COVID-19: Emerging trends in M&A deal-structuring

COVID-19 has had a significant effect on mergers and acquisitions globally, with a lot of on-going transactions pulled or delayed due to the uncertainty caused by the pandemic, and at least until parties have assessed the impact on their financial positions. It is estimated that worldwide merger activity so far this year has the lowest year-to-date figures for dealmaking since 2013. 

The substantial change in operating conditions for most companies as a result of the pandemic has forced a lot of parties to ongoing transactions to consider termination of terms, particularly for transactions that were still in early negotiations. Where binding offers were signed, and parties decided to terminate, it’s been necessary to examine the termination clauses in such binding offers and the implications of termination, e.g., if any break fees would be payable. Additionally, parties are examining force majeure clauses to determine if the pandemic would constitute a force majeure event warranting a termination of the binding offer with minimum liability to either party. 

For parties who have decided to proceed with their transactions, the trend appears to be re-negotiation of terms, taking into account disruptions caused by COVID-19 on the operations of target companies. The following trends have been of interest: 

  • Material Adverse Change: A natural consequence of the pandemic has been the treatment of material adverse change (MAC) clauses. MAC clauses are traditional buyer deal protection clauses and the definition of a MAC event is usually heavily negotiated. As a result of the pandemic, there is a lot more negotiation around the broadening or narrowing of MAC events, depending on buy or sell side.  Additionally, buyers are increasingly requesting stand-alone conditions to closing in relation to the non-occurrence of MAC events, especially where there is a significant amount of time between the execution of transaction documents and closing. 
  • Purchase price considerations: Due to the effect that the pandemic has had on target companies’ financial positions, parties are leaning towards abandoning the locked box mechanism in favour of the more traditional purchase price adjustment mechanism. It is also anticipated that while buyers may prefer the purchase price adjustment mechanism, sellers are likely to negotiate earn-outs in the event that the target company’s performance exceeds revenue expectations within a certain time frame. Given the unprecedented effect that the pandemic has had on revenues of companies globally, sellers should anticipate heavy resistance to earn-out provisions since same would typically be based on projections that are now uncertain due to recent global events.  
  • Representations and Warranties: In addition to the customary representations and MAC qualifiers, it is anticipated that buyers are likely to require that certain specific representations are made with respect to COVID-19 and its impact on a target company’s material customers, material contracts, material suppliers, employees, and the target’s material assets.
  • Due Diligence: It is likely that buyers will require additional confirmatory due diligence particularly on forward-looking positions that have been impacted by COVID-19, the effectiveness of crisis management procedures, insolvency risk, liabilities arising out of actions taken with respect to employees in response to the pandemic, to mention a few. 
  • Transaction Timetables: Parties are generally negotiating timelines that take into account the reduced operating capacity of regulatory authorities around the world as the world slowly eases lockdown measures. 
  • Representation and warranty insurance: While W&I insurance has become quite prevalent in acquisitions in recent times, an emerging trend is that underwriters are generally excluding COVID-19 and its impact from coverage. Therefore, parties will need to structure feasible risk allocation structures in anticipation of this trend. 
  • Financing arrangements: In leveraged buyouts, buyers are taking care to ensure that certain terms such as MAC events are defined consistently in both the acquisition and the financing documents. Financial covenants in financing documents will also have to be consistently drafted in line with due diligence findings on targets arising from disruptions from the pandemic. 

Although globally deals are at a 7 year low, there is a lot of optimism that deal flow will resume especially as buyers and sellers continue to assess opportunities. There have been a number of recent notable high-value transactions, particularly in the Gulf Cooperation Council (read about Abu Dhabi National Oil Company’s recent USD 10 billion transaction here ), which are bound to return investor confidence in due course.