The COVID-19 virus is impacting on pretty much everything at the moment, and this includes corporate transactions. We have identified our top 5 issues for anyone who might be undertaking (or in the process of negotiating) the sale of a business or company during this challenging and uncertain period.
1. Material Adverse Change (MAC) Clauses
Some buyers will obviously want to reconsider whether or when to proceed with the transaction in the current climate.
Parties who have already exchanged contracts but have not yet completed will want to review their agreement, and in particular any MAC clauses.
Broadly speaking, a MAC clause may allow a buyer to terminate the contract and withdraw from the transaction prior to completion on the basis of a material adverse change affecting the target business. Whether the COVID-19 outbreak constitutes a material adverse change will depend on the particular wording of the contract in each case; the actual and/or likely future effect of the virus on the business; and the timing of exchange of contracts. If the parties were already aware of the potential impact of the virus before exchange then it will be more difficult to rely on the MAC clause to withdraw from the deal.
Where the parties are planning a split exchange and completion and have not yet exchanged contracts, the buyer is likely to want to include some very clear wording within the MAC clause to ensure they can withdraw if it becomes clear before the completion date that the effect of the virus on the target business is more serious than currently anticipated. Conversely the seller may want to try and expressly exclude epidemics and pandemics from the MAC clause arguing that this is now a known event that should be factored into the buyer’s decision to proceed at the outset. As ever the final position will depend on the negotiating position of both parties.
2. Restructuring the Purchase Price
Both parties might still wish to try and complete a deal but cannot agree whether the original purchase price remains sustainable, perhaps because it is too early to assess the full impact of the virus on the target business. In this case, it might be possible to agree a mechanism for deferring part of the purchase price known as an “earn out”. Typically the sale agreement would contain a formula for determining the amount of deferred consideration depending on the target business’ profitability during the first year or so of trading after completion of the sale. If profits are badly hit by the virus then the buyer ends up paying less after completion, while if the impact of the virus turns out to be less serious than expected the buyer pays more.
The seller will want to include protections in the contract to try and prevent the buyer from artificially suppressing or diverting profits in order to pay less under the earn out.
The tax treatment of earn out payments can be tricky so always take specialist tax advice.
3. Due Diligence
In addition to the usual legal due diligence which is undertaken in respect of the target business, most buyers will want to fully understand the likely impact of COVID-19 before proceeding with the transaction. This will depend on the type of business, but a prudent buyer should consider asking a seller about:
- whether customers have already started to terminate contracts or stopped paying
- whether essential suppliers are still in a position to provide their goods or services
- whether the business has adequate IT systems to allow staff to work from home
- how many staff are currently working from home, off work altogether or working reduced hours
- sick pay, redundancy and crisis management policies and practices
- relevant insurance policies
- availability of any emergency grant or loan funding
The legal and financial due diligence processes should focus on the target business’ ability to manage the current circumstances, and the financial impact of doing so. It will be vital for the buyer to know that the target will be able to preserve its status of solvency in light of any liquidity issues. All of the issues which are identified in this stage can then be dealt with through the negotiation of warranties and indemnities in the usual way.
4. Reviewing the Warranties
The warranties given by the seller, and the disclosures made by the seller against those warranties, are a key part of most company and business sales. The impact of COVID-19 could include:
- for those who are still negotiating the transaction terms, more focus may be placed on the warranties relating to recent trading, key customers and suppliers, staff policies and working arrangements, IT systems, insurance and financing
- agreeing what level of disclosure is going to be acceptable where the seller is disclosing information about the impact of the virus on the business, in particular does the buyer want to amend the definition of what counts as “fairly disclosed” to include further obligations on the seller?
- will the buyer insist on indemnities where the seller has disclosed details of the adverse impact of the virus on the business, thereby shifting some of the financial risks back to the seller?
- if a contract has recently completed or a split exchange and completion structure requires a repetition of the warranties on completion, is there a breach of warranty or will there be a breach of warranty when they are repeated at completion without making the necessary disclosures?
- where undertakings or warranties are given by the seller to operate “in the ordinary course of business” before completion, do any of the exceptional steps now being taken by many businesses in response to the virus amount to a breach of those undertakings or warranties?
Many share and business acquisitions are funded by third party financing. COVID-19 is likely to impact on acquisition financing, such as bridging loans or long-term debt, both in terms of availability and repayment terms. Even in normal circumstances buyers will usually want to avoid committing to any legally binding agreements unless and until they have secured unconditional funding, but in the current climate particular care is needed to avoid becoming bound into an agreement which can no longer be financed.
The information on this site about legal matters is provided as a general guide only. Although we try to ensure that all of the information on this site is accurate and up to date, this cannot be guaranteed. The information on this site should not be relied upon or construed as constituting legal advice and Howes Percival LLP disclaims liability in relation to its use. You should seek appropriate legal advice before taking or refraining from taking any action.