This is a follow up to “Considerations for M&A Transactions During the COVID-19 Crisis.” See the initial post here.
The uncertainty of the COVID-19 crisis and its resulting economic effects continue to make each stage of an M&A transaction complicated. At each stage of a transaction, buyers and sellers should determine how they both define and allocate risk between them or whether the parties should proceed at all until the impact of the COVID-19 crisis becomes more clear. As the actual effects of the pandemic on target companies start to become known with each passing week, the Burns & Levinson M&A practice group shares the following additional considerations for buyers and sellers in the various stages of M&A transactions:
- Due Diligence. Buyers and sellers should carefully analyze all business elements that may be affected by COVID-19 in order to assess the target’s operational and financial stability to see if the business is in a position to withstand any solvency or liquidity issues (which will also have an impact on potential covenants included in any credit facility), as well as any specific legal issues (e.g., product liability or worker safety) that may have arisen. Buyers will want to understand and evaluate how COVID-19 might affect the target and may consider more extensive due diligence requests. Comparison of past years’ performance to similar current year periods, as well as seller projections (that have likely been reforecast), will certainly take on increased relevance. To the extent of continuing operations by the seller during the pandemic, a buyer should understand fully the measures taken to comply with usages of personal protective equipment, social distancing and other safety measures – including the documentation of, and adherence, to all such measures. A seller that has received a loan from the Paycheck Protection Program (PPP) will also require significant diligence, especially given the already heightened media and governmental scrutiny surrounding this program. If any potential issues are identified as the result of these areas of diligence, buyers will want the seller to bear these risks – whether by means of special indemnities, purchase price adjustments or otherwise.
- Representations and Warranties. If a purchase agreement is still being negotiated, buyers need to consider what specific representations and warranties should be included in order to provide adequate disclosure of the effects, liabilities, risks and potential impacts of COVID-19 on the target. On the other hand, sellers need to consider whether it may need to provide disclosures that have or will sufficiently address the risks and potential impacts as the result of COVID-19 whether or not included in the buyer’s draft of the purchase agreement. Sellers should be aware that Buyers are likely to push back on attempts to include “except as effected by the COVID-19 pandemic” or other broad exculpatory language to that effect, as buyers view such statements as broad and too subjective – and, therefore, having the potential to gut the applicable representation and warranty. Sellers with PPP loans will be expected to make representations and warranties regarding the completeness and accuracy of its application, the usage of PPP loan funds, the eligibility of the PPP loan funds for forgiveness and related matters. Sellers should take extra care in reviewing these and other COVID-19 related representations and warranties, as well as populating the associated schedules, paying particular attention to whom “knowledge” of these representation is attributed. (See “Closed Deals and Indemnification Claims” below.) Where there is representation and warranty insurance (which provides cover for losses arising from a breach of a representation or warranty) known issues are unlikely to be covered by the R&W policies. In such transactions, the buyer and the seller should work collaboratively to negotiate the purchase agreement in a way that will provide maximum policy coverage, as well as be prepared to negotiation specific indemnities and holdbacks for any exclusions that will be in the issued policy.
If representations and warranties have already been given in a signed purchase agreement, the seller should closely monitor all aspects of its operations in order to be able to confirm it has not, or will not prior to closing, breach any representations and warranties to be recertified at closing without any supplemental disclosures, unless supplemental disclosure is permitted under the pre-closing covenants of the purchase agreement (as discussed below).
- Pre-Closing Covenants. Where the purchase agreement contemplates a signing and subsequent closing, the agreement will provide for various covenants about how the business will be operated and how the parties are to act during that pre-closing period. This usually includes a covenant to continue to operate or preserve the business “in the ordinary course”. So long as COVID-19 blunting measures are being required or recommended at the federal and state level, sellers are likely to want some flexibility to operate outside the ordinary course without triggering a breach under the purchase agreement to deal with the virus, including taking actions necessary for the protection of public health or the health of its workforce (e.g., if the seller was forced to implement remote working policies, reduce its workforce or suspend part of its operations due to the impact of the coronavirus). As the taking of such measures by sellers are likely to preserve the business being acquired and also mitigate potential liability that would result from continuing in the ordinary course, buyers should work with sellers to permit commercially reasonable actions with notice to and, possibly for more material changes, approval of the buyer. This can be of particular importance in sellers with operations or employees in multiple states where the timing and the scope of the measures within each state are likely vary. Additionally, given the lack of a current understanding of the full effects of COVID-19, a seller may seek to provide that it may supplement its disclosures prior to closing for those changes and effects related specifically to the pandemic. As such disclosure supplements ordinarily do not cure any breaches of the representations and warranties, the seller should try to ensure that any accompanying termination rights are tailored to reduce the potential for termination as the result of the impact of COVID-19 on the seller’s representations and warranties.
- Termination Rights. During a pre-closing period, whether or not a termination right will be available to a party as the result of COVID-19 will depend on the terms of the purchase agreement. Buyers ordinarily have the ability to terminate purchase agreement in the event of a material adverse change (MAC) to the target’s business. The triggering events of a MAC clause are a subject of negotiation between the buyer and the seller, and ordinarily includes specific negotiated exclusions. As the result of the COVID-19 crisis, buyers and sellers need to agree upon how to include specific references to COVID-19 and/or reference to epidemics and pandemics as exclusions to the MAC definition. To the extent of actual data relating to the seller’s operations (e.g., revenue results, customer orders, supplier issues), such data will likely be helpful in determining how to craft an appropriate MAC clause. For example, if a seller has already experienced a drop in customer orders by 10%, then the buyer and seller could agree that a drop of up to an additional 5% would not be a MAC but than any drop in customer orders in excess of the additional 5% would qualify as a MAC.
Additionally, parties may seek to include a force majeure clause as a means of excusing or deferring performance of certain post-closing obligations under the purchase agreement. If the effects of the pandemic create greater long term effects on the economy than anticipated, a buyer may wish to build in the right to deferred non-contingent future installments of the purchase price. Likewise, if the transaction contains an earn out component, a seller may wish to have a longer or different period for determining whether or not the seller has achieved the earn out’s thresholds for payment. Force majeure definitions are typically events “beyond the reasonable control of a party” and will contain a non-exhaustive list of the type of events covered where parties may provide for the inclusion of COVID-19 and/or reference to epidemics and pandemics, if desired. In the case of purchase agreements, buyers and sellers will need to consider the wording of such clauses carefully to create as objective and “bright line” triggers of a force majeure as possible in order to permit the parties to rely on them and avoid challenge or the need for legal action as to their interpretation. Click here for more information on the force majeure clause.
- Long-Stop Dates. A long-stop date clause gives a party the right to terminate the purchase agreement if the closing has not occurred by a particular date. If the parties are contemplating a long-stop date in the purchase agreement, consideration should be made as to the appropriate long-stop date in light of the COVID-19 circumstances known to the parties at the time, as well as what, if any, mechanism (other than the typical mutual agreement) might merit inclusion for extension beyond the original long-stop date for certain specific circumstances.
If a signed purchase agreement provides for a long-stop date and either such long-stop date has passed or is likely to pass without a closing as a result of COVID-19, each party should assess its desire to move forward with the transaction and how best to provide incentive to the other party agree to keep the agreement in effect.
- Closed Deals and Indemnification Claims. For transaction that have already closed and for which the impacts of COVID-19 were not known or fully known at the time of closing, both sides are likely to parse through the agreement for potential indemnification claims and defenses against them. In such cases, the viability of buyer claims regarding breaches of representations and warranties will likely depend on the fulsomeness of the disclosure schedules and what was known by the seller at the time the representations and warranties were made – likely given even more importance than usual to the definition of a seller’s “knowledge” than is the case in a pre-COVID-19 transaction.
As businesses make their way through the ever-changing COVID-19 landscape, the Burns & Levinson M&A team will continue to provide updates with news from the deal front and stand ready to partner with buyers and sellers to help them get those crucial deals done even in these tumultuous times.
Mark Manning is a partner in Burns & Levinson’s Corporate, M&A, Venture Capital & Private Equity, and Intellectual Property Groups. Clients look to Mark Manning to achieve the best results in their most complex commercial transactions and internal business and legal issues. He regularly leads merger and acquisition transactions on behalf of both buyers and sellers, providing him with deep insight into what drives both sides of a deal – a perspective that helps him efficiently facilitate practical solutions to issues that keep deals from getting done. He can be reached at firstname.lastname@example.org or 617.345.3468.
Barry Kuang is an associate in Burns & Levinson’s Corporate group. Barry focuses his practice on general corporate, mergers & acquisitions, finance, distressed transactions, securities, start-up structuring and financing, venture capital and private equity matters. Barry has experience drafting, reviewing and negotiating various corporate contracts, assisting with state and federal securities law compliance, and providing support in areas of corporate governance and investor relations. He can be reached at email@example.com or 617.345.3424.