Parties that are currently in the process of negotiating an M&A deal or, alternatively, working towards the close of an M&A transaction are likely to be affected by the COVID-19 pandemic in some way. Below we list key aspects of M&A transactions to which close attention should be paid in the present circumstances and provide practical guidance.
In the present environment, buyers are advised to conduct enhanced due diligence with a risk-based approach in sectors directly (e.g. travel, leisure and retail) or indirectly (e.g. businesses with supply chains, operations or customers in containment or high-risk areas) impacted. Key points for attention during the due diligence process are:
- the potential implications of the COVID-19 outbreak on forward-looking information in the target's business plan and budget and exposure to countries highly impacted by the COVID-19 pandemic; the existing business plan and historical (financial) information may no longer accurately reflect the target's positions or prospects;
- the effectiveness and use of crisis management procedures, risk protocols and business continuity plans;
- solvency or going concern risk and the ability to service debt (especially where high-yield debt may be in place) for the target and its key contracting parties, customers and suppliers;
- the ability of the target and its key contracting parties to perform, suspend or walk away from obligations under material contracts, including through the exercise of force majeure clauses or similar provisions;
- scenarios in which non-performance by the target’s contracting party could result in the target breaching its obligations under other contracts;
- reliance or potential reliance on emergency tax relief/state aid/other measures offered by the government;
- existing insurance policies, including business interruption and health coverage;
- the regulatory, licensing and data protection implications of remote working arrangements, particularly in certain industries such as financial services;
- employer rights and obligations, including the communication and implementation of health and safety procedures at the workplace, adequate compliance with relevant health and safety guidelines and the potential impact of travel bans;
- the legal basis under privacy laws, particularly the GDPR in the EU, for the processing of health data relating to employees, visitors and customers and whether privacy policies cover the processing of sensitive personal data for COVID-19 purposes (click here for more info).
Sellers are advised to pre-emptively prepare information on these items to accommodate and mitigate buyer concerns.
Pre-signing clauses to negotiate
Transactions in the pre-signing stage: good faith limitations under Dutch law
In M&A transactions in the pre-signing stage, the buyer may wish to reconsider if this is the right time to go ahead with the transaction or whether it wishes to terminate or postpone the discussions. In the latter case, the buyer should review what the parties have discussed and agreed to date (for example the letter of intent, if any) and whether additional arrangements are necessary, such as a prolongation of exclusivity arrangements.
For specific advice for PE sponsors on transactions in the pre-signing stage, click here.
It is also relevant to note that the parties have a duty of good faith under Dutch law, which extends to all phases of commercial relationships, including the pre-contractual stage.
- The duty of good faith may preclude a party from simply breaking off negotiations during an advanced stage (even though no signatures have been put on paper yet). This duty is based on the idea that parties may incur high costs during drawn-out negotiations and may at some point have legitimate expectations about an agreement being reached.
- Remedies available to the counterparty of a party that "walks away" include (a) varying levels of damages (ranging from reimbursement of the counterparty's costs to - in very extreme circumstances - full compensation for lost profits); (b) claims for specific performance (if a party can demonstrate that it reached some form of agreement with the other party, even on a subject to signature basis) and (c) claims for continuation of negotiations.
- Whether a party actually has a claim based on the principle of good faith requires a case-by-case assessment. A seller that wishes to make a claim on this basis must meet a high standard.
- In order to mitigate such risks as much as possible for a buyer, it is imperative to add to any communication that the transaction is "subject to agreement on all transaction documents" and "subject to (discretionary) consent of the board and/or the investment committee".
In addition, boards of directors on both the buy and sell sides should consider their own enhanced obligations throughout the pre-signing stage. Click here for more information.
Conditions precedent and timelines
Sellers will be faced with reduced deal certainty arising from the crisis-related conditions, while the leverage of buyers is likely to increase if M&A activity slows down. In this case, buyers should consider including in the SPA specific conditions that reflect the expectations caused by the COVID-19 crisis, such as:
- Termination rights, e.g. on the basis of (click here for more information on these provisions):
- an MAC/MAE (see below);
- force majeure;
- unforeseen circumstances;
- certain business performance (EBITDA/revenue not being met);
- non-performance or delayed performance by key suppliers/customers;
- Repetition of representations and warranties at closing and additional disclosure.
Sellers can negotiate break fees/compensation for situations in which the buyer aims to rely on these conditions to walk away from the deal.
Finally, both the sell side and the buy side should:
- expect that obtaining the required internal approvals/governmental approvals/support may take more time, e.g.:
- the present circumstances may prompt works councils to scrutinize a deal proposal more closely and to ask questions related to the pandemic, resulting in the consultation process taking longer than usual. It could therefore be prudent to involve the works council at an early stage and proactively inform the works council of the impact of COVID-19 on the transaction and the future position of the target, in order to enable the works council to form and render an opinion as quickly as possible;
- the European Commission is working with a "skeleton crew" for merger filings.
- carefully monitor the developments relating to state aid during the COVID-19 crisis, including tax relief. Please click here for an update on measures announced by the European Commission and the Dutch government to facilitate aid to companies in need.
For the period between signing and closing of a transaction, interim operating covenants in the SPA require the seller to maintain the “ordinary course of business” in order to protect the value of the target's business (with any derogations requiring the buyer’s consent). That being said, interim operating covenants do not usually require the seller to maintain the target's financial condition. Therefore, buyers should consider negotiating and drafting specific interim operating covenants – for example relating to liquidity maintenance, debt refinancing, and working capital management - if additional protection against the consequences of the COVID-19 outbreak during the interim period is desired. A buyer may in certain circumstances seek enhanced interim financial reporting rights and specifically drafted termination rights if pre-closing performance falls below extreme levels.
Sellers should give due consideration to the fiduciary duties applicable to their board(s) and in that respect assess if the pre-completion covenants allow the board(s) sufficient leeway to properly respond to the impact of the COVID-19 crisis. This may for example warrant including a shorter than usual response time for the buyer with respect to seller requests for approval under the pre-completion covenants.
Representations & warranties and W&I insurance
Parties should thoroughly discuss and examine the representations and warranties applicable to the transaction. The buyer may seek specific additional representations in view of COVID-19, such as representations regarding contingency planning, protocols and the like. The buyer may also insist on specific disclosures against the representations and warranties, as opposed to the more European-style data room disclosure.
Sellers are advised to carefully disclose all ramifications for the target resulting from the COVID-19 outbreak, such as human resources and benefits matters relating to alternative home-based working arrangements, non-performance, events of default, cross-defaults and other potential breaches by the target, as well as the impact or potential impact of COVID-19 on the target's business, to ensure the possibility of an adequate defence in the event of a claim.
If sellers are willing to agree to extended representation and warranty coverage, it is fair for them to seek appropriate knowledge, materiality and “subject to law” qualifiers, to resist forward-looking representations and warranties, and to insist on appropriate “bring down” standards at closing. Sellers should also consider ring fencing their representations and warranties to protect against buyers having the ability to make COVID-19-related claims across the entire spectrum of representations and warranties.
If the representations and warranties will be insured by a W&I insurer, the parties should strive to minimise exclusions and limitations from the W&I insurance coverage for COVID-19-related matters, as known issues are unlikely to be covered by the policy. As COVID-19 is a known risk, insurers will most likely (i) exclude COVID-19-related losses from the policy coverage and (ii) for pending transactions signed prior to the outbreak, insist on a blanket exclusion of COVID-19 impacts when the representations made on the signing date are “brought down” to closing. Therefore, the scope of COVID-19 specific or ancillary diligence, as well as any requirement for post-signing “updates” by the seller, and the impact on the insured party’s knowledge should be carefully addressed.
Purchase price mechanisms
One aspect for which COVID-19 may result in the parties revisiting transaction fundamentals is the purchase price (mechanism). As the development of the outbreak and, consequently, its impact on the target's business are uncertain, a locked box mechanism may no longer be considered appropriate by the buyer, as the target's financial position at the envisaged effective date of the transaction may no longer accurately reflect the state of its business. Instead, buyers may prefer to continue discussions based on a purchase price adjustment mechanism, such as net debt/working capital or net asset value.
While a working capital adjustment mechanism is appropriate to mitigate the risk to the buyer of the target business no longer achieving the expected results in the period before closing, the seller may wish to secure the ability to tackle potential crises in the target's business prior to closing, thereby impacting the working capital level, without triggering a significant purchase price reduction. For this reason, the seller may for example wish to negotiate a cap or collar for a reduction in the purchase price based on the level of working capital.
If the parties cannot agree on a purchase price adjustment or an appropriate mechanism in light of the COVID-19 outbreak, they may seek other means to allocate the risks. For example, they may agree on an earn-out, a non-embarrassment arrangement (entitling the seller to a share of the proceeds received by the purchaser in the event of an on-sale) or even a rollover, the postponement of payment of (a portion of) the purchase price (possibly in multiple tranches) or a vendor loan.
When negotiating earn-outs in the current climate, it is key to assess the need to (re)consider the metrics (EBITDA/revenue/other) and associated time periods (everything will take more time).
Closing actions that are usually considered "check the box" items may now require more attention and – possibly – an unconventional approach. Parties should consider if they desire a physical closing and if this is feasible, given office closures and travel restrictions. Attention should be paid to original documents that need to be delivered, signatures that may require legalization and authentication in some form (e.g. an apostille), and any filings to be made at closing (e.g. with government institutions). The location of original documents, if they can be collected and whether additional time is required to complete formalities and filings prior to or at closing should all be determined.
Other relevant aspects include the legalization of signatures by a Dutch civil law notary and possibly obtaining an apostille for a signature (i.e. certification by a Dutch court of the legalization performed by a foreign notary). Currently, we do not see extensive delays in these processes (the courts are understaffed, however, and this situation could therefore change). For a description of practical issues to be considered for a closing in the Netherlands, please see the article on notarial practice on this webpage.
Transactions between signing and closing
In M&A transactions signed prior to the COVID-19 outbreak but not yet closed, parties should anticipate potential renegotiation attempts and, consequently, determine their position on the following topics:
- termination rights, e.g. on the basis of an MAC/MAE (see below), force majeure or unforeseen circumstances (see here for more information);
- buyer attempts to renegotiate the price, including any earn-out terms;
- breach of pre-completion covenants, for instance relating to running the business in the ordinary course;
- the target could develop acute additional working capital or liquidity requirements, for which the buyer's approval is required under the SPA;
- actions prescribed by the pre-completion covenants could present the target's board with a choice between a potential breach of its fiduciary duty or a breach of contract (i.e. the pre-completion covenants under the SPA)
- repetition of representations and warranties at closing and additional disclosure in that respect;
- slipping timing of closing, extensions and any 'drop dead date';
- as noted, the COVID-19 pandemic could prolong the time needed to obtain internal approvals, including the works council's advice, and external approvals, such as merger clearance
- leakage in locked box or line items in closing account transactions;
- performance by third parties under financing commitments;
- new or amended business contingency plans;
- W&I insurance coverage.
MAC or MAE clauses
In deals that have not yet closed, buyers should consider whether the COVID-19 outbreak could constitute a material adverse effect under the SPA. MAC/MAE clauses usually cover unforeseen events that have a long-term and material adverse impact on the value of the target. In general, it is still too soon to tell whether the outbreak will result in a temporary dip or a long-term crisis. Parties should be aware of the potential consequences on the target. If the anticipated impact on the target is expected to be of limited duration, they are advised to consider appropriate alternative solutions (such as pricing adjustments, earn-outs or other mechanics) as opposed to reliance on the MAC/MAE clause.
Whether the impact of COVID-19 will be considered an MAC MAE will depend on what is known at the time the transaction is signed and on the definition of an MAC/MAE included in the SPA (namely, whether the clause mentions or excludes pandemics or epidemics in general). Disputes will most likely focus on whether the definition typically excludes general economic or market conditions and other broad-based factors impacting the business climate or whether the target’s sector is generally sufficient to exclude the impact of COVID-19. The parties may also dispute whether the potential impact of the virus was reasonably foreseeable at the time of signing the SPA or whether the impact is sufficiently long-lasting to be considered an MAC /MAE. It should be noted that MAC/MAE definitions typically include a “disproportionally affects” qualification. Such a qualification, favouring the seller, means that COVID-19 will not qualify as a material adverse change affecting the target, unless the pandemic disproportionately impacts the target compared to its industry peers.
For transactions still being negotiated, parties should consider including explicit language to address COVID-19 risk allocation in the context of an MAC/MAE provision. They should also consider whether they wish to build in specific thresholds to establish the point at which the impact of COVID-19 on the target will constitute an MAC/MAE. In that respect, they should seek to tailor the wording to reflect the context of the COVID-19 outbreak and other situations and take into account worsening conditions due to the crisis in geographic areas in which the target is active or worldwide.
If a deal is financed with debt, it is important for the buyer to ensure that the MAE clause in the SPA and the financing documents are aligned, so that the buyer does not need to close the transaction where the financiers are able to withhold financing based on reliance on an MAE clause.
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