We have seen some acquisitions in their early stages be deferred until later in the year while both buyers and sellers wait for stability, when they can get a better idea of target values. Other transactions will continue to their agreed conclusion, the parties being committed to what they have previously decided and confident that is the best course of action. In that case, we recommend that parties apply some care and attention to the effects that COVID-19 may have on the target and arrangements governing its transfer on sale.
Generally, the usual steps required to complete acquisitions remain available for the time being, including litigation searches and the obtaining of regulatory consents and competition law determinations where applicable. Transactions should, however, build in flexibility for potential delays in these steps. Similarly, completion resolutions and meetings may require greater flexibility as to timing, particularly when needing to seek ratification by shareholders not present in person that allows for a poll to be conducted, although traditional proxy methods will probably remain sufficient in most instances. Thankfully, remote execution of documentation using electronic means is also available.
The COVID-19 situation has led to some re-examination of how acquisition agreements deal with uncertainty and their ability to adapt to current circumstances. Parties have historically attempted to deal with uncertainty by using force majeure clauses and material adverse change provisions either to modify their obligations or, potentially, to walk away from a deal. These provisions have been developed over many years to deal with numerous events not specifically addressed by the agreement between buyer and seller. We are now faced with an event which we can identify, but the outcome of which remains uncertain. Rather than relying on clauses that have been developed historically to deal with issues such as general strikes, industrial pollution, wars and the like, it is appropriate to consider much more specific provisions identifying the issues arising form COVID-19, allocating risk, or providing for a sharing of risk, or even relieving the effects of the situation altogether.
Some have commented on the difficulty of achieving an appropriate valuation for a business in current circumstances. Ultimately, this difficulty can be overcome. More challenging are any future valuation and payment obligations. Deferred consideration provisions generally determine the amount payable as a result of applicable business turnover and client retention over a defined period. If that turnover is adversely affected by a market downturn that turns out to be transient for a short period only, the buyer may get a reduction in consideration payable while still acquiring a business that has been materially discounted against its true value; needless to say, to the detriment of the seller. The parties may feel that it is more equitable to use devices to average out a downturn and to balance the risks taken by both sides. Allowing for an extension of the relevant period prior to completion for the calculation of turnover may appear attractive to the seller, but a buyer will not wish to pay on the basis of past performance when there is a long term lull. It may be that the final calculation of deferred consideration needs to be extended in whole or in part to take in a longer period to provide the desired smoothing, or even that it be resolved with an issue or retention of participating but non-voting equity.
business as usual implications
Standard provisions which require a business to operate in its “usual manner” immediately before a transaction completes will also require re-examination. It is in the interests of both the target business and the buyer that a business have freedom to react appropriately to changed conditions in order to preserve the value of the target and to enable its directors to discharge their duties in respect of its management. Instead of using standard provisions that result in the vendor breaching a covenant or warranty, these arrangements now need to be dynamic and allow the buyer an appropriate right of disclosure and/or consultation without itself becoming a shadow director of a target.
Both parties may agree to share the risk of the success or otherwise of transition arrangements, which may be subject to significant alteration or delay, either due to social isolation measures preventing access to relevant materials or equipment or due to a resulting supplier failure. Delay may also be a factor taken into account in respect of deferred consideration. Migration of systems etc. may not, for instance, be successfully completed remotely and parties will have to consider the likely issues, financial consequences and expenses associated with the impact of COVID-19 as a result of delayed transition. Mechanics governing modification of such plans may be built into documentation, whether solely contained in transitional services agreements or within the acquisition agreement itself.
We do expect the generation of new warranties, as if there are not enough already. For a seller, it would be ideal to seek to exclude adverse effects arising from COVID-19 from warranties. A buyer is unlikely to accept all of the associated risk and to at least require warranties regarding the ability of employees to work remotely, that remote capacity has been tested and that to do so will not cause any breach of law or regulatory requirements. A seller should avoid any warranty that the target is generally robust against the effects of COVID-19 on its operations. Buyers will have to be more specific in order that sellers can properly assess the risk associated with the warranty. Warranties may also be sought regarding the ability of the target to operate without key personnel adversely affected by COVID-19. Our advice would be to resist any such warranty unless this has been represented as a key sale feature. The passing of all such risk to a seller is inappropriate and other devices should be used where there is agreement to share the risks potentially posed to the target as a result of COVID-19. Warranties confirming that specific procedures are in place and have been tested successfully (which should include the parameters of what constitutes success, such as allowing a defined number of employees to continue operations) would be appropriate. Warranties regarding third parties will also have to be re-examined, particularly if a seller can be demonstrated to have been aware that the third party is itself exposed to risk.
While the usual devices for risk allocation will continue to play their part, extraordinary circumstances dictate that clients be encouraged to reconsider these devices in the light of recent events and to consider what the specific risks are to their business and their acquisition targets and to ask their advisers to ensure that these have been addressed appropriately in the documentation.