What issues should sellers anticipate when closing a transaction during the COVID-19 pandemic?
The coronavirus pandemic (COVID-19) significantly impacts transactions and businesses across the globe, including those supported by private equity and venture capital. In this blog post, we discuss the issues sellers should anticipate when closing a transaction signed before the COVID-19 outbreak.
1. Buyers may try to walk away or renegotiate the deal.
Due to the devastating impact of the pandemic on economic prospects and businesses worldwide, sellers should anticipate attempts by buyers to renegotiate transaction terms or terminate the transaction altogether. Below we discuss three potential grounds for renegotiation or termination, namely (i) a material adverse change (MAC), (ii) other closing conditions and (iii) force majeure or unforeseen circumstances.
Sellers should expect buyers to review the transaction terms to determine whether they have the right to terminate or not perform their obligations based on circumstances relating to COVID-19. Even when the MAC clause does not clearly provide for a right to terminate or not perform obligations, the potential occurrence of an MAC could be used by buyers to create leverage for renegotiation of the transaction terms.
Whether the impact of COVID-19 qualifies as an MAC will depend on the parties' intent when they signed the transaction documents. The wording of the MAC definition will be the starting point of this analysis. Obviously, if pandemics are specifically excluded, there is little room for discussion. In the absence of specific wording to this effect in the MAC definition, buyers could try to claim that more general wording on changed economic or market conditions and the business climate in the target’s sector is sufficient to cover the impact of COVID-19. Depending on the signing date, buyers could indeed argue that, given its extreme effects, the COVID-19 outbreak should not be viewed as an ordinary risk of doing business, even though at the signing date it was common knowledge that a future global pandemic would eventually occur. That being said, MAC definitions typically include “disproportionate effect” carve-outs and qualifications, which sellers could use to support their position that COVID-19 should not qualify as an MAC, unless the pandemic disproportionately affects the target compared to its industry peers.
- Other closing conditions
Buyers may also try to use other closing conditions to terminate or renegotiate transaction terms, e.g. merger control clearance, third-party consent and change-of-control waivers. These terms usually contain general undertakings by the parties to use reasonable efforts to ensure satisfaction of certain conditions as well as specific undertakings on how to do so. Discussions with buyers on these topics will likely focus on whether the buyer has satisfied its undertakings. In the interim period, sellers should closely monitor efforts by buyers (or lack thereof) to comply with their undertakings. In this regard, sellers should pay specific attention to any “long stop date” or similar termination provisions to avoid buyers backing out of the deal simply by letting the date expire. Although buyers will usually not be able to rely on these types of provisions if they are in breach of their undertakings, sellers are advised to consider requesting specific performance of buyer undertakings sufficiently in advance of the long stop date, if any.
- Force majeure or unforeseen circumstances
General force majeure or unforeseen circumstances clauses are not common in Dutch M&A transactions. While Dutch law provides for a statutory defence of force majeure, the threshold is high. A buyer will typically only have a reasonable chance of success if it can successfully demonstrate that it is unable to meet its contractual obligations to the seller due to a specific, material and unconditional legal prohibition. Although governments around the world have introduced various measures, including complete lock-downs, none of these measures legally prohibits a buyer from paying a purchase price and acquiring shares in a company. This means that it is unlikely that buyers will be able to successfully claim that COVID-19 qualifies as an event of force majeure, giving them the right to terminate or renegotiate the transaction terms.
Buyers may also seek to modify or set aside specific transaction terms and conditions on the basis of the statutory concept of unforeseen circumstances. The doctrine of unforeseen circumstances is interpreted narrowly by the Dutch courts. The decisive factor is whether the parties have expressly or implicitly made allowances for such circumstances in the contract, not whether the circumstances themselves were unforeseen or not. A buyer invoking unforeseen circumstances must be able to prove that the contractual balance has been distorted to such an extent that it cannot reasonably be expected for the agreement to continue in its current form. In other words, the effects of the unforeseen circumstance must clearly fall outside the normal commercial risks for buyers. This is a significant hurdle to overcome, especially between professional parties, despite the extreme circumstances caused by COVID-19.
2. Complying with pre-closing covenants will require coordination with buyers.
Typically, a seller is required to ensure that the target continues its “ordinary course of business” during the period between signing and closing, with any derogations requiring the buyer's consent. Sellers will need to think about how such pre-closing covenants affect their flexibility to address and react to the current circumstances, including through 'extraordinary' measures to reduce costs and preserve cash. While buyers should generally be in agreement with the target management's approach to preserving the business through turbulent times, sellers will need to engage and work collaboratively with buyers to get to closing and bear in mind that they will not necessarily be able to take key decisions unilaterally, even when the circumstances require a quick response, such as where:
- the target's financial situation requires immediate working capital or other liquidity above and beyond the agreed limits; or
- the target's business plan or business contingency plan, used as a benchmark in the covenants, is found to be no longer appropriate and to require immediate long-term adjustments.
That being said, sellers should not despair as a Dutch court could conceivably find that the principles of reasonableness and fairness prevent the buyer, under these circumstances, from using a pre-closing covenant to back out of the deal.
3. Bring-down of representations and warranties at closing will require increased efforts by sellers.
Representations and warranties in a purchase agreement are made as of a particular point in time. As representations and warranties speak to historic matters, COVID-19 will not result in a direct breach of warranties in transactions signed before the outbreak. However, if the representations and warranties are to be repeated by the seller at closing, certain representations and warranties could be affected by COVID-19 such as (i) business operations and continuity, (ii) the status of material contracts and commercial relationships, (iii) counterparty risks, (iv) collectability of receivables, (v) indebtedness and (vi) full disclosure. Sellers should carefully analyse whether COVID-19 related effects can and should be disclosed under the transaction terms and the potential consequences for non-disclosure (e.g. right of the buyer to walk away) and/or their potential liability after closing (e.g. claims by buyers for damages resulting from a breach). Relevant questions include:
- Are the closing warranties affected by COVID-19?
- Do the transaction terms contain an obligation for the seller to disclose breaches of the closing warranties?
- Can the seller avoid liability as a result of disclosures under the transaction terms?
- Can the buyer use disclosed breaches of the closing warranties to walk away from the deal?
4. Expect delays in the satisfaction of closing conditions and formalities.
The fulfilment of closing formalities such as obtaining regulatory approvals will likely take longer than usual due to government office closures, staffing shortages and similar causes. For example, the European Commission is working with a "skeleton crew" on merger filings and encourages delaying merger notifications, where possible. In addition, it will take longer to send original documents, obtain legalisation and authentication (e.g. an apostille) of certain documents, and make the necessary filings at closing (e.g. with government institutions). Sellers should think practically and creatively with buyers to ensure that closings progress smoothly in the current environment.
For more information on notarial and legalisation practices in the Netherlands during the COVID 19 crisis, please see "Companies in the Netherlands: Notarial practice during Covid-19" on our website.