The so-called SARS-CoV-2 pandemic (the "Pandemic") has a significant impact on the M&A business worldwide. If nothing else, this is also owed to the uncertainty in the markets, as the economic effects of the Pandemic and its continuance cannot be reliably assessed. All sectors are not equally affected by the Pandemic. Especially interesting targets, whatever it may be that makes them attractive for a bidder in the individual case, are still sought-after even in the current situation, both by strategists and financial investors in equal measure.
There will be a time after the Pandemic so that the current situation can also create new opportunities. However, it is mandatory that the (potential) impact of the Pandemic on the target be considered already today in the contractual documentation and that corresponding precautions be taken in the planning and in the performance of the transaction, too. It is particularly the following topics that deserve special attention:
1. Purchase price determination
1.1 Company valuation and debt financing
Great importance is always attached to the company valuation, but slightly more so in the current situation. As it stands, basically the same standards apply as before the Pandemic. But it will have to be well thought out which of the special effects of the Pandemic may need to be considered in the valuation (to adjust it). Further, the purchaser will not want to pay a "pre-pandemic price" without protecting itself against the possibility that negative pandemic effects will not be fully reversed again. As the present annual financial statements of the targets generally do not yet reflect any effects of the Pandemic, they must currently be read with a high level of caution; the current and possibly also the medium-term situation of the company may already have changed significantly (negatively) within a short period of time. If the target is e.g. a manufacturer of face masks or disinfectants, it will have to be considered whether the current significant increase in orders will last so that the valuation would need to be revised downward accordingly. As always, this also depends on the individual case so that no universal recommendation can be made.
If the purchaser wishes to finance the transaction (at least in part) with borrowed funds, this may turn out to be exceptionally difficult at present. Banks require a sufficiently reasonable company valuation for this and, at present, they are oftentimes struggling to assess the impact of the Pandemic and to align it with the business valuation presented. Therefore, purchasers should approach banks very early in order to explore whether financing the transaction with borrowed funds is even realistic. If sufficient liquidity is available, the purchaser can consider fully financing the transaction with its own funds at first. Any planned leverage effects may also be achieved later on by retroactively (re)financing the transaction with borrowed funds. This may be of interest to financial investors above all.
1.2 Locked box vs. closing accounts
It is the purchase price determination that continues to be of major relevance. In light of the Pandemic, the so-called locked-box mechanism increasingly agreed in the last few years is likely to lose importance at first. From a purchaser's perspective, closing accounts has already been the preferred mechanism before, too. Even more so today, as the target has either already experienced material changes due to the Pandemic since the last reporting date and/or (further) changes can reasonably be expected to occur until the closing date.
The range of topics to be considered is so wide that it is hardly possible to reasonably anticipate them beforehand in the customary locked-box mechanism. Therefore, it should be reasonable for both parties to rely on closing accounts. Otherwise, at least from a purchaser's perspective, unwanted surprises may be encountered until the closing date. It is likely to be difficult, as well, to take corresponding risks into account already in the purchase price. Also in this regard, the further course of the Pandemic is too indeterminate and the purchaser would have to mark the purchase price down to such a degree that this is generally hardly acceptable to the seller. Closing accounts is therefore the mechanism of the hour.
When agreeing upon it, the parties are at liberty (as they would also be otherwise) to stipulate certain items or issues by way of explicitly agreed principles, procedures or business practices in deviation from the accounting principles otherwise applicable. It suggests itself focusing on this even more in the current situation in order to find the "right" purchase price also in times of a pandemic.
1.3 Purchase price adjustment
If it is reasonable to expect that negative effects will not be felt by the target until after the closing of the transaction, the purchaser should take precautions in this regard, too. Such effects would not be included in the usual purchase price adjustment, as closing accounts are drawn up on the closing date and subsequent issues do not necessarily have to be taken into account by way of a clarification of the value. Still, the parties should contemplate defining a certain period of time after the closing to be considered in any case as a period for clarifying the value when drawing up the closing accounts. This could, at least in part, counter the effects following the closing.
Further hedging mechanisms are possible, such as with holdings from the purchase price or debtor warrants provided by the seller. The parties could reduce the purchase price from the outset and provide for an earn-out clause in favor of the seller. It would also be conceivable that e.g. part of the purchase price does not become due until after the closing of the transaction within a period of time to be agreed upon and only if the target has got "through the Pandemic well".
It strongly depends on the relevant target and its business model which parameters are to result in an adjustment of the purchase price in the individual case. However, as the conceivable future effects of the Pandemic are very complex, in general, such mechanisms suggest themselves that reference the company's proceeds and earning power. But it is also circumstances that indirectly affect the earning power that are conceivable, such as the extension (or termination) of customer contracts and the like. In this regard, hardly any limit is imposed on the parties' imagination.
2. Financing of the target
2.1 Redemption/assumption of intra-company (or intra-group) liabilities
The parties should give ample thought to the current and future financing of the target already beforehand. Oftentimes, shareholder loans, cash pools or other intra-group financing arrangements are in place that are to be terminated in the course of the transaction. Where the parties intend for a return of these instruments, it should be thought about whether the liquidity needed is currently available or can be procured from third parties. The Pandemic poses a particular challenge to many companies especially with regard to their liquidity. Therefore, it may be even more important to realize the redemption of such instruments in as conservative a manner as possible in terms of liquidity. In this regard, it suggests itself, as would also be the case otherwise, that the purchaser acquire such instruments including takeover. From the seller's perspective, for instance, a return of loans would generally be unfavorable anyway for reasons of insolvency law. However, these liquidity needs should not be underestimated, especially as the target may even have increased liquidity needs so that a redemption of such instruments by the target may be all the more difficult.
2.2 (KfW) loans
Where the target finances itself with third-party funds, e.g. by way of bank loans, this may also entail higher complexities as a result of the Pandemic. In this regard, it has to be considered that, for instance, the loans presently provided by German stated owned KfW in the course of the Pandemic, e.g. under the "Special Program of the KfW for 2020 (KfW-Sonderprogramm 2020)", are subject to special conditions. For example, the following restrictions and conditions apply to loans granted during the term of the "Special Program of the KfW for 2020 (KfW-Sonderprogramm 2020)":
Profit and dividend distributions will generally not be permitted during the term of the loan.
In the case of a relevant influence by private equity investors, a credit will only be granted under the condition that no distributions are made to the investors during the term of the credit.
The credit lines approved by the target's main bank must be maintained.
Asset transfers between companies of a company group or in the framework of company split-ups or between corporations and their shareholders will be excluded.
The aforementioned conditions are mere examples. But they show that these issues must already be thought out at an early stage of the transaction. However, an early redemption of such KfW loans will generally be possible against payment of an acceleration fee.
3. Transaction security
3.1 Conditions precedent
In light of the Pandemic, the parties have to be all the more careful when agreeing conditions precedent. Where the parties are not fully in control of the occurrence of such a condition, its contents and also the consequences of its nonoccurrence should be well-considered. The parties should at least (as they should also do otherwise) explicitly provide for the possibility of waiving conditions precedent so that no so-called deadlock occurs. In principle, this is not a particularity of the Pandemic. However, its imponderables bring this topic to the fore even more.
3.2 MAC
Material Adverse Change ("MAC") clauses have experienced a renaissance due to the Pandemic. Rather unpopular with sellers due to the transaction insecurity inherent in them, such clauses are currently frequently necessary for purchasers. In a large number of constellations it would virtually be negligent for a purchaser not to demand security by way of a MAC clause. Should, between signing and closing, a material adverse change occurs in the target, in its market environment or generally in the (global) economy, the purchaser can unilaterally withdraw from the transaction due to a MAC clause. At the same time, the parties have to make sure that the MAC clauses are reasonably determinate. It is in both parties' interest to have clarity on the continuance or discontinuance of the transaction.
Particularly in the current situation, it must be considered more which trigger event the MAC case is to be conditional upon. It cannot be the existence of the Pandemic itself, as the MAC case would otherwise already have occurred before signing. In this regard, too, such mechanisms suggest themselves that reference the company's proceeds and earning power. But also the cancellation of material contracts of the target can constitute a relevant event. In this regard, too, the parties are largely at liberty to decide.
3.3 Long stop date
In particular where the closing of the transaction is dependent on third parties, the parties should consider agreeing long stop dates. For instance, if the transaction requires the approval by an authority (e.g. the German Federal Financial Supervisory Authority (BaFin) or cartel offices), this process of approval may experience a significant delay given the current Pandemic. In this regard, it is advisable contacting the corresponding public bodies as early as possible in order to get a sense of the time horizon to be expected. Where, for either or both parties, the attractiveness of the transaction is also dependent on the closing occurring within a certain period of time, long stop dates should be agreed. If the closing does not occur within such a time limit, the entitled party (or even both) may back out of the transaction. Whether this shall entail a break-up fee or any other penalization will be left to the parties' negotiations. If the unsuccessful expiry of the long stop date is demonstrably a result of the Pandemic and cannot be attributed to either party, such penalization should generally be the last thing to do.
4. Warranties
It is mandatory to check the catalog of warranties agreed between the parties for its compatibility with any effects of the Pandemic. It is likely that various of the common warranties require adjustment. This concerns, for instance, warranties relating to the topics of
Compliance with statutory provisions,
Conduct of business in the past,
Existence of third-party rights of termination under material contracts,
Imminent, threatened and/or pending (also labor law) disputes,
Insolvency status,
Existence of (imminent) events insured,
Public aids and their callability and
Existence of circumstances as a result of which the target's business is anticipated to be, or is already being, negatively affected.
Especially if there is a more than insignificant time period between signing and closing, it will be mandatory from the purchaser's point of view that the warranties also cover the point in time of the closing. Although this is generally customary and acceptable to sellers, the particularities of the Pandemic must be considered in this regard, too. For the average seller, it is hardly foreseeable how the market environment will develop after the signing so that it may involve significant risks to provide warranties for the closing. If it is not acceptable to the purchaser that the warranties only cover the signing, a so-called closing update will suggest itself, which is also conceivable in the form of a so-called disclosure letter. Then, the seller can check e.g. a few days before the closing whether, during signing and closing, new facts have arisen that lead to a breach of warranty in terms of the closing. Where this is the case, the seller can disclose these facts against the warranties and thereby escape liability. What is important in this regard from the purchaser's perspective is that these facts and breaches of warranty may not already have existed at the point in time of the signing. If any breaches of warranty have already existed at signing, the seller's liability should not be affected accordingly. Such a closing update should reasonably distribute the imponderables existing for both parties among the same. From the purchaser's perspective, this mechanism should also be combined with a MAC clause in order to protect against overly severe changes (see above).
If a warranty is to be given "to the best of the seller's knowledge" or qualified in a similarly subjective manner, it may suggest itself to clarify that the knowledge of the existence of the Pandemic and of its current and potential future effects on the (global) economy and the target alone will not constitute knowledge on the seller's part giving rise to liability in respect of a specific breach of warranty in the individual case. The same will apply to the attribution of a third party's knowledge.
5. Ordinary course of business
SPAs generally refer to the target's "ordinary course of business" in various places. Examples of this are the catalog of warranties and the seller's customary duties regarding the continuation of the target in the time between signing and closing. From the seller's perspective, it is important adjusting the "ordinary course of business" to the current situation. Many companies have been and are being forced by the Pandemic to hazard deviations from the ordinary course of business; many examples of this are conceivable. It is imperative that any special topics be defined as precisely as possible and as part of the (current) business so that the seller does not run into breaches of warranty or of other duties knowingly. Especially with regard to the continuation of business until the closing, the seller must reserve reasonable liberties so as to be able to respond flexibly to any (further) effects of the Pandemic without being dependent on the purchaser's goodwill. For the purchaser, it will be inversely relevant not to give the seller "carte blanche" due to the Pandemic.
6. General practical considerations
6.1 Meeting in person and powers of attorney
Where it is necessary to meet in person in the individual case (e.g. certifications), the applicable travel and contact restrictions are to be taken into consideration. It should suggest itself relying on phone, video and e-mail as much as possible to perform the transaction. In the case of certifications, powers of attorney can be given to the notary's employees, too.
Where powers of attorney are to be used to perform the transaction on an international level, such powers usually need to be certified before the relevant foreign notary and to be furnished with an apostille/legalization. Any powers of attorney should be obtained as early as possible and furnished with appropriately long terms. In part, in individual countries, special regulations exist that have been issued on the occasion of the Pandemic. For instance, notaries in the Netherlands may perform certifications by video transmission, which can accelerate the corresponding processes.
6.2 Involvement of third parties
Inter-company transactions oftentimes require acts or declarations to be performed or issued by third parties (see also the foregoing on the long stop date). Such third parties include authorities (BaFin, cartel offices, tax authorities, etc.), certain employees (data room, Q&A) or banks (financing of the transaction, redemption of liabilities). In times of nationwide home office and widespread short-time work, the parties should plan as early as possible which persons need to be involved so that the transaction experiences preferably no or at least hardly any delay. In this regard, it suggests itself involving all persons as early as possible and keeping them up to date on the transaction process.
6.3 Deadlines
Oftentimes, SPAs include numerous deadlines to be adhered to by the parties to perform acts or to issue declarations. The Pandemic is not considerate of deadlines so that it should be weighed in each individual case how to define the beginning and the end of any time limits.
7. Be careful with 'catch all'
Where the parties flirt with the application of general clarifications reading that (for instance) "pandemic-related effects are to be taken into account between the parties in good faith" or "pandemic-related effects do not give rise to a breach of warranty", we can only advise against this. Foremost, the purchase agreement should define and stipulate as precisely as possible what it is that shall actually apply. Otherwise, disputes will be inevitable, as, in the individual case, the parties will have different points of view on how such universal provisions are to be understood.
The above statements should be read as examples and are not exhaustive. As always, also in times of a pandemic, a careful due diligence and formulation of the SPA will be required. Essentially, the Pandemic is no more (but also no less) than an economic risk to be discussed in detail by, and reasonably distributed between, the parties. However, an inter-company transaction can turn out exceptionally challenging due to the current accumulation of (special) economic and legal issues caused by the Pandemic alone. It is therefore all the more important to carefully plan and perform the transaction with the help of experienced advisers.
.jpg?crop=300,495&format=webply&auto=webp)
