COVID-19 impact : UK M&A and other corporate transactions

The World Health Organization (WHO) has declared the COVID-19 outbreak a pandemic and governments around the world are taking unprecedented emergency peacetime measures. In at least the short term, the effect on M&A is likely to be profound.

For many transactions, where the seller is responsible for delivering the target business in a particular state, this will be a very significant (or even impossible) challenge. From the buyer's perspective, it will want to ensure that it understands the risks associated with the target business it is acquiring and that, in certain circumstances, it is not obliged to complete the transaction. The implications will also vary depending on the stage of the transaction.

COVID-19 will inevitably be a complicating factor at each stage of an M&A transaction. Where an agreement has already been signed, parties should look at whether some provisions in the agreement could be triggered or affected by the impact of the virus. Where a transaction is at an earlier stage in the process, parties should consider how they want to limit, or define, the risk allocation between them or indeed proceed at all until the impact becomes clearer.

We consider its potential impact on M&A and other corporate transactions below and see here for our flowchart summary of this potential impact.

See our Coronavirus (COVID-19) feature for more information generally on the possible legal implications of COVID-19.

M&A transactions

Due diligence

Buyers will want to understand and evaluate how the virus might affect the target company and should consider more extensive/specific due diligence.  For example, it might need to understand the virus' impact on the target company's financial condition and prospects, supply chains, key customer/supply contracts, banking agreements, joint venture agreements, insurance policies, company policies (eg employees), what contingency planning has been done, and other key risks. If potential issues are identified, buyers may be more inclined to look to the seller to bear these risks by asking for a price adjustment or a specific COVID-19 related indemnity.

In addition, the solvency of the target business should also be reviewed (this will also have an impact on the covenants included in any credit facility) to see if the business is in a position to withstand any liquidity issues in the aftermath of the outbreak (especially in sectors most obviously hit such as hospitality, aviation, retail, etc.). 

A review of potential changes in laws or practice, anticipated to arise due to the outbreak, such as changes to work place leave policies, and how this will impact ongoing operations and compliance matters, should also be considered.

Pre-closing undertakings

Where there is a gap between exchange and completion a seller will normally give various undertakings about how the business will be operated during that period. This usually includes an undertaking to continue to operate the business "in the ordinary course".  A seller may want some right to operate outside the ordinary course without the buyer's consent where necessary to deal with the virus - for example, if it was forced to suspend a substantial part of its business due to the impact of the coronavirus.

Representations / warranties

If representations and warranties have already been given, the seller needs to check that it has not inadvertently breached any of them or that they can still be repeated at closing, if applicable, without any additional disclosures being made.

If the agreement is still being negotiated, a buyer needs to consider whether it should include some COVID-19 specific warranties as a way of eliciting more information about any risks and potential impacts of the virus on the target business. In these turbulent times, a buyer is also more likely to push for warranties to be repeated at completion and will pay very close attention to any operating restrictions imposed on the seller during the gap between signing and completion.

For a seller, disclosures against the warranties need to be considered carefully to ensure that all potential implications of this virus have been addressed. Where there is warranty and indemnity insurance (which provides cover for losses arising from a breach of warranty or in certain cases under an indemnity) known issues are unlikely to be covered by the W&I policies (and certain providers are already looking at including specific exclusions).

There may also be a rise in demand for key person insurance policies for business succession or business protection purposes.

Completed deals

Circumstances arising from the outbreak may shine a light on issues giving rise to potential claims for breach of warranties and indemnities in respect of deals already completed and where contractual or statutory limitation periods have not yet expired. An example might be in relation to the efficacy of crisis management procedures or plans. Notice requirements often require swift notification of potential claims, together with supporting detail. Failure to address these requirements strictly may mean that the ability to claim is lost.

Termination rights

Material adverse change (MAC) clauses - these clauses (which, as a rule of thumb, are more typical in US deals than European and Asian deals) usually give the buyer the ability to terminate the agreement if there is a material adverse change or effect with respect to the target's business after the signing date but before completion.  What constitutes a material adverse change or effect is negotiated between the parties and is often subject to several exclusions (which may themselves be subject to further exclusions) and every MAC clause is therefore fact-specific.

If the parties choose to include a MAC clause, they will need to decide how any adverse consequences of the virus are allocated between them. In general, parties have already started considering the inclusion of specific references to COVID-19, epidemics and pandemics as an exclusion from the circumstances which would cause or have a material adverse effect - or specifying that, for there to be a MAC, the impact of COVID-19 on the applicable party must be disproportionate by comparison with others. The express exclusion of COVID-19 from MAC clauses is to be expected as these provisions are designed to deal with unexpected circumstances. COVID-19 is now very much a known risk and contractual provisions to deal with it are more likely to be specific.

In respect of deals that have already been entered into, a party seeking to rely on the MAC in question will need to carefully consider whether the MAC can be invoked in light of the virus (generally speaking, courts have historically been reluctant to invoke MAC clauses).

Force majeure clauses - this is a clause that relieves a party from its obligations to perform the contract in certain extreme circumstances (force majeure does not, for example, operate automatically under English law generally and, as such, a specific force majeure provision would need to be included in an agreement to allow a party to rely on it). Whether the coronavirus outbreak and / or the resulting government restrictions are covered will be determined by the wording of the specific contract term and applicable law.

Many contracts define what constitutes a force majeure event by reference to events "beyond the reasonable control of a party" and contain a non-exhaustive list of the type of events covered. Parties will need to consider the wording of such clauses carefully to see whether they can rely on them or want to challenge them.

Timings

Regulatory approvals - the time taken to obtain regulatory approvals could be affected if government or regulatory bodies are forced to close due to the outbreak. This in turn could impact any long stop date for completion of the transaction, lengthen the period during which the seller has to operate in the ordinary course and may give the buyer a greater ability to terminate for a material adverse change.

Long-stop dates- a typical long-stop date clause gives a party the right to terminate an agreement if the completion has not occurred by a particular date. If a long-stop date is already in place and completion is now unlikely to occur as a result of the virus, a party should consider whether (i) a party can terminate the agreement as a result; and (ii) the long-stop date should, if possible, be extended with the agreement of the other party (depending on the circumstances, this might even be part of a wider re-negotiation of the deal.)

Where the long-stop date has not yet been agreed, consider whether it is possible to actually include one or if it should be further in the future than it otherwise might have been, to allow for these challenging circumstances.

Financing

The virus could impact the availability of acquisition financing, including bridge facilities and permanent/takeout financing, and the terms of that financing; as well as what due diligence the finance provider wants to carry out on the target and, in some cases, the buyer.

Target companies are likely to be active in trying to obtain covenant waivers where they expect defaults of relevant financial covenants.

Price protection: Locked box

Where deals were planned to have locked box mechanisms, a buyer may push to move to a more completion accounts-style working capital adjustment. This effectively pushes back the valuation date of the business, allowing for the uncertainties and fluctuations around performance and receivables to be taken into account. A seller, unwilling to agree to a pure completion account mechanic, may be willing to consider a hybrid structure where the price is still set by reference to a locked-box account date, but certain items such as cash and working capital are tested at completion. There can then be a pound for pound price adjustment against expected levels.

Price protection: Earnouts

To provide price protection in the post-completion period, (particularly relevant now when parties may not be confident of the market having settled by their completion date), a buyer may seek to defer consideration, retain a portion of the purchase price or seek an earnout structure where part of the purchase price is paid by reference to the financial performance of the business in future periods. A seller may be reluctant to accept such pricing mechanism as they will have very limited control over the business after completion. If an earnout is agreed, the parties will need to consider whether this pandemic is a factor that can be taken into account or will be ignored when calculating the earnout.

Deal strategy

Rather than buying or selling 100 per cent of a company, the parties to a transaction may decide to share the risk on valuation by dealing with a stake in the company instead. This allows the seller to retain some value in the company whilst the buyer does not take on the entire valuation risk during these uncertain times. The deal may also be structured to allow the buyer to obtain full control of the business in due course and the seller to fully exit.

A possible alternative to acquiring a minority stake of ordinary shares would be to structure the transaction using a different capital instrument, such as a preference or convertible share. This may allow a more flexible agreement to be reached on valuation, allowing for the current turbulent market. For example, the buyer could acquire convertible preference shares with the conversion date set for a time when the market is likely to be more stable. The conversion ratio could be set at a level that matches the buyer’s current view of the investment value, but if the seller is able to deliver additional value by the conversion date, the actual conversion would result in the buyer receiving a lower percentage stake.

A buyer may also consider reducing their exposure to valuation risk by joining with others to form a purchasing consortium. This will allow each consortium member to commit less resources to the purchase, but there will be other, potentially complicating issues that will have to be worked through.

Signing remotely

As more employees have to work from home, the question arises as to whether it is possible legally to execute contracts and deeds using an e-signature. See "Remote working - signing legal documents using e-signatures" for more frequently asked questions on this.

Project management

Careful consideration will have to be given to the practical implications of progressing a transaction in the current environment. For example, many dealmakers have also suspended travel and are having to work from home, which makes pursuing and agreeing deals far more difficult. In addition to the challenges of remote working (see "Signing remotely" above), the availability of dealmakers/advisers/key players should also be taken into account and contingency plans put into place to cover illness and other foreseeable consequences of the virus (there will inevitably need to be even more conference/video calls if a deal is to be agreed.)

General corporate transactions

General meetings

Companies will need to consider how they can hold general meetings as part of their contingency planning.  With the 2020 AGM season commencing this will apply to AGMs and the need for companies to approve routine business such as the approval of final dividends as well as the convening of general meetings to approve specific corporate actions.   

Under the Companies Act 2006 and the articles of association of most UK public companies, quorum provisions are typically light, requiring as few as two shareholders to be present, so should not present a practical issue.  Nor should voting, the vast majority of which is undertaken by way of proxy.  However, with Government policy discouraging social gatherings and therefore physical attendance at meetings, securing a means of attendance and shareholder engagement will present more of a challenge.  Many companies will be authorised in their articles to permit virtual attendance online or by telephone and it will be necessary for companies to evaluate these provisions and logistical arrangements with their lawyers, registrars and auditors in order to determine the best option in all the circumstances.

See new rules to temporarily ease company meeting and filing requirements for more information on the Corporate Insolvency and Governance Act 2020 measures impacting shareholder meetings.

Financial reporting and dividends

Companies will need to consider what disclosures they make about the virus in their annual report and accounts. In February 2020, the Financial Reporting Council (FRC) wrote with guidance on disclosure of risks and other reporting consequences arising from the virus and reminding them of the "need to monitor developments and ensure they are providing up-to-date and meaningful disclosures" in their annual reports. This applies to all companies required to prepare a strategic report (both listed and unlisted).

The FRC has also issued guidance on audit issues arising from COVID-19 in which it states that, in the current circumstances, additional time may be required to complete audits and it is important that this time is taken, even at the risk of delaying company reporting. The FRC stresses that companies, and in particular their audit committees, must understand that it is vital that auditors have sufficient time and support to carry out their work to an appropriate standard, including reassessing work done to reflect changed circumstances. In some cases, this may require companies to reconsider their reporting deadlines.

In these unusual times, unprecedented changes have also been made to the rules around the reporting of financial results and payment of dividends for all companies. Companies are coming under pressure to cancel or defer the payment of dividends that are due to be paid to preserve capital. And, a delay in financial reporting allows more time for more/different audit work.

On 26 March 2020, the Financial Conduct Authority, Financial Reporting Council and Prudential Regulation Authority issued a joint statement setting out various measures to ensure information continues to flow to investors and to support the continued functioning of the UK’s capital markets. On the same date, Inside AIM was published with changes to the rules for AIM companies.

See COVID-19 - impact on UK financial reporting and dividends for more information.

Disclosure obligations

Publicly traded companies need to be mindful of their responsibilities to disclose inside information under the EU Market Abuse Regulation (and, in the UK, also for AIM companies, under the AIM Rules for Companies).

Relevant inside information could include adverse changes in a company's trading performance (or expectations of performance) arising from the impacts of the virus (for example, disruption to supply chains or reduced customer demand), even where the root cause of the issue is publicly known. For example, a number of listed airlines have updated the market on the impact of the outbreak on passenger numbers. Companies will also need to consider the inclusion of specific risk factors arising from the outbreak in public circulars/prospectuses.

The FCA have published Primary Market Bulletin 27 to provide key commentary for issuers and market participants in light of the Covid-19 pandemic. Whilst the FCA recognises that there might be slight delays, in the short term, in issuers meeting their disclosure obligations, issuers are expected to continue to comply with their obligations under the MAR and relevant FCA rules and to make every effort to meet them in a timely fashion. The FCA is also expecting persons discharging managerial responsibilities and ‘persons (who are) closely associated’ to continue to meet their notification requirements under MAR within the prescribed time frame.