Deal-making in a crisis: how M&A deals are affected by covid-19
The covid-19 pandemic generates complex challenges in almost every area of law. This is because of the deep economic crisis it will produce – some speak of a recession similar to the Great Depression of the 1930s – and the alteration of the conditions in which businesses operate. Juan Tagle, an M&A partner at Chile’s Prieto Abogados, considers the impact on M&A deals in various stages of completion.
Some of the first legal queries arising from this situation concentrated on the labour and health legal fields, as well as in the characterisation of this epidemic as a force majeure and its impact on several long-term contractual relationships (for example, contracts for leases, supply, construction, insurance, financing and services).
This article considers the main consequences this event could have for companies’ merger, acquisition and joint venture operations, whether in progress or recently closed. This analysis may vary depending on the applicable law of the respective contracts, including judicial precedents in the corresponding jurisdiction.
M&As currently under negotiation
It must first be determined whether there is any obligation to continue with the negotiation or whether to close the deal under already agreed terms, which may emanate from a memorandum of understanding, letter of intent, exchange of letters/e-mails or the existence of any other instrument signed by the parties. Normally the binding or non-binding nature of such agreements is expressly established, but it is not unusual for such a point to be unclear or even for the parties to have a different understanding of it, particularly considering that legal counsel is often not involved in the negotiation or drafting of such documents.
In this sense, taking into account the intention of the respective client to persevere or not with the deal, it will be important to design a strategy either to exit the negotiation cleanly (that is, without contingencies or future claims by the counterparty) or to request the continuity of the business, trying to establish some sort of obligation in this sense. In either case, it seems important to promptly prepare a clear communication to the counterparty, stating the path you want to follow and in line with the existing agreements and the applicable law.
If the negotiation is terminated, it will be necessary to agree an adequate term for the responsibilities imposed by a confidentiality or non-disclosure agreement. If one company is the recipient of reserved information, they will need to comply with the obligations established in the respective agreement (elimination of files, return of physical material, etc).
Similarly, in this scenario it will be important to ensure that the services agreements of the various advisors that may have been hired (financial advisors, lawyers, auditors, technical specialists, etc) are properly terminated, to ensure that they do not continue to incur unnecessary work and that there is clarity regarding the remuneration due.
But if the intention is to persevere in the transaction, a whole new chapter should be added to the company's legal, financial and technical due diligence. This should investigate the consequences for the company's business and contracts as a result of the pandemic, as well as the financial effects of the crisis, mainly on the target’s future liquidity and solvency. Legally, it will be important to know about possible risks of suspension or early termination of relevant contracts in the event of potential force majeure claims based on the global epidemic; occupational risks associated with quarantine and the imposition of remote working; and contingencies associated with health situations in the workplace and possible contagion of workers.
If the deal is to continue, it would be advisable for the parties to anticipate the possible consequences of the crisis on the transaction (eg, impact on price, payment conditions, guarantees, performance-related price clauses, and put or call options), to anticipate possible disputes. A very important part of this is the legal and regulatory changes announced or implemented by governments as a result of the covid-19 crisis. It is salient to adequately model their impact on the flows of the target company or the business subject matter of the transaction.
Finally, a complete review of the representation and warranties required to be made by the parties should be revisited, in light of the new global economic scenario produced by the crisis, as well as a review of the transitional management regime of the company in the event of there being a gap between closing and signing.
M&As that are signed, but not closed
In the case of M&A deals or joint ventures agreements signed but not yet closed, the first step should be to enquire whether the client intends to close the deal as originally agreed upon, or whether they wish to close it with the amendment of certain commercial or legal conditions in light of the new global and national economic scenario, or even withdraw from it.
In either case, it will be necessary to analyse the conditions the closing of the transaction are subject to and assess whether one or more of them is under risk of not being able to be fulfilled due to the covid-19 crisis. For example, the deadlines established for regulatory approvals or corporate restructurings may not be met. Along the same lines, it is a common condition for closing in M&A agreements that the reps and warranties made by the parties in relation to themselves and the company or assets subject to the deal remain unaltered, which, given the deep economic crisis that is looming the future, is highly unlikely to be fulfilled.
Additionally, it will be necessary to evaluate whether the change of circumstances generated by the pandemic is equivalent to a material adverse change (MAC). It is customary for a MAC clause in a contract to enable parties to withdraw from a deal or request a change in the economic conditions of the transaction. The analysis of this clause is also relevant for the modifying potential reps and warranties agreed upon at the time of the execution of the contract, which can no longer be fulfilled at the time of closing.
Whether or not there is a MAC clause, it will be necessary to evaluate whether the pandemic is equivalent to an event of force majeure, which enables one of the parties to excuse itself from its respective obligation to buy, sell, merge or carry out the agreed joint venture or to request a modification of the terms thereof. The possible application of legal theories that allow the revision of signed contracts due to a change in the essential circumstances of the business that were in sight at the time of the original agreement may be analysed.
Finally, in the event of a dispute over whether or not a transaction should be closed, or about whether the conditions to which it is subject are met, or whether arguments based on MAC clauses or the alleged existence of force majeure apply, it will be necessary to take into account liability for damages which the defeated party will be exposed to. For example, whether there are limitations of liability associated with the price of the transaction or whether damages for loss of profit, moral or consequential damage or other are excluded.
Closed M&As with outstanding obligations
The crisis generated by covid-19 may also have consequences for recently closed M&A deals that have outstanding obligations. These obligations could be breached as a result of substantial changes in the economic conditions generated by this crisis.
For example, a buyer’s obligation to acquire an additional stake in the company from the sellers at a fixed price could be challenged on the grounds of force majeure or possibly under a MAC clause as described above. The same applies to clauses providing for additional payments according to the company's performance, or for ancillary contracts associated with the M&A deal, which are usual in this type of transaction (for example, contracts related to property leases, supplies and consultancy).
In this sense, it is advisable to review in detail the remaining obligations in a recent M&A transaction, to analyse possible consequences generated by this crisis.