As Covid-19 continues to rapidly permeate our society and affect all walks of life, it is imperative to analyse the impact of Covid -19 on India’s economy and particularly Mergers and Acquisitions. The virus has undoubtedly caused business disruptions and economic turmoil, raising various new considerations for parties participating in either proposed or pending M&A transactions. Unpredictability and uncertainty of the post-pandemic scenario has exhorted businesses to focus on managing their core commitments and recovering the time which was lost due to lockdown, forcing M&A deals to take a backseat. Experts during the last quarter of 2019 predicted 2020 to surpass 2019 as the fourth strongest year for M&A on record. Since December, things have changed, rather dramatically due to the ongoing global healthcare pandemic. Enumerated below are some key legal issues and considerations for parties in analyzing and addressing potential risks and problems arising as a result of Covid -19’s impact on signed M&A transactions.
- Material Adverse Effect- The Material Adverse Effect (MAE) or the termination clause typically allows a stakeholder to terminate the agreement in the event of any material adverse change in the seller company. The buyer is not obligated to close the acquisition if the seller has suffered a MAE since the signing of the agreement. The MAE provision seeks to allocate between the parties the risk of certain negative circumstances occurring or existing during the relevant period. Whether a pandemic like the coronavirus can be constituted as a MAE depends on the language used in the contract to define the clause and the repercussions of the pandemic on the seller’s business. Courts have generally adopted a stringent approach while interpreting MAE clauses. Transient adverse circumstances are not sufficient to invoke MAE clauses. The situation should be egregious enough to substantially affect the seller’s business. Hence, resorting to MAE clauses is not an attractive option for parties, considering the high threshold required. Parties should instead use such clauses to leverage bargaining power and alter terms of the deal.
- Representations and Warranties – The pandemic will inevitably force buyers to demand for additional focused representations and warranties from the seller. This is to give the buyer a right to walk away from such deals where representations and warranties given by the seller have become fallacious over time. Further, it also enhances the post closing indemnification remedies available for the buyer. Sellers should strive to limit potential indemnification exposure by including broad disclosures regarding the impact of Covid -19 on the target’s business and providing the buyer with a potential right to walk away as a result of such disclosure updates.
- Pricing Mechanisms – Pricing mechanisms were already prone to discussion and dispute and the pandemic has exacerbated the situation. Sellers would be inclined towards the ‘locked box pricing mechanism’, which fixes the purchase price after evaluating the financial statements before the purchase agreement. On the contrary, buyers would opt for a post-closing purchase price adjusting mechanism, where the purchase price is calculated based on the state of the target business as of closing. This would successfully allocate the economic risk of the target business between signing and closing to the seller. The major problem will be the potential disagreements in adjustment calculations owing to the abnormal inventory levels and unusual numbers for accounts receivable and payable.
- Regulatory delays – The SEBI and the RBI have permitted filing of applications electronically, while the CCI has permitted parties to file combination applications electronically and pre-filing consultations through video conferences. While these are encouraging developments, the approvals and consents required from regulatory authorities should still be a consideration for the parties. Parties should expect delays in obtaining governmental approvals, third party consents and other closing logistics. If a closing is unlikely to occur within the agreed date, parties should be mindful of the right to repudiation that might be available to them. Further, on consensual extension of date, parties should deliberate on the allocation of risk caused by the delay. A potential solution to the delays caused by regulatory approvals would be to adopt acquisition via shares or by compulsorily convertible instruments directly linked to target’s performance.
- Due Diligence – Acquirers must undertake significant additional due diligence to assess the effect of the coronavirus crisis on the seller’s business. If interim due diligence detects material or potential risks that impact target valuations, parties may wish to review their termination rights and consequences, or renegotiate the purchase price. Buyers should diligently identify the impact of lockdown and travel restrictions on the target’s business and should evaluate the effectiveness and use of business continuity plans and crisis management procedures adopted by the seller. Sellers should proactively assist the buyers by providing information about the repercussion of the pandemic on the target’s business.
- Ordinary course of business during interim period – Transaction documents in Indian M&A typically contain covenants for the targets regarding their conduct (which are mostly operational in nature) during the period between execution and closing. A common covenant mandates the target to continue to undertake its business “in the ordinary course of business” which signifies the target’s business to operate on a day-to-day basis as in the past. Owing to the exceptional circumstances caused by Covid- 19, reasonable exceptions should be given to such covenants. Despite the best efforts from the seller’s side, some inevitable ‘rescue steps’ would have been taken without the buyer’s knowledge to meet some challenges initiated by the pandemic. Sellers will be forced to establish that the covenants warranted only commercially reasonable compliance and the deviations undertaken from the “ordinary course of business” will not erode the buyer’s interests.
- Third Party Financing – Transactions that depend on third party debt financing should contemplate on situations where the third party financier refuses to grant funds to the buyer. In such a scenario, buyers would want to include a ‘financing out’ condition, which exonerates the buyer from any liability due to non-payment. Sellers should consider a ‘reverse break fee’ but such a remedy is not preferable under current circumstances. The most ideal option would be to ensure the third-party financing documents will not allow the lenders a way out.
- Difficulties associated with Court Remedies – Seeking court remedies can prove to be extremely burdensome for the parties due to the postponed or sustained docket timelines and revised operational mechanism that engages telephonic hearings and virtual proceedings. Parties can have apprehensions about the relative utility of adjudication and practicability of remedies like specific performance. This would increase the possibility of a compromise between the parties to reach an amicable solution, rather than terminating the deal.
ConclusionIndian economy is entering a slowdown phase. In such a situation, the next 12 months are extremely crucial. As Covid- 19 gradually unfolds, we are bound to witness a change in M&A transactions with deal pipelines largely limited to value buying and bargaining for cheap assets. Although Covid has drastically affected the M&A market, it appears to have triggered reforms in other sectors. Innovative measures have been undertaken by the government in the Health & Pharmaceutical sector to tackle the challenges posed by coronavirus.
As business and regulatory environment surrounding Covid is in a state of uncertainty, the future can present additional concerns and challenges. The coronavirus pandemic might be a humanitarian crisis but it has certainly rattled the business world. Post coronavirus crisis, many companies will have to fight for survival and some may even have to face the prospect of business closure. Stakeholders in an M&A transaction should be wary of the situation to cope with timeline changes and counter the impact of Covid outbreak on transaction documents. While regulatory authorities have tried to address concerns by taking adequate measures, the vast multitude of issues concomitant with the pandemic will definitely have a detrimental impact on M&A deals.