While the COVID-19 pandemic rattles markets, M&A deals continue to weather the storm and proceed, albeit slower than anticipated with more challenges than originally planned. 

Companies currently engaged in M&A transactions “must overcome increased risk and uncertainties,” according to the authors of this article, and prepare for the worst-case scenario.

Many M&A practitioners are dazed by the prospect of closing a signed deal in these unprecedented market conditions, but there are ways to proceed cautiously without jumping towards termination as the sole option in these extraordinary circumstances. 

This paper discusses ten key legal issues and considerations for parties in addressing potential risks and problems in signed, but not closed, deals, and offers insights for parties to consider during renewed negotiations. 

Purchase price adjustments

Surprisingly, there has not (yet) been a spike in announced deal terminations due to the pandemic. However, pre-COVID-19 valuations might be the first renegotiation to be contemplated by buyers, while sellers will look for ways to force buyers to close more expeditiously. Expect buyers to seek to renegotiate purchase price adjustment floors or collars if the target’s working capital and liquidity levels are significantly below the agreed criteria. 

A decline in the target's financial metrics (e.g. EBITDA-to-debt ratios) may also cause lenders to walk away, causing risks for both parties if there is a third-party "financing failure".  

For deals where the consideration will be paid with buyer stock (in particularly where there is a fixed exchange ratio), there may also be governance risk, as stockholders of the target may view themselves as being underpaid and stockholders of the buyer may now be overpaying.

Is COVID-19 a material adverse change (MAC)?

Many parties will immediately turn to material adverse change (MAC) clauses in transaction documents to determine if the recent pandemic qualifies for relief of either party’s obligations. However, MAC clauses are designed to protect buyers from unforeseen events relating to the target’s business or industry and are typically not drafted to cover global economic fallouts. Parties should carefully review the specific MAC clauses in the transaction documents and consider how sensitive the “trigger” is for such clauses to apply.

Interim operating covenants

Conducting operations in the “ordinary course of business”, as typically required in a purchase agreement, is a significant threat to the deal if extraordinary measures are needed (layoffs, capex deferrals, drawing down credit lines, etc.); actions that could breach the covenant and give the buyer a walk away right. These issues will also extend interim period due diligence.  

Bring-down of representations and warranties

Sellers may find it hard to sign off on the accuracy of their representations and warranties at closing - including business continuity, counterparty risks, customer orders, or indebtedness - providing the buyer with another potential walk away right. 

Even if the “bring down” condition is qualified by materiality, addressing the appropriateness and adequacy of remedies should be considered. Transaction insurance underwriters will typically exclude coverage for a known breach so recourse will likely need to be revisited.

Are the regulators working from home?

The paper also discusses regulatory delays and other closing logistics as an important consideration for parties in a post-COVID-19 environment. Parties should expect delays in obtaining government approvals including antitrust, FCC, and CFIUS and negotiate extensions for key deal regulatory approvals. If extending any outside date termination provisions, in particular, the authors caution dealmakers to consider which party should bear the risk of delay and for how long.  

The same caution may apply to the judiciary as deal parties reassess the value of adjudication and enforcement of remedies, such as specific performance if the courthouse is closed.  

In the final analysis, these considerations may incentivize the parties to compromise and negotiate a more balanced deal - rather than abandoning the deal on technical arguments.