The coronavirus (COVID-19) outbreak has created unprecedented and unseen challenges for M&A markets. The crisis abruptly interfered with virtually any deal on the table, in each phase of the transaction.
The coronavirus forces companies (on both buyer as seller side) to shift focus to mitigating the impact on operations and supply chain, challenges in management of employees, and more broadly on business going forward. Combined with external delaying factors and practical problems such as difficulties in timely obtaining merger clearances and other third-party consents, present deal flows will most likely be adversely affected and some of the initiated deals may be aborted or put on hold in the weeks to come.
In this note we explore a few ways to help identify and mitigate uncertainties and unexpected delays in connection to COVID-19 in M&A transactions under Belgian law.
Can exclusivity comfort dealmakers in the pre-contractual phase?
We are seeing that transactions are being temporarily suspended until the situation has normalised. For negotiations that are ongoing, the parties involved may consider entering into a ‘standstill’ exclusivity arrangement for a couple of weeks or even months, in order to see how the situation develops without actively proceeding with the transaction. For sellers this would mean less deal certainty, but given the circumstances it may be the better alternative to terminating the deal altogether. If parties already agreed exclusivity prior to the crisis, e.g. by way of a letter of intent, it may be appropriate to agree an extension.
An important consideration for parties involved in ongoing transactions is that the economic landscape (and the valuation of a target asset) can be entirely different within a few months (or even weeks) – especially taking into account an event such as the COVID-19 crisis. Therefore, most parties will wish to ensure that their pre-contractual arrangements do not imply any binding commitments in relation to the acquisition. This will require careful drafting to reflect the intention of the parties.
Is there a potential risk of liability of parties inadvertently backing out of a deal?
As a general principle, parties are free to determine whether or not they wish to enter into an agreement. This also implies that transaction negotiations can be ceased by a prospective seller or buyer (insofar as such seller or buyer does not violate any terms previously agreed upon).
By way of nuance, this freedom is not absolute, and parties are bound to certain principles of reasonable (professional) behaviour. Consequently, ceasing negotiations can, in some cases, be considered a ‘pre-contractual fault’ (culpa in contrahendo) in accordance with Belgian civil law, especially when negotiations are already in an advanced stage. Such ‘pre-contractual fault’ could, in turn, lead to an indemnification obligation, provided that the other party proves in court that it incurred damages and that the damages are the consequence of the ‘pre-contractual fault’.
Pre-contractual liability in the framework of transactions is generally limited to rather exceptional circumstances, e.g. when a prospective seller or buyer abruptly ceases negotiations, especially if there are no legitimate reasons for doing so, or when negotiations are artificially prolonged even though there was actually no intention to enter into an agreement).
That said, Belgian courts are generally rather conservative when calculating indemnities, as they will, in these circumstances, usually only award compensation for actual costs and direct losses (e.g. costs of advisors), but no damages for loss of profits or opportunity. However, do note that case law exists in which Belgian courts considered that a compensation for loss of profits in the context of pre-contractual negotiations could be justified in circumstances where the agreement would certainly have been concluded if one of the parties would not have wrongfully ceased the negotiations (but this remains rather exceptional). Moreover, one might expect Belgian courts to give due consideration to the current factual circumstances related to the COVID-19 crisis and judges may even take a more pragmatic view on some of the new cases brought before them, as such developing a temporary ad hoc 'COVID-19' case law.
Can I expect delays in the due diligence process?
Unexpected delays may arise as early as during the exploratory or due diligence phase of a deal. Surely, virtual data rooms – which have been the industry standard for many years already – remain operational, but in view of the recent ‘lockdown-like’ measures, it will be less evident to (timely) populate such VDR’s. Employees will have more difficulties in obtaining or timely gathering the right information or may not even have physical access to some of the company’s records.
At the same time face-to-face meetings (e.g. management meetings or presentations) or site visits will not be able to take place. Audio or video conferences with management will in some cases offer a solution, but in other cases a lack of physical discussions and visits may prove a steep hurdle to overcome.
Conceivably, when parties would wish to proceed with the deal nonetheless, one could to some extent capture the adverse consequence of an incomplete due diligence in the transaction documentation, for instance through broader representations with fewer qualifiers, specific indemnification obligations, or the inclusion of a confirmatory due diligence as condition precedent, whereby certain checks and verifications are to be carried out prior to completion (e.g. receipt of a certificate of non-insolvency or certain permits, absence of change of control clauses in material contracts, etc.). Careful drafting of this type of provisions is essential, to avoid the satisfaction of such conditions to depend exclusively on the will of a party (louter potestatieve voorwaarde / condition purement potestative), as this could potentially render the entire agreement null and void. This approach would obviously require more risk appetite on the buyer’s side.
What are the additional focus areas of the due diligence investigation?
In times of uncertainty, parties may consider looking into new focus areas in the due diligence investigation to identify and understand the potential impact of the COVID-19 outbreak on the target’s business and whether any risk-mitigating measures have been undertaken. The due diligence investigation could, for instance, include reviewing:
- supply chains to understand implications on inventory and operations, and whether the target has alternative suppliers available on short notice;
- the ability of the target and its counterparties to temporarily or even definitely suspend its contractual performance under material customer and supplier contracts (e.g. on the basis of force majeure, even in the absence of express clauses, or on the basis of contractual termination rights);
- the target’s response plan regarding its employees
- (e.g. temporary unemployment scheme for economic reasons or home-based work arrangements);
- coverage under insurance policies for losses due to COVID-19;
- the expected financial impact on revenues and solvency of the target
- (e.g. an increase in losses may cause the target to fall within the scope of the alarm bell procedure);
- the potential breach of business covenants and financial covenants provided in financial agreements or related to subsidies; and
- the impact on contemplated investments in the context of regulatory requirements
- (e.g. under environmental permits or concession agreements).
A new definition of Material adverse change (MAC) clause?
MAC clauses are frequently included in acquisition agreements, typically in the form of a condition precedent or a termination right, allowing the buyer to abandon the transaction after the signing of the agreement if an event occurs that has or may have a significant adverse effect on the business of the target. The definition of what constitutes a ‘material adverse change’ is often heavily negotiated between transaction parties. A MAC clause can be broad and generic, or refer to company-specific events. It is not unusual for a MAC clause to contain certain exclusions (or carve-outs). A MAC clause may, but need not, include quantitative guidelines.
Dealmakers negotiating in times of COVID-19 should seek to tailor the definition of ‘material adverse change’ to these extraordinary circumstances, taking into account the industry and the geographic areas in which the target operates. Buyers, on the one hand, may try to obtain that a significant drop in revenue, sales or loss of contracts caused by the coronavirus crisis – the existence of which is a known event but the impact of which is hard to predict – be covered within the definition of ‘material adverse change’.
Sellers, on the other hand, will attempt to exclude COVID-19, and more broadly, pandemics, epidemics and general economic conditions, from the circumstances that cause a ‘material adverse change’, arguing that the buyer is aware of the market volatility caused by the COVID-19 crisis.
Buyers negotiating MAC exclusions will wish to include a ’disproportionally affects’ qualifier, thereby securing the right to still invoke the MAC clause if the target is disproportionally affected as compared to other companies acting in the same industry.
In case of leveraged transactions, buyers will also try to ensure that the MAC clause in the acquisition agreement ties in with the MAC clauses in their financing agreements in order to avoid any ‘financing gap’.
What is the impact on prior approvals and long stop date?
The coronavirus is expected to cause delays in obtaining regulatory approvals, such as merger control approval, other governmental approvals and in general any third party consents.
The European Commission encourages companies to delay merger notifications originally planned until further notice, where possible, due to the organisational impact of COVID-19 measures and a steep increase of urgent State-aid cases. The Belgian competition authority has issued a similar communication. In practice this entails that parties should expect that the European Commission or the Belgian competition authority will postpone (almost) all pre-notifications of new cases.
Other authorities, such as the Spanish competition authority, have suspended all mandatory decision deadlines.
Parties contemplating the insertion of a long stop date in their transaction documents should contemplate whether the proposed long stop date is attainable in light of the additional struggles to interact with home working government officials and contractual counterparties. If the transaction requires a merger control notification, the long stop date should take into account that the merger notification may have to be postponed.
In share purchase agreements that have already been signed but not completed, long stop dates may need to be elongated. While elongating the long stop date accommodates parties in obtaining the required approvals to consummate the transaction, parties should also bear in mind that this also extends the interim period during which the buyer may abandon the transaction for material adverse change (if the transaction documentation contains this type of provision).
How can parties negotiate price adjustment mechanisms in the aftermath of the COVID-19 outbreak?
The uncertainty caused by COVID-19 may also have an influence on the choice of the completion mechanism used to determine the final acquisition price, for which the two most commonly used mechanisms are ‘completion accounts’ and ‘locked box’. Buyers may find it difficult to accept a locked-box mechanism with a date prior to the COVID-19 crisis, as it would allocate all risks of a possible value reduction (which may be significant but potentially only of short term effect) to the buyer. Instead, buyers may prefer the mechanism of completion accounts, or in case the locked-box mechanism has already been agreed, try to re-negotiate the locked-box date to a later time.
As the long term financial impact on the target of the COVID-19 measures may be a ground for discussion, parties may consider including an ‘earn-out’ mechanism, by which part of the purchase price is calculated on the basis of the future performance of the target after closing. Typically, the amount of the ‘earn-out’ is linked to the profits or the sales of the target, but ‘earn-outs’ can also be calculated on the basis of other financial or even non-financial milestones. If parties agree on an earn-out mechanism, sellers should ensure they have adequate protection during the earn-out period providing them the best chance of maximising the earn-out.
How can parties adapt the conduct of business clauses?
Conduct of business clauses typically require the target to continue operating ‘in the ordinary course of business’ which means that the target’s business must continue to operate as it has in the past. As emergency actions triggered by COVID-19 (e.g. switching to alternative suppliers, implementing remote work policies or suspending part of its operations) are generally not considered to fall within the ordinary course of business, sellers should consider requesting for carve-outs to this principle, allowing them to take emergency steps without the prior approval of the buyer.
A common carve-out for this type of provision would be to allow the target to carry out all actions ‘required by law’, including implementing any COVID-19 emergency measures required by law. Even without such express carve-out it would be unreasonable for a buyer to oppose the implementation of legally required emergency measures by the target. Tension may however arise between transaction parties if the target wishes to implement certain measures for internal policy or reputational (or even operational) reasons, in particular if such measures would trigger additional expenses or have an additional impact on the revue, and thus have an impact on price.
What does it change for representations and indemnities?
Prudent buyers will request specific representations and indemnities related to COVID-19 to limit their exposure to risks. In particular, buyers may request specific representations around emergency actions, supply chains, employment measures and insurance coverage, or indemnities around similar topics in the event seller’s disclosures or the due diligence investigation lead to any concerns regarding such topics.
Moreover, in the current context buyers should give additional importance to obtaining representations surrounding the status of key supplier and customer contracts, as well as representations that no key suppliers or customers are in breach of their obligations or seeking to terminate their contracts following the impact of the coronavirus (including on the ground of force majeure). Sellers making COVID-19 related representations should insist on knowledge and materiality qualifiers. As the coronavirus situation is unclear, sellers should try to avoid conceding to forward-looking representations and repeating them on closing.
Dealmakers involved in negotiated or even signed agreements should be mindful of the possibility that some of the representations that have been given may in the framework of the COVID-19 outbreak have become untrue, or potentially become untrue if they were to be repeated on closing. This may, in some circumstances, prompt re-negotiations with the respective sellers.
How does COVID-19 impact the completion process?
Even for deals that overcame the COVID-19 related challenges faced from the due diligence phase up until signing, organisation of the completion process can still be a cause for pause.
In Belgium, completions are often still organised through a physical meeting. One of the reasons for doing so is that, for deals involving Belgian targets, the share register (at least for companies of which the shares take the form of registered shares) has always been a physical booklet, to be (physically) signed by seller and buyer (or their proxy-holders).
However, parties could also consider organising a virtual completion. A key point of discussion for such virtual completion is expected to be the recording of the transfer in the target’s share register, on behalf of both buyer and seller, to ensure enforceability vis-à-vis the target and third parties. The granting of a proxy for the recording of the share transfer to one of the parties’ legal advisors, holding the register in escrow until receipt of payment of the purchase price, could offer a solution for the inconvenience caused by the buyer and seller being in different locations. Other completion actions (payment of purchase price, replacement of management, entering into of a transitional service agreement etc.) should, in general, be less cause for concern as many of them can easily be put in place virtually.
Conclusion
As the impact of the sudden COVID-19 pandemic remains unpredictable it goes along with a high degree of uncertainty which is to be addressed between M&A transaction parties. Removing uncertainty from M&A transactions is impossible but cautious dealmakers may mitigate the uncertainty caused by COVID-19 to some extent through increased due diligence and careful contract drafting, deploying some or all of the above considerations.
