M&A and Capital Markets Law: What Needs to be Considered? COVID-19 Poses Major Challenges for (Cross-Border) M&A Transactions and Capital Market Deals
COVID-19 poses great challenges, especially for cross-border M&A transactions and capital market deals. In the last five years or so, the M&A sector has seen a strong seller's market in which sellers have been able to generate high selling prices and enforce contractual arrangements in their favour. This will likely change rapidly now. Government imposed quarantines and travel restrictions already have a negative impact on due diligence reviews, contract negotiations as well as signings and closings of transaction. Particularly affected by COVID-19 are industries that traditionally have particularly strong economic ties to regions affected by COVID-19, such as the automotive and automotive supply industries, chemical and pharmaceutical products, electrical equipment, machinery, metals and natural resources as well as food and animal feed.
The recent dramatic developments on the domestic and international stock and capital markets pose great challenges for current and planned capital market transactions.
M&A transactions put to the test
In the current situation, a distinction must be made as to whether an M&A transaction is in the (i) pre-signing phase or (ii) in the phase between signing and closing.
Considerations for the pre-signing phase
For the pre-signing phase, it can be expected that COVID-19 will cause buyers to suspend and reconsider key aspects of cross-border transactions during the re-evaluation of a deal. Often MOUs or LOIs are drafted as non-binding documents so that, with the exception of pre-contractual culpa in contrahendo aspects, buyers are usually free to decide whether or not to further pursue the transaction. In addition to an up-to-date review of the buyer's own business model and liquidity planning with regard to the target company, the following aspects will also play a role:
- Does it currently make sense to pursue the transaction under the given circumstances? Does the envisaged purchase price, which is based on historically high evaluations, need to be (significantly) adjusted? Does the planned purchase of the target company still make sense with respect to the strategy of the purchaser under the given circumstances?
- How is the target company affected by COVID-19 and the exceptional situation in the countries where the target company operates?
- Are key customers and suppliers of the target company negatively affected, influencing the business model of the target company or even questioning it (e.g. interruption of the supply chain, etc.)?
Which negative impacts can travel restrictions have?
In a first step, the buyer's management/board of directors must address these issues internally. Subsequently, however, the buyer's supervisory board, if its approval is necessary for the transaction, will also demand appropriate information and protection against possible risks in the contractual documentation: Fundamental adjustments to the representations and warranties as well as specific indemnities will be just as indispensable as carefully drafted MAC clauses and closing conditions that provide the buyer with the best possible protection under the changed circumstances. Break-up fees in favour of the seller will be more difficult to negotiate.
If public shareholders' resolutions are also required for the execution of a transaction (e.g. resolutions on capital measures, merger or demerger resolutions or other reorganisation steps), the management board and supervisory board will have to prepare themselves for probing questions from the shareholders. In addition, in the interest of transaction security, the question will arise as to whether, in the light of COVID-19, the public general meetings required for the transactions can take place at all in a legally effective manner in individual cases, since, for example, the presence of a certain number of shareholders at the general meeting may be exceeded (in Austria currently a threshold of 100 persons). The question of the legally effective conduct of general meetings arises not only for transaction-related (extraordinary) general meetings, but also for all ordinary general meetings of listed companies in general – the general meeting season is about to start in Austria! While general meetings physically held in the USA can de facto be easily avoided (Warren Buffet just referred his Berkshire shareholders to proxy voting), this is not legally possible in Austria. Creativity is therefore needed: The companies Andritz and Palfinger, for example, recently asked their shareholders not to attend their general meetings physically, but to be represented by proxy in order not to exceed the one hundred person threshold. The shareholders' right to ask questions at the Annual General Meeting naturally suffers as a result, and it remains to be seen how shareholders will react in this respect.
Overall, the pre-signing phase of M&A transactions presents a number of complex problems. In our opinion, deals will often be postponed or ultimately cancelled, but in any case modified with regard to their deal structure.
Revival of distressed M&A?
On the other hand, a (considerable) increase in new distressed M&A transactions can be expected in the short term, in which experienced buyers will prefer to acquire companies at favourable valuations that have fallen into economic difficulties due to the effects of COVID-19 – even in spite of government support. Accordingly, market consolidation will take place in individual segments, which will lead to vivid (distressed) M&A activity. Tailor-made refinancing of ailing target companies and the consideration of insolvency law aspects will play a major role in such transactions.
Are there ways to withdraw from a deal?
A completely different situation arises in transactions where the transaction documents were signed before the outbreak of the corona crisis and where the transaction is in the phase between signing and closing. In this case, it must be carefully examined whether there are possibilities for the buyer to withdraw from the deal via MAC clauses in the agreement, force majeure arguments or the loss of the foundation of the transaction. Or else to adjust the conditions of the transaction, in particular the amount of the purchase price. In the case of unilateral share deals or share for share transactions, completely new economic parameters apply in any case due to the dramatic price declines on the international capital markets in recent days. The dramatic fall in oil prices also leads to similar questions in M&A transactions in the oil and oil-related industry sector.
In all of the above-mentioned cases, attention must always be paid to the specific nature of the concrete transaction and the existing agreements. The present statements are therefore only of a general nature and cannot substitute concrete advice in individual cases.
What needs to be considered in stock exchange and capital market transactions?
Due to the troubled last few days on virtually every stock exchange in the world, the framework conditions for capital market transactions have changed significantly. In particular, the risk factors of Prospectuses and Offering Circulars now contain extensive information on COVID-19 and its effects on the business models of issuers. The drafting of underwriting agreements between issuers and issuing banks, legal opinions and comfort letters also reflect the changed circumstances. In the absence of sufficient authorised capital, resolutions of the general meeting pose considerable challenges due to the aforementioned practical reasons. Share buyback programs must be subjected to critical review under the changed market conditions.
What to consider in M&A due diligence reviews?
Travel bans, quarantines and business interruptions massively affect the daily business operations of companies. This also affects on-site inspections and personal management meetings as part of due diligence audits. It can currently be noticed that buyers are waiting with their purchase decisions until the on-site inspections can be completed and the impact of COVID-19 on the business of the target company can be better evaluated.
From the buyer's perspective, it is advisable to prepare questionnaires to the sellers in order to carry out a concrete legal and economic evaluation of the risks associated with COVID-19. In this context, particular attention should be paid to whether and how the main commercial contracts of the target company cover a possible failure to perform due to an event such as COVID-19 and how this may affect the economic performance of the target company. Special attention should also be paid to crisis management at the target company, especially with regard to the effectiveness of measures already taken.
What should the buyer consider during M&A contract negotiations?
The buyer should insist on the inclusion of provisions in the sales contract that specifically address the risks associated with COVID-19. This can be achieved by warranties that explicitly guarantee certain characteristics of the target company as well as exemptions that provide for risk balancing with respect to risks already concretely identified (such as a significant interruption of the supply chain). In addition, purchase price mechanisms should be considered which take better account of the current uncertainty than, for example, a fixed price. For example, so-called earn-out clauses should be considered here, which tie the payment of at least part of the purchase price to the further economic development of the target company.
As probably the most important precaution, the buyer should insist on a wide-ranging exit option if there is a significant deterioration in the asset, financial or earnings situation of the target company between signing and closing of the purchase agreement. MAC (Material Adverse Change) contract clauses derived from Anglo-American contractual practice are a useful tool in this respect. Such clauses are often included in the purchase agreements as conditions precedent. If certain material circumstances defined by the parties in advance occur in the period between signing and closing, the contract is not validly concluded or the parties may exercise a right of withdrawal.
The challenge when drafting MAC clauses is generally to provide the most precise possible definition of the materiality threshold desired by the contracting parties. However, it should also be noted that both Austrian courts and international court practice, especially in arbitration proceedings, tend to apply strict standards when examining the validity of MAC clauses. This is especially the case if the scope of application of MAC clauses (also) refers to circumstances that occur only after the closing of the transaction. MAC clauses must therefore be formulated with great care. Otherwise, there is a risk that they will not be accepted by (arbitration) courts in the event of a dispute.
What should the seller consider during M&A contract negotiations?
In the interests of transaction security, the seller will attempt to ensure that events such as COVID-19, which are regularly outside its sphere of influence, have no or the least possible negative impact on its contractual position. Additional warranties and indemnification in favour of the buyer in connection with COVID-19 are often unavoidable at the moment. However, the seller should in any case try to limit the resulting economic risk to an economically reasonable extent by means of various permissible limitations of liability, such as maximum liability amounts, tax allowances and minimum thresholds. With regard to any MAC clauses, the buyer should ensure that their application is defined as precisely as possible. In order to minimize any misuse of such contractual provisions by the buyer, the seller should insist on an appropriate break-up fee. This can effectively prevent or counteract an unjustified exit of the buyer by referring to an alleged MAC.
What to consider in stock exchange and capital market transactions?
Risk factors and other parts of the prospectus must take into account the changed circumstances. In particular, underwriting agreements must take the COVID-19 situation into account in the interests of the issuing banks. For issuers, upcoming general meetings represent a major challenge. A careful and prudent preparation of such general meetings, which also takes into account the changed circumstances, is even more important than before.