Covid-19 coronavirus: points to consider on M&A transactions
Managing Partner, Beijing/Shanghai
20 February 2020
As coronavirus (Covid-19), spreads across the world, it has been widely reported that some companies are looking to suspend or terminate their contractual commitments. Factory closures, port and travel restrictions on goods and workers, a decline in energy demand, and reductions in consumer spending are affecting many sectors including manufacturing, transport, tourism, energy and retail.
Current indications are that global M&A activity so far in 2020 is significantly down on the equivalent period last year – uncertainty about the potential impact of the virus may be partly to blame for that – and cross-border dealmaking is under pressure.
In the wake of the ongoing epidemic, companies are facing a number of difficulties, and many of our clients are asking how they can protect themselves in M&A deals that are currently underway where the target has trading links with (eg significant imports to, exports from, or production sites or operations in) those parts of the world that are most severely affected by the virus.
Any such links may not be immediately apparent; they could arise anywhere in the supply chain. Here are some pointers.
Data rooms and due diligence
Sellers should consider including information in the data room about the possible impact of the virus on the target including, where relevant, appropriate mitigation and contingency plans. Buyers should consider conducting due diligence on the level of risk and on the target’s scenario planning. Relevant considerations include:
- the ability of the target and its counterparties to perform their obligations under material contracts
- any contractual rights or legal principles that may excuse non-compliance or allow contracts to be terminated (including force majeure and frustration)
- any commercial re-negotiations with counterparties that are underway or termination rights that have already been exercised
- alternative suppliers
- impact on revenues and solvency risk
- change in law risk (including the impact of travel restrictions, quarantine measures and government-mandated closures) and government initiatives
- insurance, and
- health issues, including the implementation of appropriate precautionary measures.
Buyers could consider including a condition precedent for a specific (and high impact but low likelihood) coronavirus-related issue identified during the due diligence process. However, assuming the virus is likely to have a significant but time-limited impact, it is perhaps more likely that the transaction will be put on hold until the situation has stabilised, unless there is an urgent reason for entering into it (eg a distressed seller).
Material adverse change
The impact of the virus will probably not trigger a generic Material adverse change (MAC) agreed since news of the virus was widely reported (at that point an adverse effect was perhaps foreseeable, in many cases the virus is may be unlikely to have a long-term impact on overall earnings potential, and it may be caught by any carve-out for changes in general market conditions). It also seems unlikely that sellers will concede a MAC that is specifically related to the impact of the virus unless, perhaps, it is linked to a specific risk (like termination of essential contracts) or triggered by an actual (as opposed to anticipated future) financial impact in the period between signing and completion. If a deal is to include a MAC, the seller should consider including an express coronavirus-related carve-out.
Sellers should check they can comply with pre-completion conduct of business covenants, whether general commitments about ordinary course of business or trading, or specifically linked to contracts, production or employees. Obligations to finalise appropriate contingency plans may also be appropriate.
Warranties and repetition
Buyers should consider requesting warranties around risk assessments, scenario planning and adverse impact of the virus. Sellers conceding these should seek knowledge and materiality qualifiers, and avoid subjective or forward-looking warranties, and repeating warranties at completion.
Sellers should consider a general coronavirus-related exclusion of liability. Ring-fencing (so that coronavirus-related claims can only be made under specific warranties and not under general warranties like the accounts warranty), buyer’s knowledge, changes in law and other limitations may also be relevant.
Sellers should carefully consider the need for coronavirus-related disclosures (for example against material contracts warranties), being as specific as possible to satisfy any requirement for ‘fair’ disclosure.
Targeted indemnities for specific known risks may be appropriate. Much will depend on the relative bargaining power of the parties, and sellers are likely to insist that any indemnity is of limited duration and capped at an appropriate amount.
For more information on the potential impact of coronavirus on your business or transaction, please speak to your usual A&O contact or to any of the contacts listed.