The M&A market has been significantly impacted by the COVID-19 pandemic, with companies managing increased risk and disruption as they turn their focus to internal operations and altered business plans. Many acquisition processes are moving forward at a slower and more vigilant pace, while others have been put on hold indefinitely. Parties who are pursuing deals in this environment are facing unprecedented issues, both from a business and a legal perspective. 

To assist companies in addressing what is a rapidly-changing landscape, we have compiled a list of some of the key considerations that buyers and sellers should keep in mind when evaluating, pursuing, and negotiating M&A transactions during and in the aftermath of the COVID-19 crisis.

Due Diligence

Companies should be prepared to undertake enhanced due diligence designed to more acutely assess business vulnerabilities, particularly those related to work-stoppage, supply chain interruptions and overall risk management. In the past a buyer may have become comfortable with uncertainties by evaluating how a target withstood similar conditions historically. However, given the novelty of the COVID-19 crisis, helpful precedents are not available or reliable. Key diligence items that companies should now focus on include:

  • Whether the target company's insurance policies cover losses caused by COVID-19 and whether any claims have already been made.
  • Impact of the crisis on existing material contracts, including each party's ability to walk away from the contract.
  • The economic impact of COVID-19 on suppliers, customers and business partners.
  • Ability of the target to pay outstanding debt and other financial obligations.
  • Existence and adequacy of a target's business continuity plan.
  • Whether the target's workforce can weather COVID-19, including an ability to work remotely, policies regarding workplace health and safety, impacts on equity and incentive plans, ramifications of workforce reductions, and the like.
  • Evidence of any complaints or claims from employees for failing to provide a safe working environment or accommodation.
  • Overall review of the target's adherence to new laws and regulations related to COVID-19.
  • Whether the target has issued or received force majeure notices to excuse non-performance of contracts due to COVID-19 interruptions.

Material Adverse Effect ("MAE") Provisions

MAE provisions are primarily intended to give buyers the ability to abandon a transaction if an unforeseen event occurs that has (or may in the future have) a materially adverse impact on the target's business. It is important to note that invoking an MAE clause to terminate a transaction is challenging under normal circumstances and courts typically set a high bar for finding an MAE – the terminating party generally must show that the effects of the event "substantially threaten the overall earnings potential" in a "durationally-significant manner". No Delaware court has found that an MAE has occurred as relating to 9/11 or the 2008 Financial Crisis, as the Akorn v. Fresenius case in 2018 represents the only time that Delaware courts have found that an MAE had occurred in the context of a merger transaction. A key takeaway from the Akorn case is that Delaware courts will look to whether any of the contractually agreed-upon MAE exceptions apply (i.e., to confirm the MAE is not the result of industry-wide effects) before determining that a stand-alone MAE has occurred giving buyer a termination right. Given that MAE provisions are not usually intended to address changes affecting entire industries or the economy as a whole (a standard MAE carve-out), including in some instances express carve-outs for epidemics, pandemics or disease outbreaks, the impact of the COVID-19 pandemic is likewise unlikely to constitute an MAE triggering a buyer termination right under definitive agreements that were entered into prior to the pandemic.

For transactions with negotiations currently underway, parties are likely to heavily negotiate the allocation of COVID-19-related risk and bring MAE clauses into sharper focus. Sellers will seek specific carve-outs from the definition of MAE for events such as, disease outbreaks, epidemics, pandemics (including COVID-19), and/or any other health crisis or public health events (as declared by the World Health Organization), effectively shifting the risk of COVID-19 to the buyer. In response, buyers will want to include a "disproportionate impact" exception to the carve-out for MAEs that impact the target's business more significantly than other industry participants. 

The ultimate duration of the COVID-19 outbreak and its aftermath, as well as whether it has a disproportionate impact on certain businesses and industries over time, will undoubtedly influence how MAE provisions are crafted in the future. In the meantime, parties should make sure that MAE clauses intended to address the COVID-19 crisis include specific qualitative and quantitative thresholds that, if met, would give rise an MAE and a buyer's walk right. Objectivity, certainty, and specificity will be more important than ever going forward.

Outside Dates

Parties should consider the tolling or extension of "outside dates" or "drop dead dates" after which the parties would no longer be required to close the transaction. Deals requiring regulatory approval may experience unanticipated delays while regulators institute work-from-home policies, function with a reduced workforce and manage an unforeseen number of questions and concerns. Third party consents and change in control approvals may take longer to obtain as well – vendors, customers, landlords and others are also overcoming operational hurdles and may not be able to make such consents a priority. In addition, integration efforts and transition planning will likely be impeded and delayed for similar reasons.

While longer periods between signing and closing heighten the risk of an MAE (discussed above) and impact interim operating covenants (discussed below), parties should be prepared to negotiate later outside dates, particularly in deals requiring regulatory approvals. It may be prudent to include automatic extensions if material consents are not obtained, provided that the parties have used reasonable efforts to secure them.

Interim Operating Covenants

Interim operating covenants limit the actions a seller can take between signing and closing without first obtaining the consent of the buyer. They are drafted to ensure the seller continues to run the business in the ordinary course and give the buyer the ability to weigh in on material and non-ordinary course decisions. As a result of COVID-19, sellers may be considering various non-ordinary course actions related to liquidity, debt financing, contract termination, treatment of employees, adherence to new regulations, etc.

Given potential delays in closings and the resulting extension of interim periods between sign and close, sellers will likely seek more freedom to respond quickly and effectively to repercussions of COVID-19 without being required to seek buyer consent in connection with certain interim covenants. Buyers should be responsive to such concerns and rely on materiality and dollar thresholds to safeguard their interests. Sellers should push for appropriate exceptions to interim operating covenants to address the pandemic, such as an allowance to take any measures necessary to comply with "COVID-19 Measures" including shelter in place orders, social distancing, mandated closures, and the like. It may be helpful to include a pre-closing cooperation covenant stating that the parties will cooperate in the development and implementation of an action plan to address possible impacts of COVID-19 (if one is not in place prior to signing).

Representations and Warranties

Parties will need to pay close attention to seller representations and warranties to ensure that disclosure schedules address all potential consequences of the COVID-19 outbreak, particularly with respect to employee compensation and benefits matters. Buyers should seek COVID-19 specific representations and warranties that are tailored to the key items discovered during the diligence process (discussed above), including representations addressing workplace health and safety, inventory, supply chain sufficiency and any contingency planning. It may be prudent to ensure that sellers represent that they will disclose financial statements demonstrating the target's financial condition during the crisis.

Parties should pay particular attention to the representations and warranties regarding customers and suppliers. Buyers may want Sellers to represent that, likely to their knowledge, no major customer or supplier (i) is subject to any government order related to COVID-19 imposing significant restrictions on such customer or supplier's business, (ii) has reduced its workforce by more than a certain percentage and/or (iii) has declared or filed for bankruptcy.   

Representations and Warranties (R&W) Insurance

R&W insurers are now modifying underwriting policies to address COVID-19- associated risk. When relying on R&W Insurance as a source of any post-closing indemnification, parties should be aware that R&W insurers will likely exclude coronavirus-related losses from their policies as a "known" issue, leaving little opportunity for reimbursement. Insurers will likely have heightened due diligence expectations and requirements for COVID-19 impact on the target business. Therefore, providing for traditional seller-funded post-closing indemnities may become more commonplace for any COVID-19 related losses.

There will likely be enhanced scrutiny by insurers for deals that are currently in the interim periods. Insurers may start asking COVID-19 specific questions during bring-down calls prior to closing and may want additional information on any steps the parties have already taken to address COVID-19 related impacts.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.