May 20, 2020

COVID-19 in M&A transactions while interim period

M&A transactions privately negotiated are being deeply affected by the sudden Covid-19 outbreak, many in the basics and fundamentals of a recently agreed deal.

In nowadays international transactions M&A agreements signed (e.g. a share and purchase agreement, SPA) require certain events, conditions to be satisfied (e.g. regulatory approvals, conditions precedent) for completion needing a period of time.

For certainty, the agreement provides that business risk passes to buyer right upon signing the agreement. In turn, it is also common to introduce buyer termination rights (apart from other remedies like price reduction): fulfillment of certain conditions precedent, interim period obligation to conduct the business “as a going-concern in the ordinary course of business”, except under the occurrence of an event constituting a “Material Adverse Change” (MAC). Representations and warranties (R&W) are often qualified, subject to the lack of material adverse change event in the target business and/or the seller undertakes to reiterate R&W upon closing.

COVID-19 outbreak occurring during the interim period may cause serious distress in different forms and intensity, affecting the target -e.g. governmental measures prohibiting target’s business activities, operations, suspension of governmental procedures, sudden plummeting of customers’ orders and sales, while structure costs remain, supply chain failures- of the buyer: – inability to transfer non-cash items agreed as consideration (e.g. shares, real property, etc.), failure of its lenders,.. etc.

Deals completed with running earn outs while part o consideration agreed is subject to the performance of target business under the management control of buyer; M&A insurance policy agreements pending signature may be at peril; Auditors are reviewing their approach to financial statements closed just a few weeks before the COVID-19, or about to close addressing going-concern issues…

The impact of the COVID-19 pandemic outbreak leads many to plead force majeure, hardship and in M&A, the application of Material Adverse Change (MAC) clauses generally included in M&A agreements. Needless to say, the urgent issue is now for signed agreements: the solution to the conflicts will depend on how this contingency was contemplated and if so, how clauses are drafted.  Most jurisdictions lack specific regulation on the impact of a pandemic in legal transactions in progress, or running obligations, other than the general statutes on force majeure, hardship, and the like. if parties fail to reach amicable settlement courts will solve, on a case-by-case basis.

In Spain MAC clauses are common in M&A and VC deals as they provide a flexible tool to balance parties risk allocation, but the wording of the clause must be wide enough to cover a huge variety of contingencies and scenarios but also accurate enough to clearly identify triggering events and the effects in the deal.  If this is not the case in agreements already signed, parties will have recourse to the general legal framework in which this matter is quite restrictive to alter the sacred general rule of obligatory fulfillment of contractual obligations (“pacta sunt servanda”) where the parties agreement is binding under the “perpetuatio obligationis” principle. Spanish courts are likely to approach cases in two major ways:

Force majeure – supervening impossibility

The Civil Code provides that no one is liable for those events that could not have been foreseen or that, foreseen, were inevitable based on this Spanish courts developed throughout years “force majeure” doctrine differentiating to categories: (i) Obligations to deliver a certain thing or set of things when it is lost or destroyed without the fault of the debtor will be extinguished, terminated, so the obligor is discharged. But this does NOT apply to monetary obligations, as money is fungible. (ii) Obligations to perform (services): the obligor is released if performance becomes legally or physically impossible for a reason beyond the control of obligor before the due date or expiration.

“Rebus sic stantibus”doctrine.

An elaboration of jurisprudential doctrine also highly restrictive emerged from the 2008 financial crisis, according to which the ruling principle concept is adjusted to “pacta sunt servanda,.. rebus sic stantibus”: the agreements are binding so long as the basis on which they were undertaken remain.

Accordingly this doctrine does not discharge the obligor, but rather, based on the severability principle to preserve where feasible the validity and continuity of legal transaction, and will introduce adjustments to mitigate the disproportionate unbalance triggered by the event under strict requisites i.e. the cause alleged, must: (i) be external, i.e. not caused by any of the parties, esp. the party seeking to escape an obligation (neither directly nor indirectly);  (ii) be extraordinary; inevitable (beyond obligor); (iii) be unforeseeable (this varies according to the debtor’s profile – one cannot expect the same foresight capacity from a professional as from a private individual or a consumer and therefore higher standards of care are applied to a professional, entrepreneurs, businesses, and investors); and (iv) cause a substantial break to the deal balance. Spanish Supreme Court declares that economic crisis per se is not sufficient to discharge or reduce the price.

In other jurisdictions used as the law applicable to the agreement, like the UK, the courts are reluctant to accept a claim from businesses and investors to get rid of obligations undertaken in valid contract of course any interpretation on drafting will not benefit the party seeking discharge of an obligation, though the key issue to establish will be to determine what “material” exactly means in each case, i.e. quantify in monetary terms and time the scope of the adverse change which, needless to say will be necessary when in most of the cases buyers may seek for price reduction or damages.

It is difficult, right now to have the data and perspective to assess the financial impact since at present countries are still under different emergency status (e.g. confinement), with all or part of business activities and operations suspended, borders closed, transport not operating, and legislators keep issuing new laws and measures.

The fact that some MAC clauses exclude events or changes affecting markets generally -unless the change considered is disproportionate to that in other comparable businesses- does not help esp. sellers. On their side, buyers may face problems with their lenders and their term sheets.

Another important point is to what extent this may constitute a breach of warranty or a pre-closing commitment where depending on jurisdictions the outcome may be the termination (e.g. in the US) while in others, damage compensation (e.g. UK.

In any event, during the interim period seller must at all times act in good faith and keep buyer informed.

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