Coronavirus: how to negotiate M&A transactions during lockdown

As people retreat into their virtual worlds, this article addresses some of the implications for private M&A transactions which are currently being contemplated, negotiated, or have not yet been completed.

Valuation and sale preparation

Market volatility and general uncertainty will undoubtedly result in some sellers reconsidering whether this is the right time to sell, and there may well be a greater disconnect than usual between a seller’s and a buyer’s expectation of value. A seller will be concerned about achieving full value for the business as well as being concerned about the ability of any buyer to fund any purchase, all against a backdrop of a potentially lengthy and uncertain sale process. Meanwhile, a buyer will want to gain as much understanding as possible of the impact of COVID-19 on the target’s financial projections to support its own valuation.

Should a seller decide to delay any sale process, the time could be usefully used in bringing its corporate housekeeping up to date, so that when the time is right, they are fully prepared.

Due diligence

For transactions already in progress, buyers are understandably concentrating their due diligence efforts on the impact of COVID-19, to get a better understanding of how the target may be affected.

Inevitably there will be greater focus on specific COVID-related issues, such as:

(i) key contractual and financing arrangements, for example if force majeure, right to renegotiate or termination clauses are being invoked;

(ii) payment terms and outstanding debtors;

(iii) customer and supply chain arrangements (including alternative supply sources), production delays, and possible staff shortages;

(iv) risk of any covenant breaches in any financing arrangements;

(v) general solvency and robustness of cash flows;

(vi) regulatory changes resulting from the pandemic and business continuity policies;

(vii) entitlement to any emergency funding and/or tax relief from the government;

(viii) policies dealing with remote working of employees, and steps to protect data; and

(ix) availability of insurance coverage (and whether business interruption is covered) and potential claims.

In response to due diligence requests, the parties should be aware that:

• businesses affected by the COVID-19 outbreak can apply to Companies House to request an extension to file their accounts, reports and confirmation statements, but must apply for an extension before the relevant filing deadline
• physical onsite visits and meetings may not be possible due to current lockdown arrangements, so remote options may need to be explored

Acquisition documents

Sellers and buyers will undoubtedly be considering the need for specific COVID-19-related provisions in their acquisition documents, with a view to allocating any risk to one or other party. These may include:

(i) purchase price adjustments or an element of earn-out in case revenues and profits are adversely impacted during an agreed time period following completion;

(ii) specific warranties and indemnities regarding operational and financial impacts; and

(iii) a specific material adverse change clause, where there is a gap between signing and closing.

Purchase price adjustments and earn-outs

For earn-outs or other performance-related arrangements that are already in place, sellers may be looking at taking significant reductions in any earn-out or other payments, as revenues and profits suffer in the current climate, and it is unlikely that any provisions to protect a seller will have been included in any historic acquisition agreements to cover this unforeseen pandemic (not surprisingly, as buyers will only have been expecting to pay for profits or revenues which are actually achieved).

As mentioned above, valuing businesses will have become more difficult and buyers will be keen to understand whether revenues have been lost permanently or on a temporary basis. As a result, earn-out mechanisms based on the future performance of the target may become more attractive, although sellers who are able to do so may well prefer to delay any sale until the economic outlook is more certain.

For deals currently being negotiated, the parties will at least be able to consider price adjustment and earn-out mechanisms which can take into account how profits may be adversely affected by the impact of COVID-19 and sellers may also look for additional comfort as to how the buyer will meet any post-closing payments, for example with parent company guarantees.

Warranties and indemnities

Buyers may insist upon more specific warranties on the status of key contracts, adequacy of supply chain arrangements, business continuity and disaster recovery plans, and the protection of data, whilst the sellers will want to make appropriate disclosures and avoid any forward-looking warranties.

New specific disclosures could be required as a result of recent events, particularly against warranties covering events since the last accounts date, customer and supplier contracts, compliance with law and regulation, the robustness of IT systems and employees’ working arrangements.

For new transactions, rather than relying on warranties, which if disclosed against may not provide any recourse to the buyer, it may be preferable to negotiate specific contractual provisions to deal with any prolonged period of interruption to the business. This may include a greater element of the consideration being based upon a price adjustment or earn-out mechanism.

Another reason why a buyer may be reluctant to rely solely on warranties is that, in the case of transactions negotiated in recent weeks, it might be argued that the buyer entered into the agreement at a time when the COVID-19 risks were well known and so could reasonably be expected to factor them into the agreed price.

It also seems likely that COVID-19 and related matters will be a general exclusion to any warranty and indemnity insurance policies for future transactions.

Gap between signing and closing

• Repetition of warranties

Repetition of warranties can be a subject of considerable debate between sellers and buyers where there is a gap between signing and closing. It is likely that sellers may resist any repetition of warranties more strongly in the current environment, whilst buyers may more aggressively seek the repetition of certain warranties which are fundamental to the target business and its ability to operate.

The position in relation to repeated warranties will depend upon the precise wording of the acquisition agreement and the warranties. If ongoing disclosure by the seller is required, it may be that any fresh disclosures trigger a claim for damages or possibly a right to terminate.

In practice, a buyer may prefer to rely on a “material adverse change” clause, as referred to below.

• Restrictions

Where there is a gap between signing and closing, restrictions are often imposed on the activities the seller can undertake during this period and usually include an obligation to continue to operate the business in the ordinary course. In the current circumstances this may not be possible, so a seller should consider whether any exclusions are required in order for it to be able to comply with government measures or other emergency situations which arise or where employees are not able to carry out their roles as usual (for example, mandated home working).

Buyers, on the other hand, might want greater control during the gap period, and might look for increased information provisions, and access and consultation rights, but any access rights of the buyer to the business or specific individuals during this period may need to be limited where there is a COVID-19 shutdown or self-isolation.

• Material adverse change

There may be greater emphasis on the inclusion of material adverse change (MAC) clauses (which to date have been relatively rare in the UK) which give the buyer the right to withdraw from the deal if the business deteriorates significantly during the gap period, with the buyer seeking to allocate the risk of any COVID -19 downturn to the seller. No doubt there will be considerable discussion as to the exact nature and scope of such clauses, but their effectiveness is likely to be greater if tied to specific events for the business with detailed consequences. To the extent that the current crisis is covered by any MAC clause, it also raises the issue of whether a buyer is likely to be treated as having accepted any risk, as the pandemic, and global health situation, is already well known.

• Consents

The parties will need to take into account the potential for delays in obtaining any consents, and the viability of any long-stop dates will have to be carefully considered.

Holding meetings

As part of the sale process there may be a need for both shareholder and board meetings.

Board members do not need to all be in the same place to hold a board meeting and many private companies’ articles will allow board meetings to be held by telephone and may permit written resolutions to be passed or the text of the resolutions by email to be approved by directors. For good corporate governance, it would be sensible for a director or the company secretary to confirm afterwards to the directors that consents to a proposed resolution have been received from all directors.

Likewise, private companies can pass written resolutions of shareholders (subject to certain exceptions) provided they comply with the statutory procedures set out in the Companies Act 2006.

The provisions of the company’s articles should always be checked.

Remote closing

“Remote” closings, when the parties and their lawyers are all in different locations, are now relatively commonplace. There are established procedures to be followed and the parties involved should agree the closing mechanics well in advance to avoid any last-minute hitches.

However, with increased working from home, and the need for social distancing, signing agreements and evidencing that they have been properly signed may be more difficult, although most people now have ready access to a printer and scanner.

Electronic signatures can be used instead of traditional wet-ink signatures to sign deeds, exchange contracts and complete transactions. Using electronic signatures avoids the need to sign, print and scan paperwork so can be a convenient option when so many people are working remotely.

HMRC has temporarily changed the way it deals with Stamp Duty so that duty must be paid electronically, and relevant information and documentation must be sent by email, with e-signatures being accepted.

Keystone has a team of highly experienced lawyers who have taken many companies through the private M&A process. If you are considering your M&A transactions and have questions on the topics raised in this article, please contact Lance Feaver.