M&A, merger control and COVID-19
June 2020 | SPECIAL REPORT: MERGERS & ACQUISITIONS
Financier Worldwide Magazine
June 2020 Issue
The COVID-19 pandemic is presenting businesses with unprecedented commercial, financial and legal challenges.
Signed deals
Many businesses that signed contracts prior to the outbreak are now finding themselves either unable or unwilling to comply with the contractual terms. In the context of a sale and purchase agreement (SPA), such terms may include the conditions to completion and the timeline for their satisfaction.
In circumstances where the parties wish to proceed with the deal recorded in the SPA but on different terms – for example, to extend the time limit for satisfying regulatory clearance conditions – the parties amend the SPA. This may be effected by a simple side letter. Under English law, contracts, including amendments, must be supported by adequate consideration. If there is uncertainty as to whether consideration is being given under an amendment, the amendment should be executed as a deed. Under English law, deeds are deemed to be for adequate consideration.
Contracts to be executed as deeds have certain formal delivery requirements that may, in present circumstances, prove to be challenging to implement. For example, deeds must be executed in the presence of a witness, which will be challenging while social distancing measures are in place. As English law currently stands, witnessing a signature over video call is not permissible.
If the parties are unable to agree to amendments, the SPA may simply terminate on its terms.
In SPAs, the buyer may have required the inclusion of a material adverse change (MAC) clause giving it the right to terminate and walk away in the period before completion if the target business is ‘materially and adversely’ affected by an unforeseen event or circumstance. The effectiveness of a MAC clause’s protection will depend on the wording of the clause – for example, whether events that affect all businesses within an industry equally are excluded. In the UK, there is little precedent with regard to the English courts’ views on MAC clauses.
If one party is faced with a breach by the other party of its obligation to complete under the SPA, that party’s most likely remedy will be a claim for damages for breach of contract (likely to be its wasted transaction costs). A party may also seek the equitable remedy of specific performance under which the claimant asks the court to compel the breaching party to perform its obligations. Specific performance is considered an ‘exceptional’ remedy and is only granted at the court’s discretion when damages are not an adequate remedy.
Competition conditions
Merger clearance is one of the key regulatory conditions precedent to completion that is impacted by COVID-19. SPAs often include a deadline for submission of the merger filings required to satisfy the merger clearance condition precedent. Obtaining those merger clearances before the drop-dead date for completion will be a contractual obligation on the buyer under the SPA. Failure to do so may put the buyer in breach, unless the SPA excuses such failure. Completing the transaction without obtaining all necessary merger clearances may put the buyer, and in some jurisdictions, all parties, in breach of the merger control laws of the relevant jurisdictions. This problem – known as ‘gun-jumping’ – can expose them to heavy fines and invalidation of the transaction.
COVID-19 is creating delays and uncertainties in the merger clearance process. Competition authorities such as the European Commission (EC) have been encouraging parties to delay making merger filings as much as possible and to expect delays in their ability to process filings. They have also been using their powers to ‘stop the clock’ – i.e., suspend the passing of time under statutory deadlines – more frequently given the often very onerous information and document requests imposed by competition authorities.
Competition authorities, such as the UK’s Competition & Markets Authority (CMA), have been keen to emphasise that merging parties cannot expect less scrutiny or a softer ride than they would expect in normal times.
That said, we are likely to see more cases in which parties advance ‘failing firm’ and ‘flailing firm’ defences. A ‘failing firm’ defence seeks to establish that the target was bound to exit the market regardless of the transaction, and that there is no less anti-competitive alternative to acquisition by the buyer. By contrast, the ‘flailing firm’ defence seeks to establish that either party, while not on the imminent brink of collapse, has been so weakened that its past performance is no indication of its current and future competitiveness. The EC and CMA have emphasised that they will review such arguments with the same rigour as in normal times.
Finally, governmental controls on foreign direct investment (FDI) can be expected to increase, creating further scope for uncertainty and delay in cross-border transactions. In the EU, most countries now have FDI regimes for the oversight of acquisitions of strategic infrastructure and assets by non-EEA buyers. In response to the current crisis, the EC has encouraged EU countries to implement and enforce such regimes, to apply them to the healthcare and research and development sectors, and to cooperate with each other in these enforcement efforts.
New deals
While M&A deal volume has fallen worldwide and notwithstanding the turbulent market conditions, a number of dealmakers are finding opportunities and signing new deals. The COVID-19 crisis will provide challenges to new deals as well as existing ones.
With most businesses operating remotely, due diligence takes longer. Organising the collation of soft copies of the relevant documents in virtual data rooms is time consuming when personnel are not centrally located and distributing hard copies would be a slow and expensive process.
Thorough due diligence, however, is important. Buyers are now expecting in-depth analysis of the target’s compliance with banking covenants and the scope of its employee sick pay schemes and force majeure and MAC clauses in existing contracts. There is also a need for the buyer to understand the potential impact of the COVID-19 crisis on the fundamental value of the target business.
Delays in organising due diligence on the sell-side and enhanced due diligence on the buy-side will extend the timeline of most deals. These delays and the related uncertainties may have an increased impact in the case of distressed and accelerated M&A, where the deal timeline is tight.
The current crisis is also having an impact on the warranties and indemnities (W&I) that are given by the seller. For example, buyers may expect warranties in relation to business continuity, the status of material contracts, contingency plans and financial robustness. However, in a market where a seller’s financial position may threaten the likelihood of future recovery if there is a warranty breach, W&I insurers, which are commonly the next source of financial recompense, may be reluctant to provide adequate coverage for far-reaching and high-risk warranties.
While low stock prices will create exceptional opportunities for M&A, the range of factors discussed above makes for an unusually challenging environment for those involved in or contemplating deals.
Derek Jones and Matthew Levitt are partners and Inaya Homoud is an associate at Baker Botts LLP. Mr Jones can be contacted by email: derek.jones@bakerbotts.com. Mr Levitt can be contacted by email: matthew.levitt@bakerbotts.com. Ms Homoud can be contacted by email: inaya.homoud@bakerbotts.com.
© Financier Worldwide
BY
Derek Jones, Matthew Levitt and Inaya Homoud
Baker Botts LLP