Issues in private M&A resulting from COVID-19

The COVID-19 pandemic has changed the way we do business, resulting in many changes to the law to deal with the economic and social changes and it will no doubt change the way transactions are implemented in Australia. This piece is designed to prompt thoughts of what changes may be required in private M&A documents in order to accommodate and allocate risks (and to deal with procedural and logistical matters) relating to COVID-19 and the fallout from this pandemic.

Material adverse change or material adverse effect clauses

One of the first provisions in a sale agreement which a purchaser may look to for deal protection is a material adverse change (MAC) (or material adverse effect) clause either as a condition to completion or as an express termination right.

Sellers may seek to expressly exclude the effects of COVID-19 (or pandemics generally) from a MAC clause. Indeed, it is typical that matters which affect the economy generally are excluded from matters which would otherwise constitute a MAC, so it will be interesting to see whether practice evolves to expressly include pandemics as a MAC (on the basis that this would exclude them from the customary exception for events which affect the economy generally).

For deals signed in the near-future, and brokered on the basis that the worst of the pandemic has passed, a purchaser should consider expressly including the occurrence of a second-wave of the pandemic as a MAC event (with or without a requirement for a certain economic threshold to be reached to establish a that MAC has occurred).

Conditionality (including regulatory approvals)

In an uncertain market, purchasers seeking greater deal protection and flexibility may take some comfort from more conditionality in a sale agreement. Some examples that a purchaser may seek to include (in addition to other purchaser-friendly conditions relating to no MAC and no breach of material warranty) are:

1. a condition that no material customers or suppliers have cancelled orders, defaulted on any payments, suffered an insolvency event or invoked a force majeure clause in any agreement with a member of the target group;
2. a condition that there have not been, in the purchaser’s reasonable opinion, any legislative measures taken by a government authority which: (i) have a material adverse effect on the business; or (ii) prohibit either certain activities of the business or prohibit customers or suppliers dealing with the business (consider whether this condition would be duplicative of a MAC (if included));
3. if the deal was predicated on the basis that the worst of the pandemic had passed, a condition that no further outbreaks or second waves of COVID-19 have occurred (although query what measures would be used to determine whether a further outbreak or second wave had occurred and whether this condition would be duplicative of a MAC (if included)); and
4. if there is a lengthened period between signing and completion, that certain financial metrics are achieved in the intervening period. In cross-border transactions, this might include a condition that exchange rates have not moved outside pre-determined parameters, or a condition that the financial performance of the target group has exceeded certain thresholds in the period immediately prior to completion.

Under the recently amended FIRB regime, as part of the Federal Government’s response to COVD-19, a new form of FIRB condition will be required in order to accommodate both the granting of approval (or, rather, “no objections”) from the Treasurer and, if sooner, the lifting of the restrictions on foreign investment applicable to the transaction. The parties will also need to revisit the length of sunset dates for the satisfaction or waiver of conditions to accommodate the extended time required for approval to be obtained from FIRB.

Due diligence, warranties, indemnities and W&I insurance

The warranty and indemnity regime in a sale agreement will be another obvious avenue for purchasers to seek protection from the effects of the pandemic on the target group.

From the outset of the transaction, due diligence should be focussed on the ability of the target and its counterparties to continue to operate in a less certain business environment.

The review of a target’s contracts should include particular attention to the following provisions: term, termination for convenience, suspension rights, pricing, force majeure and obligations for minimum orders. On the supplier side, contract review should make note of whether for example, if the target were to take cost-saving measures post-completion, it would be entitled to terminate or suspend expensive supply agreements, suspend obligations, reset pricing, switch to cheaper alternative suppliers or reduce the amount purchased from suppliers under those contracts.

From an employment law and industrial relations perspective, any pre-completion restructuring or redundancy exercises should be carefully reviewed, as well as ongoing relationships with unions and the target group’s obligations to comply with industrial instruments, each of which may make any proposed redundancies or restructuring more difficult. Also, if the target has taken advantage of any recently-announced stimulus measures such as the JobKeeper scheme, eligibility for, and compliance with, any such schemes should be scrutinised.

Looking at due diligence from a practical perspective, the operational aspects of due diligence may require a different approach, given that some operations are closed, with employees stood down, offices closed (with the potential for delays in access to primary source documents) and management may not be available to travel or attend management presentations.

Purchasers should consider what additional or tailored warranties should be included in the suite of warranties and indemnities to drive disclosure and to allocate pandemic-related risk to the sellers. Some examples may include warranties with respect to:

1. any of the target’s customers cancelling orders, seeking to rely on force majeure provisions, defaulting on payment and / or seeking relief from payment terms;
2. the target’s insurance coverage for pandemic-related losses;
3. the possible effects on the target’s supply chain and inventory and whether any suppliers have defaulted, materially delayed deliveries or sought to rely on force majeure clauses; and
4. the actions taken by a company in dealing with the effects of the pandemic (for example. the making of redundancies or eligibility for, and compliance with, government stimulus package measures) or their readiness to respond to another pandemic.

Finally, if the transaction envisages coverage by warranty and indemnity (W&I) insurance, close scrutiny should be given to the breadth of pandemic-related exclusions in the W&I policy. We are already seeing very broad exclusions included in policies for any loss arising from, or which is increased by, COVID-19. The very wide ambit of such exclusions has the ability to cut across entire swathes of warranty protection, decreasing the value of the protection offered by such insurance. If exclusions of this nature cannot be negotiated out of the policy or restricted to a sensible scope, the purchaser may require comfort that any excluded coverage is compensated by the sellers or related parties (and adequate credit support is in place in respect of such coverage).

A further consequence of the new FIRB regime (together with its extended processing time for applications), is that transactions requiring FIRB approval will have extended intervening periods between signing and completion. As a result, new breach cover may be more attractive to purchasers than in a transaction with a much shorter period between signing and completion, however new breach cover may not be offered in all transactions.

Conduct restrictions

In transactions with an extended period between signing and completion, a seller should consider including exceptions to, or providing greater flexibility to comply with pre-completion undertakings for matters required to deal with the fallout from the pandemic. Some examples of this may include permitting the target to make redundancies, increase its borrowing capacity or implement other changes to ordinary course trading (in each case, without the need for the purchaser’s consent).

Similarly, in transactions featuring consideration payable as an earn out, purchasers should consider accepting exceptions to, or providing greater flexibility to comply with, post-completion conduct restrictions (i.e. earn out protections in favour of the sellers). Such restrictions will enable purchasers to deal with matters resulting from the pandemic, which are not otherwise considered ordinary course or which may not otherwise be permitted by the earn out protections.  

Purchase price adjustments

The pandemic may also have an impact on purchase price adjustment mechanisms:

1. in transactions using completion accounts, parties should consider and discuss with their financial advisors how to determine the target working capital and treat particular line items in working capital and whether customary accounting policies are still appropriate in light of the effects of the lock-down on trading and working capital (for example in relation to inventory and accounts receivable/doubtful debts); and
2. parties should prepare for a higher likelihood of disputes in relation to post-completion adjustments and provide for more robust (whilst flexible) dispute resolution mechanics in the sale documentation (while ensuring that those dispute resolution mechanics, including any expert determination provisions, permit the resolution of disputes without the need for face-to-face meetings).

Other matters

There are plenty of other matters to consider not just in sale agreements but in general transaction documents (for example, exclusivity agreements). Some items to give some thought to include:

1. in less certain economic times, sellers should be even more keenly aware of credit support issues and may seek to obtain more comfort than usual that a prospective purchaser will be in funds on completion: sellers should consider the inclusion of a parent company (or personal) guarantee and equity commitment letters.
2. are there other processes which require any face-to-face interaction? Some examples may include dispute resolution clauses which require meetings in person and conditions precedent or due diligence access provisions (not just in sale agreements but in exclusivity agreements, heads of agreement or terms sheets) which permit or require meetings with customers or employees. Be sure to accommodate the necessary flexibility to enable remote interactions between the relevant parties and ensure that due diligence can all be conducted via a virtual data room.
3. consider how the relevant transaction documents will be signed if they need to be signed remotely and in particular, if documents are to be signed in accordance with section 127 of the Corporations Act 2001 and if there are any deeds or other documents which need to be witnessed. The Commonwealth government and various states have recently passed legislation permitting electronic execution and the witnessing of documents by telecommunications such as FaceTime and Zoom. These measures are not uniform across state and federal legislation: for more information, please see this note by our colleagues on the electronic signing of documents.

Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania).