Merger And Acquisitions In The Times Of Covid-19

The ramifications from the spread of coronavirus are being felt strongly across industries

As with any contract, the devil is in the details

It is important to revisit the definition of MAC

With each passing century, humankind has become ever more vulnerable to epidemics due to a combination of a growing population and better connectivity. Despite that, both the incidence and impact of epidemics have gone down dramatically in the last few decades. There has always been a reason to believe that in the arms race of doctors and germs, doctors run faster!

That may be the reason that even with ample warning of the risk of new viruses, we failed to set up defences against Covid-19 or other infections. In addition to the human impact, there is a significant commercial implication being felt globally. The ramifications from the spread of coronavirus are being felt more strongly in some industries as opposed to others and have also affected numerous aspects of the M&A world.

This note identifies challenges in the M&A environment, presented by the novel virus, and attempts to analyse the nuances of the document one relies on when things go wrong – The Insurance Policy

Office lockdowns and travel restrictions have been slowing the due diligence process and, in some cases, have resulted in deals being postponed or even cancelled. Deals are commonly priced based on multiple of turnover numbers, which given the current situation, are difficult to predict resulting in valuations of target companies being adversely impacted.

The risks for portfolio companies really depend on whether they are in the ‘essential business’ category if they are prepared to address and handle mandatory lockdowns, workforce health and safety concern, data breach considering the compromised availability of firewalls during WFH (the acronym most of us are familiar by now), cash flow issues or possible insolvencies, the strain they are facing in complying with any provisions in material contracts.

As with any contract, the devil is in the details. We have all at some point been guilty of overlooking the fine print of legal documents. However, this is the time, we need to revisit some of the clauses to get a hold of where we stand.

Force Majeure (FM)

By law, this means an unforeseen circumstance (outside of the party’s control, such as a natural disaster, act of terrorism or war) that prevents someone from fulfilling a contract. This is an exception of what would otherwise translate into a breach of contract. The list of types of events that could trigger the FM clause may vary and include epidemic or even government-imposed lockdowns.

Some contracts provide for a pause feature, where things can be put on hold until the FM event is resolved, while some contracts provide for some amount of limitation in time after which either party may cancel the agreement post giving notice of a certain number of days.

Material Adverse Change Or Material Adverse Effect (MAC/MAE)

This clause again provides the right to either party to terminate the contract in case of any event that has a tremendous negative impact on the economic viability of the transaction. Here too, language is key. It is important to revisit the definition of MAC to check if it is broad enough to capture what effect a pandemic will have on the representations.

Indemnity, Representation Or Warranties

It is essential to carefully draft the wordings of each indemnity, representation and warranty. With the Covid-19 situation, it may have so happened that some of the negotiated R&W do not hold true anymore. Example, a target company’s financials may now look very different or its supply chain may have been massively impacted.

While the negotiating power may not always be in your favour, but at least having regard to some of the above points will stand you in good stead.

Coming to the next big contract that is expected to deliver when things go wrong – Insurance. The insurance company does promise to have your back at the time of a covered peril operating/ loss/ breach of R&W, however, to limit its losses, insurers have introduced the concept of exclusion to the cover offered.

With the uncertainty of Coronavirus and the massive outbreak witnessed across countries, industries and companies, insurers have included exclusions related to Covid-19 in their policies as well.

Below are some of the exclusions that have been included in policies that are in consideration lately:

  • Losses arising out of the Covid-19 Virus
  • Communicable Disease Exclusion (Including, not limited to, a virus, bacterium, parasite or other organism or any mutation thereof, whether deemed living or not, regardless of the method of transmission)
  • Pandemic or epidemic, as declared as such by the World Health Organization or any governmental authority
  • Losses arising from or relating to any business interruption or other business downturn solely to the extent such interruption or downturn arises out of the coronavirus (including any resulting Covid-19 sickness) or any government or other regulatory sanctioned response thereto
  • Losses arising due to Pollutants (where the virus has been categorized as a pollutant, thereby excluding the coverage)
  • Loss that represents the portion of Loss that is increased by the Covid-19 virus

Most of the above exclusions encompass any and every loss that may be related to Covid-19. The scope of the exclusion can be limited post negotiation excluding coverage of only certain focused R&W depending on the operational profile of the target company example labour and material representations. A few insurers may be willing to narrow the exclusions post completion of the underwriting and diligence process

  • Loss arising out of the loss of key personnel/management due to the Covid-19 virus
  • Loss arising out of supply chain interruption due to the Covid-19 virus

Buyers are then in a better place and can diligence specific areas or exposures. They can also request a larger seller escrow for matters excluded from the policy.

As scientists are throwing different chemicals into test tubes hoping to chance upon some new medicines that will control the virus, our expectation is that in the long run, R&W insurance will again become competitive in terms of coverage and move back to the standard exclusion of ‘known risks/breaches’.

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Written by Pankhuri Saxena


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