April 30, 2020
M&A in times of Covid 19

By Rupin Chopra and Vibhuti Vasisth

The COVID-19 outbreak and the efforts and steps being taken around the globe to contain its spread, has undoubtedly resulted in dramatic business disruptions and economic turmoil, raising various new considerations for parties participating in either proposed or pending Mergers & Acquisitions transactions, and for public companies assessing their vulnerability to unsolicited suggestions. The numerous issues faced by individual companies are seemingly endless, but there are a number of topics that we expect to be of a particular interest to the M&A participants. Discussed below is a summary of key M&A topics to consider in respect of the COVID-19 pandemic and its (potential) impact.

On-going M&A transactions and COVID-19, what to really expect?

Covid-19’s impact has already started to affect and impair M&A activities in India. Corporates are now facing tougher strategic choices between – whether to jam the brakes or to step on the gas, in respect of the ongoing deals. The key drivers of decision making range from and include: change in business outlook, concerns arising regarding valuation, liquidity crunch due to reduced lending ability of the banks and consequent reallocation and arrangement of surplus funds. Cross-border transactions have also been severely impacted due to the lockdown which has resulted in closure of the international borders.

In various sectors, such as aviation, hospitality and tourism, there has been a direct impact on the businesses, and parties may look/seem to walk away from the transactions, amidst long-term uncertainties that COVID-19 has given rise in. In other sectors, namely, consumer goods, manufacturing, etc., where the impact is a little less severe, buyers may want to reconsider valuations or downward price adjustments may be sought. This becomes particularly relevant, given that January 2020 has experienced the Indian stock markets at an all-time high and buyers may now wish to re-consider their valuations.

As parties negotiate acquisition agreements amidst the turmoil resulting from the COVID-19 pandemic, they should also be taking into consideration, the unpredictability of future events, the potential impact of these uncertainties on the assumptions underlying a transaction, including those regarding future performances, and the elevated and eminent risks presented by the pandemic that would be allocated (expressly or implicitly) under the agreements. This places a particular emphasis on certain areas of the acquisition agreements, one such being the material adverse effect (MAE) Clauses. Acquisition agreements typically includes a material adverse effect clause, which allows a buyer to refuse to close a transaction if, between signing and closing, the target suffers a dramatic, durationally significant and company-specific downturn in its business that has severely threatened and impaired the overall earnings-potential of the target.

While MAE clauses are negotiated and discussed at length, the bar for proving an MAE is so high that rarely has a court found sufficient facts to excuse a buyer from closing an M&A transaction due to an MAE. However, with broad sectors of the global economy brought to a virtual standstill, the COVID-19 pandemic has a strong potential to trigger business disruptions at a scale that could (or even may) put pressure on the interpretation of these provisions, and the drafting choices that were once considered routine may have significant consequences for the concerned parties. As a result, we have seen, and expect to see, heightened negotiations of these clauses in the wake of the COVID-19 pandemic, as well as an uptick in associated litigation[1].

MAE definitions frequently, explicitly exclude events broadly impacting industries, markets and economies, as well as natural disasters and various other “Acts of God,” and sellers have increasingly focused on excluding pandemics (including COVID-19 expressly) and their potential effects on the targeted businesses to minimize the potential closing risk posed by COVID-19 and the alike. Even when events like present pandemic are squarely and specifically excluded, there is often “an exception to the exception” for events of this nature and alike, that disproportionately impacts the target business. In drafting these provisions, the concerned parties should consider whether there are risks associated with the present pandemic that they are not prepared to accept and whether the drafting of these provisions allocates those risks in a manner that is consistent with their expectations. Having said so, there is always a limit to the degree of risk allocation that can be accomplished by fine-tuning of the MAE definition. Because the courts have set the bar so high for an MAE, it is a blunt instrument by nature, and parties that wish to specifically allocate risks associated with the present pandemic (more particularly in private transactions) may be better served focusing on other areas of the acquisition agreement.

Additionally, parties may also need to re-look certain other covenants, to be able to respond efficiently to the present challenges. Sellers may want to reassess the standstill obligations and the various actions that require the purchaser’s consent, which in turn enables a dynamic response to the present crisis. Purchasers would have to bolster their Right to Seek Information in respect of the target businesses from the sellers (including specific detailed formats and negotiating specific warranties, indemnities, etc.), given that site access or a physical audit may not be feasible. Purchasers are also likely to carefully re-consider and appreciate the terms and conditions of employment, new hires, appraisal cycles, employee commitments, etc.

Further, in the event that the Covid-19 crisis and the lockdown conditions were to continue for a significant and an unexpectedly longer duration so as to make closing impossible, the concerned parties could consider flexible alternative interim structures so as to give effect to their commercial understanding, and proceed to close the transactions once the crisis subsides.

What to expect from the deals in the times of COVID-19?

In addition to the impact that COVID-19 may have on buyer and seller risk appetites and some of the fundamental considerations like pricing and governance, travel restrictions, office closures and quarantine requirements, the outbreak could also impact the nuts and bolts of the deal-making process in numerous ways, as discussed hereunder:

Increased Delays and Dropouts: M&A deals which were at the structuring stage would most likely be deferred to a later date, preferably to be activated once the crisis subsides. Seller-driven bid processes would likely experience a drop-out in bidders.

De-Globalisation: Cross-border investments may be knocked since the MNCs and PE funds are likely to conserve cash during this uncertain market and chances are that they become increasingly inward looking.

Stimulants & Catalysts: Financial stimulus packages and measures that may include tax relaxations announced under the Union Budget 2020 (including rationalisation of provisions pertaining to DDT[2] and other exemptions on investments by sovereign wealth funds[3]), along with relaxation of compliance norms by regulatory bodies such as SEBI, RBI and MCA could be a catalyst required to ease the M&A process.

Opportunities: The crisis may open up certain buy-side opportunities, which may leverage the lower valuations in the short term that can then seek a higher return on capital in the long run. A similar trend had been observed post the 2008 recession where PE funds and MNCs with sufficient “dry powder” deployed their funds to pick up stressed assets on the cheap during the aftermath period of the crisis.

Limitations: The approach to enter M&A transactions during this period would require to factor in the limitations posed by the present crisis, and would need to be recalibrated to address the prevalent risks.

Due Diligence: The due diligence process would have to undergo a change i.e., rely less on physical meetings and site visits, while placing more reliance on virtual data rooms, and focusing on  consequences of the target’s failure to perform its obligations under crucial contracts (including force majeure and termination rights), its ability to pay-off the debts and insolvency risk, liabilities towards the health and medical care of employees (including availability of insurance), compliances with governments’ directives relating to Covid-19 and compliances with data protection laws (as any information collected by companies regarding the medical condition of their employees would be considered as ‘Sensitive Personal Data’). Read here our detailed article on data privacy protection in the employment sector amidst COVID-19.

Preferred Structures: Given the potential delays in obtaining regulatory approvals, parties might also prefer structures involving the least regulatory interfaces. A share acquisition may, thus, be preferred over court approved schemes or slump sales under business transfer agreements. Further, the consideration adjustment provisions linked to key business parameters may need to be hard-coded in the transaction documents, so as to provide a deal certainty as well as a value certainty.

What clauses are likely to be heavily negotiated and focussed on, in the given scenario?

MAE Clauses: The concerned parties would be required to specifically agree on how the impact arising as a result of the Covid-19 crisis would affect the transaction. The buyers seem likely to insist on enlisting events such as pandemics, lockdowns, closure of international and domestic boundaries as MAE events, whereas the seller would want to push for a narrower MAE Clause.

The ‘Change in Law’: New measures are being announced (almost weekly) by the government. Further, the apportionment of risks on account of a ‘change in law’ are likely to be acutely contested. Given the limitations on due diligence on account of the crisis, purchasers are also likely to ask for inclusion of a satisfactory bring-down due diligence (including an on-site inspection), as a condition precedent to closing.

Warranties: Purchasers would be required to assess the risks emanating for the targets of the Covid-19 crisis and detailed warranties would be sought. Not only would the sellers appropriately qualify these warranties using knowledge and materiality qualifiers, they would also want to appropriately consider disclosing any/certain specific facts, which would be relevant to the Covid-19 crisis while making disclosures. There may also be greater reliance on warranties and indemnity insurance, and the policy coverage would require negotiation.

Regulatory Approvals: The SEBI and the RBI have permitted filing of applications electronically, while the CCI has permitted parties to file combination applications electronically[4] and have also permitted pre-filing consultations through video conferences[5]. While these are certain welcome moves, the approvals and consents required from States / local and municipal authorities would continue to pose a challenge.

E-Signing: In the context of the deal execution, parties would be placing increased reliance on e-execution and e-signing of the agreements, however, stamping and registration of the agreements would still remain a concern during this period.

Corporate Approvals: One may also expect to see board and audit committee approvals being obtained through videoconferences[6] or audio-visuals, and the shareholders’ approvals, where ever required, by way of remote e-voting.

Looking ahead and what does the future hold?

As the financial markets stabilize and companies gain a greater understanding of the consequences resulting from COVID-19 pandemic, opportunities would arise for the right buyers and sellers to return to deals that were either already in the pipeline or in the initial stages of due-diligence. Uncertainty about future prospects and unquantifiable risks are obviously front of mind for the dealmakers.

While the short-term effects of the Covid-19 crisis on the M&A landscape may be quiet drastic, it is expected that this crisis may also precipitate a change in the outlook of the consumers and result in a realignment of priorities at the governmental level towards sectors such as the healthcare and pharmaceuticals, as well as its other allied fields such as medical research, medical devices, etc. Not only would this spawn opportunities for increased localisation, but it may most likely result in further consolidation.

Several measures have been undertaken by the government as a response to the Covid-19 crisis, such as permitting practice of telemedicine through video conferences, telephones, and other internet based platforms, while also facilitating retail sale of drugs to the doorstep of the consumers[7]. Further, the innovations in technology and introduction of artificial intelligence, would result in newer business opportunities within the newly found ‘health-tech’ space.

Additionally, considering that a large proportion of India’s population is without any insurance of any kind[8], a crisis of this kind and nature is likely to underline the gravity of the need for obtaining insurances, including health insurances, thus, likely to result in significant uptick in the insurance sector and consequently, increased M&A activities. Further, essential sectors such as healthcare, pharma, FMCG, IT, etc., are also likely to see a major boom, and M&A activity would surely follow.

The present situation is a humanitarian crisis, but it has significantly impacted the businesses and the economy, domestically as also globally. One hopes that this catastrophe subsides soon with the discovery and delivery of a vaccine in order to reach stabilisation in the present scenario. That apart, in the meanwhile, work from home and stay safe.

Finding the best path to navigate the various challenges faced by the concerned participants in the current deal-making scenario would require careful analysis of the facts and circumstances surrounding a proposed transaction. The authors of this alert or the attorneys at S.S.Rana & Co. with whom you have regular contact are available to advise you if you wish to discuss any of the matters discussed herein above.

[1] https://www.wilmerhale.com/en/insights/client-alerts/20200422-merger-and-acquisition-considerations-during-the-covid19-pandemic

[2] Finance Act, 2020 has amended the Income-tax Act, 1961 to allow dividend or income from units to be taxable in the hands of shareholders or unit holders and inter alia domestic company or mutual funds are not required to pay any DDT.

[3] Section 7, the Finance Act, 2020 amending Section 10(23FE) of the Income-tax Act, 1961.

[4] CCI Notice dated March 30, 2020 available at https://www.cci.gov.in/sites/default/files/whats_newdocument/30thcircular.pdf.

[5] CCI Press Release No. 48/2019-20 dated March 19, 2020 available at https://www.cci.gov.in/sites/default/files/press_release/PR482019-20.pdf.

[6] Rule 2 of the Companies (Meetings of the Board and its Powers) Amendment Rules, 2020 available at http://www.mca.gov.in/Ministry/pdf/Rules_19032020.pdf.

[7] Ministry of Health and Family Welfare notification dated March 26, 2020 available at https://www.mohfw.gov.in/pdf/Doorstepdelivery26B.pdf.

[8] Press Release by Press Information Bureau dated May 8, 2015 available at https://pib.gov.in/newsite/PrintRelease.aspx?relid=121445.

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