurance underwriters to begin including exclusions from coverage for losses stemming from the impact of COVID-19 based on the assumption that buyers have already taken the impact of COVID-19 into account.
