The outbreak of the novel coronavirus disease 2019 (COVID-19) and the measures being taken at every level to contain the spread thereof is a rapidly evolving public health and humanitarian issue. Naturally, COVID-19 and its social and market impacts have also found their way into M&A processes in various ways. This article summarizes the principal issues that M&A practitioners are likely to confront as they push forward with transactional activity in the COVID-19 pandemic environment.
While the situation remains fluid and subject to daily changes, existing M&A processes generally appear to be continuing forward (on both the buy side and the sell side). That being said, in certain jurisdictions and in industries particularly affected by the COVID-19 outbreak, some deals are on pause as the parties evaluate the effects of the outbreak. This is likely to lead to price renegotiations and, in some cases, termination of negotiations if buyers are unsure whether they are overpaying for an asset under current circumstances. As the pandemic continues to expand and the related market volatility persists, buyers and sellers that are party to pending M&A processes should increasingly expect sudden halts to their deals and a tendency toward re-evaluating and potentially renegotiating material terms (including pricing). One tool to bridge such newly erupting valuation gaps might be the greater use of earn-outs to prove out the impact of COVID-19 on the business over time.
An increasing number of sellers may also be reconsidering if and when to launch new auction processes. Setting aside economic and market realities, there are also practical concerns with commencing a process at this juncture (e.g., due to the logistical challenges of conducting in-person management meetings and on-site diligence).
When negotiating acquisition agreements, parties should also consider providing for extensions of drop-dead dates and otherwise adjust deadlines to take into account the anticipated extension of regulatory review periods, particularly competition review in the U.S. (where early termination of the HSR waiting period will be unavailable) and in Europe.
COVID-19 and its overall economic impact on the target businesses has become a focal point of recent buy-side due diligence processes, and buyers may expand their typical due diligence efforts to cover, among other things, the following areas:
Parties will likely face logistical challenges in addressing typical and/or enhanced due diligence needs of buyers (especially on-site visits), which may result in a delay of the overall transaction. Furthermore, buyers may feel compelled to recommission in full or partially supplement previously completed due diligence reports (e.g., relating to market assessment or the integrity of revenues and earnings of the target) to reflect the post COVID-19 reality.
Lenders appear to be honoring existing debt financing commitments. However, buyers may become increasingly concerned about the consequences under their acquisition agreements, and their rights under debt commitment papers, if the lenders do not lend into a committed deal. Given that the MAE clause might be difficult to invoke to address COVID-19 risks, some buyers may see this as an opportunity to request a “financing out” condition or at least a limited version thereof that is triggered by a COVID-19 related financing failure that would not require the buyer to pay a reverse breakup fee. Others may be considering extending the drop-dead date or tolling the triggering event for payment of a reverse breakup fee arising from COVID-19-related issues. Buyers whose deal documents do not have such provisions should consider the legal remedies under their commitment papers in the event of a lender funding default. Buyers should also be in close and continuing contact with their lenders, be alert to any indication that funding may not be forthcoming, and be prepared raise the lenders’ reputational or relationship risks should they threaten a failure to fund.
COVID-19 is affecting both the process and the scope of representation and warranty insurance underwriting. In transactions that have already bound, carriers and the deal parties are scrutinizing representations most likely to be implicated by developments surrounding COVID-19, as well as policy language that likely did not fully contemplate the severity of recent developments. Underwriters are also using pre-closing “bring-down” calls to carefully assess and specifically document the known or anticipated impact of COVID-19.
Caveats in nonbinding indications of insurance are appearing to the effect that underwriting diligence will include an investigation into the potential impact of COVID-19 on the target’s business. Underwriters are beginning to require an exclusion for such impact, ranging from more tailored exclusions capturing the target’s anticipated business interruption to broader formulations of exclusions tied generally to losses arising out of or relating to COVID-19, and compliance with government directives, policies or actions in response thereto. MAE definitions and common “could/would reasonably” expected standards are falling under enhanced scrutiny, as are representations regarding customer and supplier relationships, absence of changes or MAE, undisclosed liabilities, compliance with laws, and adequacy of insurance, among others, particularly where they involve a forward-looking element. Underwriters, like buyers, can be expected to be keenly focused on MAE provisions in purchase agreements and force majeure language in the target’s commercial contracts.
Buyers relying on representation and warranty insurance should be prepared to address policy exclusions relating to COVID-19, both with respect to specific exclusions (e.g., supply-chain interruptions) or more broadly (e.g., all losses arising out of business interruption related to COVID-19).
The COVID-19 outbreak, its related containment measures and the current market turmoil are changing on a daily basis. The impact of COVID-19 on M&A transactions is also rapidly evolving as dealmakers adjust in real time to the changing circumstances. Transaction processes may be put on hold, economic deal terms may be subject to reconsideration and renegotiation, due diligence efforts may be redoubled and enhanced, and parties may press to reallocate deal and certainty of closing risks. Practitioners need to be alert and nimble as buyers, sellers, lenders and insurance underwriters scramble to navigate the transactional challenges presented by the unprecedented circumstances of the COVID-19 pandemic.