Out-Law Guide | 01 Apr 2020 | 5:41 pm | 7 min. read
Here are some considerations for sellers and buyers who are involved in, or contemplating, M&A in the current climate.
Where transactions involve a split exchange and completion, sellers often agree to undertakings in respect of the target business that are intended to ensure that the target business is run materially in the ordinary course during the gap period.
These gap controls may be subject to exceptions designed to provide the seller with a degree of flexibility to act in the best interests of the target business. In the current circumstances, sellers should consider whether these exceptions go far enough to enable them to adapt to the rapidly changing environment. For example, operational changes may be needed to comply with government measures, such as mandated home working, or to respond to economic challenges facing the business.
Buyers, on the other hand, might want greater oversight during the gap period. Additional consultation rights and information provision may be desirable to ensure that there is a seamless transition to the buyer on completion.
A joint committee, made up of representatives of both the seller and the buyer, could provide a useful forum for collaborative discussions between the parties in respect of steps to be taken by the seller to safeguard the target business.
If completion is conditional on regulatory approvals in any jurisdiction, such as merger clearance or regulatory change in control approval, the parties should consider whether there is any guidance from the regulator that timeframes may be relaxed.
For example, the European Commission has asked transacting parties to delay notification of mergers where possible, although it is still accepting merger filings, especially under its 'simplified' procedure, where substantive competition issues do not arise. Transactions already under review, particularly those raising substantive competition concerns, could experience delays as both the Commission's and the merging parties' resources are stretched during the pandemic. The UK's Competition and Markets Authority currently expects to meet its statutory merger review deadlines once a merger notification is accepted, but the informal 'pre-notification' engagement with the CMA – before a notification is officially accepted – could experience delays, potentially impacting deal timing.
Any extension of turnaround times which results in a longer period between exchange and completion could introduce greater risk for one or both parties. Long stop dates for completion to occur will also need to be carefully considered.
Listed companies proposing to engage in M&A should keep a close eye on their share price. In such a volatile market, seemingly low value deals could, for instance, hit the thresholds for shareholder approval or announcement under the UK Listing Rules or the AIM Rules. A falling share price might also limit a party’s ability to offer a meaningful break fee in the event that the transaction fails.
Companies contemplating M&A involving EU-based targets should be aware of the recent European Commission announcement and guidance urging member states to be vigilant during the Covid-19 pandemic and to screen for "attempts to acquire healthcare capacities, for example for the production of medical or protective equipment, or related industries such as research establishments, for instance developing vaccines, via foreign direct investment" which could limit supply to the EU market of certain goods or services.
Material adverse change (MAC) clauses are relatively rare in European deals. Where these do exist, they tend to exclude macroeconomic events which affect the market generally. It is therefore unlikely that a generic, European-style MAC clause will allow the buyer to withdraw from a signed deal as a result of Covid-19.
For deals being negotiated now, the impact of the virus will probably not trigger a generic MAC clause as the virus is already widespread and its effects are being felt. Buyers may nevertheless seek a termination right in the event that certain specified circumstances arise between exchange and completion. Such termination rights are likely to be highly unattractive to sellers, particularly where an announcement is made to the market on exchange. Sellers may therefore prefer to delay deals until the immediate impact of the virus is clear, rather than compromising deal certainty.
If the buyer has concerns about the financial stability of the seller and its group, but nevertheless wishes to enter into a split exchange and completion deal, it may want to consider a specific termination right which is exercisable if the seller becomes insolvent or, for example, enters into liquidation between exchange and completion. The intention would be to offer a clear exit route for the buyer in circumstances where it might otherwise be compelled to complete the transaction on the agreed terms, including price, notwithstanding that it may simply rank as an unsecured creditor in respect of claims under the sale and purchase agreement.
Due diligence and disclosure
Buyers engaging in due diligence investigations should approach these afresh. Areas that we would expect to attract greater scrutiny include:
Sellers should also reflect on whether additional disclosures are needed against the warranties. New specific disclosures could be required as a result of recent events, particularly against warranties covering events since the last accounts date, customer/supplier contracts, compliance with law and regulation – including in jurisdictions where new laws have been introduced, communications with regulators, the resilience of IT systems, any temporary relaxation of IT security standards and employees’ working arrangements.
Repetition of warranties can be a subject of debate between sellers and buyers where there is a split exchange and completion. Against a Covid-19 backdrop, this may be a hotter topic. Sellers may resist any repetition of warranties more strongly given the changing landscape, whilst buyers may more aggressively seek the repetition of certain warranties which go to the heart of the target business and its ability to operate.
Buyers should consider whether the impact of the virus needs to be factored into their valuation of the target business. For some businesses, the impact of Covid-19 may be short and sharp with the target business expected to recover once the most severe public policy restrictions are lifted. For others, the loss of revenue will be permanent.
Valuing businesses will be more difficult and there may be disconnects between sellers' expectations and buyers' valuations. To bridge this gap, earn-out mechanisms predicated on the future performance of the target business may become more popular.
It may be significantly more difficult for buyers to secure debt financing to fund the purchase price. Sellers should ensure that they understand how the buyer is proposing to finance the acquisition. This will inevitably be an important consideration in competitive auction processes and bidders could find they are significantly disadvantaged if they are dependent on third party debt.
Buyers may wish to take out transaction insurance, such as warranty and indemnity insurance, as an alternative to relying on the seller’s or a guarantor's covenant. Sellers may also want to explore insurance as an alternative to placing monies in escrow, as security for tax or other claims, in order to retain cash.
Many M&A deals involve the provision of services by the seller to the target business for a transitional period following completion. Buyers may be more focussed on these supply arrangements and related business continuity arrangements, particularly where the seller is “passing through” material services outsourced to a third party. The parties should also consider whether the current pandemic could affect the timeline for any pre- or post-completion separation activity and, consequently, the duration of any transitional services.
The parties should reflect on the practicalities of complying with their obligations in the sale and purchase documentation. Traditional approaches may be inappropriate or unworkable at present.
For example, sellers will need to find new ways of informing and consulting with employees subject to the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) if their workforce is working from home or self-isolating. Management meetings and site visits may also need to be held remotely or deferred. Virtual solutions are available to meet these challenges but plans should be drawn up and technology tested in advance.
Electronic signatures can be used instead of traditional wet ink signatures to sign deeds, exchange contracts and complete transactions in many jurisdictions, including England. Using electronic signatures avoids the need to print, sign and scan paperwork so can be a convenient alternative when so many people are working from home.
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