Covid-19 threatens surge in M&A disputes
07 October 2020
The pandemic has led to a sharp up-tick in disputes between buyers and sellers, with the prospect of litigation and arbitration on aspects of the deal process that have rarely been tested before.
In the hard-bargaining atmosphere of fiercely fought M&A deals, it is not uncommon for disputes to develop between buyers and sellers.
In the past, where parties have been unable to resolve their disagreements commercially, we have seen a steady flow of such disputes being resolved before an arbitral tribunal, where the agreement includes an arbitration provision, or, otherwise, in court.
The dramatic damage inflicted by the Covid-19 pandemic on companies across sectors has led to a surge in M&A-related dispute enquiries from clients, whether they be buyers, sellers or targets. This trend looks set to continue.
It is still early days. While there have been a number of interim rulings, few Covid-19-inspired cases have yet resulted in substantive judgments or arbitral decisions.
However, there has been a noticeable spike in litigation threats and lawsuits being filed and we will see some coming to trial or involving hearings in the coming months (where answers are needed on an expedited basis eg because of an impending completion date).
Some will test aspects of the transaction process for the very first time.
Points of conflict
Disputes are cropping up in a number of areas.
Conflict is arising around deals between exchange and completion as a result of investment propositions possibly looking very different since the onset of Covid-19.
Buyers are increasingly seeking to rely on Material Adverse Change (MAC) clauses or force majeure (or equivalent) clauses.
Alternatively, buyers are looking to rely on legal doctrines such as frustration or impossibility (depending on the jurisdiction in question), or to trigger historically rarely-enforced contractual provisions, including:
- covenants to operate in the ordinary course of business;
- failure to “bring down” or repeat representations and warranties on closing; and
- failure to provide documents and information.
The aim of this action varies.
Buyers are generally looking to:
- get out of the deal altogether;
- stall the deal until market conditions improve; and
- force a renegotiation on price.
Sellers, on the other hand, tend to prioritise getting the deal across the line on the agreed terms, or, in some cases, agreeing to some, preferably limited, changes.
The approach taken by the parties will be dictated by the strength of their respective legal positions, their bargaining power and various other factors. For instance:
- availability of financing;
- existence of break fees or reverse break fees;
- availability of deposits to be drawn down on in the event a party walks away;
- existence of other suitors waiting in the wings;
- parties’ wider strategic plans; and
predictions on how Covid-19 will play out in the relevant sector.
Pre-Covid-19 terms may no longer appear attractive
Elsewhere we are seeing disputes around signed deals that require conditions precedent to be satisfied, often against a specific timeline.
These draft terms may have been acceptable before Covid-19, but may now be difficult or impossible to achieve. Here, again, there may be threats of litigation, although in our experience parties are generally trying to renegotiate disputed parts of the agreement without putting the entire deal at risk. We have, however, also seen buyers using the failure to meet the strict timing for conditions precedent to try to avoid completion altogether.
Completed deals also face complications
Another area of dispute centres on completed deals, for example where disputes have arisen between shareholders or partners in a joint venture due to the impact of Covid-19 on the business.
In more benign circumstances, these disputes may not have crystallised. Now, investors are more willing to raise issues, if doing so enables them to renegotiate agreements or to make an exit. Strategic priorities and risk appetite may have altered due to the changed business environment, as a result of which there is a greater willingness on the part of investors to enforce their rights.
Disputes are also surfacing around consideration, for example where earn-out or deferred consideration has been agreed. Earn-outs are conceptually quite straightforward. However, they are commonly the subject of post-M&A disputes. This is likely to be even more the case following Covid-19, in relation to:
- poorly defined metrics;
- uncertainties over the timing of meeting targets; and
- the scope of any restrictions on the target or buyer’s ability to take certain steps during the earn-out period that could influence whether the earn-out is realised, or its quantum.
The risk of further pandemic waves will add more complications.
Covid-19 disputes cover new ground
In the past, in many jurisdictions, triggering MAC and ordinary course covenants has been a rarity. With the onset of Covid-19, these suddenly took on a significance that the drafter had almost certainly not foreseen.
There is relatively little case law, for instance, surrounding MACs in English, Hong Kong and U.S. law.
So, this is a whole new area for courts and tribunals to grapple with. Precedents will, with a few exceptions in certain countries, predate the Covid-19 crisis. In any event, these clauses are often bespoke and tailored to the specific needs of the transacting parties, so judicial precedents may be of limited value.
For instance, some MAC clauses might include a valuation threshold.
We recently advised a buyer on a case where the MAC clause under the sale and purchase agreement (SPA) was triggered if valuation fluctuated by 20% or more between signing and completion. The significant movements in the market meant the buyer was able to make a strong argument that it was not obliged to complete the transaction. The deal did complete eventually, but at a lower price.
However, the majority of MAC clauses do not contain an objective threshold, leading to significant uncertainty as to whether the clause has been triggered.
Similarly, covenants to operate in the ordinary course come in very different forms. Some may be qualified through the use of “reasonable efforts” or “best efforts”; others by reference to “past practice” or the actions of comparable companies in the same industry. The issue of consent is also proving to be fertile ground for disputes.
Moreover, what about the impact of government measures designed to stem the spread of the virus? These raise all kinds of questions. For example, should a seller be penalised for having been forced to close or suspend operations and furlough staff to meet government-imposed restrictions? What if it needs to take out emergency financing in order to remain a viable enterprise?
Sectors seeing the most disputes
- Travel and tourism
- Transport, notably aviation
- Real Estate, particularly commercial
Overseas investors are also growing increasingly concerned that discriminatory taxes or disguised measures, such as unjustified regulatory fines, may target them, as governments seek to recover the costs of fighting the pandemic.
Some are seeking to exit investments in what they consider to be high-risk jurisdictions, or renegotiate, to ensure they are protected under international investment treaties.
This situation has been exacerbated by the continuing trade war between the U.S. and China and by a growing trend towards protectionism. Traditionally these issues were of greatest concern to natural resources companies, but increasingly telecommunications and tech-related investments are also under threat.
The valuation conundrum
One of the biggest uncertainties in M&A deals surrounds the valuation of assets.
Even before the crisis, buyer and seller price expectations were diverging. Now the question is, how do buyers and sellers value assets, not only immediately, but also in the medium and long term?
In many cases, parties accept that Covid-19 is an exceptional event and are willing to see their deals through, perhaps with slightly amended terms.
However, inevitably, in some instances the stakes are simply too high and the positions of the parties too divergent for a settlement to be reached.
For new transactions launched since the onset of Covid-19, we are seeing a more sophisticated approach to negotiating and drafting agreements, particularly around MAC and force majeure clauses as well as covenants that have come to the fore since the pandemic.
But where a deal has already been signed and the gulf between buyers and sellers is too wide to bridge, this is likely to result in hard-fought litigation, with often substantial sums and reputations at stake. The novelty of the situation and the absence of settled case law in some areas means the outcome of these disputes is difficult to predict.
If the global financial crisis is anything to go by, court battles will not only be fiercely contested, but also last a long time.
In times of increased litigation threats, businesses need to think ever more strategically, and where appropriate, leverage the varying approaches taken in different jurisdictions across the globe.