COVID-19 and impact on the negotiation of M&A transactions
The health crisis related to COVID-19 had a significant impact on merger and acquisition transactions during this period.
The announced economic crisis could also have a significant impact on the activity related to these transactions despite the measures taken by the French government.
Companies, depending on their business sectors, may be in a range of situations from those not affected to those whose activities have been halted, suspended or affected.
In this new period of crisis, relations between sellers and buyers will no longer be the same as the latter will try to manage as best they can the risks related to the deterioration of the economic context. As a consequence, risk management will be at the center of future M&A transactions.
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Covid-19 obviously had an impact on the M&A ongoing transactions during the health crisis. However, it also seems obvious that it will leave its mark on future transactions.
Impact on ongoing transactions
As for all the different economic activities, merger transactions between companies have been largely impacted by the Covid-19 crisis.
It is difficult today to make a precise and exhaustive assessment of the continuation or not of the transactions during this period.
Moreover, for such an assessment to be relevant, it is still necessary to take into account the state of progress of the negotiations between the parties at the time of the health crisis (due diligence phase, signature of the share purchase agreement, completion of the sale) and also to take into account the sector of activity.
Initial data seem to indicate a decline in M&A activity on the global market of nearly 40% for the first half of 2020 compared to last year. Major M&A deals have been multiplying since this summer (Veolia Suez offensive, Altice USA bid for Cogeco or LVMH bid for Tiffany). The momentum seems to have picked up again, even if business worldwide remains significantly lower than in 2019.
The occurrence of Covid-19 had various effects on transactions: the conditions of the transaction (in particular the price and the representations and warranties) may have been called into question, the transaction itself may have been called into question or the timetable of the transaction may have been called into question. This is what happened, for example, in the United States in the Victoria's Secret and CorePower Yoga cases, where the court had to be seized to enforce the sale. Each situation is different depending on the target, the buyer, the financing and the sector involved.
For transactions that were not yet definitively completed, there was a real risk that the occurrence of the virus could justify the end of negotiations between the parties without this being considered abusive by the courts.
Nevertheless, we note that the M&A transactions have continued despite this particular context, even with terms different from those initially planned.
This crisis will have a profound effect on future transactions and has brought back to the forefront contractual renegotiation mechanisms that have sometimes been forgotten, the usefulness of which seems much more obvious today.
Impact on future transactions
This crisis has brutally highlighted one of the main challenges of M&A transactions: the management of risk and uncertainty. This issue is particularly important when there is a long period of time between the signing and closing of a deal.
It is important to remember that there are nowadays several contractual mechanisms that try to mitigate this problem: Material Adverse Change (MAC) clauses, hardship clauses, representations and warranties or even the adjustment of the sale price.
The purpose of MAC clauses is to specify the conditions under which a transaction may be terminated following the occurrence of an event that could significantly impact the situation of the target company. This clause protects the interests of the acquirer since it gives it the possibility, according to the conditions negotiated with the target, to exit the transaction. It is advisable to be as precise as possible on the drafting of the clause in order to avoid litigation on its application. The pandemic will certainly multiply its use and practitioners will not fail to refer directly to this epidemic (or a health risk) in their clauses in the future. This clause may prove particularly useful between the signing and the closing, integrated as a condition precedent of the transaction.
Hardship clauses could also be emphasized in future M&A transactions. This clause makes it possible to require that new negotiations be opened when the occurrence of an event of an economic or technological nature seriously disrupts the balance of the services provided for in the contract. The parties, in order to avoid the uncertainty of the applicability of Article 1195 of the Civil Code on hardship, may decide contractually upstream the conditions for the application of hardship clauses (definition of imbalance, contingency situations, effects of the clause ...). Unlike the MAC clause, the clause only allows for a renegotiation of the terms of the contract, the consequences of which will be to be negotiated between the parties.
The negotiation of the representations and warranties of the sellers for the benefit of the buyer is also likely to be more difficult. The problem with these representations and warranties is that they are negotiated as soon as they are signed but reiterated on the day of closing. In the event of a long period between the signing and the closing, there is a real risk that they cannot be verified on the closing date, in particular if a guarantee was provided on the management of the company during the current financial year and that a crisis such as the Covid crisis would occur. In the future, mechanisms for updating these guarantees in the event of exceptional circumstances may be imagined.
Finally, one of the most obvious levers is the selling price. Instead of a fixed price, buyers will increasingly want to resort to a price that can be adjusted on the basis of certain objective criteria. Earn-out clauses should therefore be more and more present in the absence of locked box mechanisms providing for a predetermined fixed price as of the signing.
As we have seen, this crisis will therefore be an opportunity for legal practitioners to confront new issues in order to secure the divergent interests of the parties as much as possible.