19 March 2020 By:
The wide availability of financing and low interest rates of the past ten years has driven one of the most robust M&A markets in history. It is uncertain, however, what impact the coronavirus disease (COVID-19) pandemic will have on the M&A market over the short-, medium- and long-term. Outlined below are certain considerations that participants in the M&A market may wish to keep in mind as we progress through these unprecedented times.
For M&A transactions that have already signed but have yet to close, the key focus at the moment for many is on the certainty of consummating the transaction. Along these lines, there are a few key elements worth considering.
First, from the perspective of satisfying the conditions precedent contained in the definitive acquisition documentation, the focus in many deals will be on the “no material adverse change” or “MAC” condition. There will undoubtedly be arguments as to whether the current events constitute a material adverse change in the context of a proposed transaction. That being said, it is worth remembering that the ability to prove this standard has historically been elusive – not until the October 2018 in Akorn, Inc. v. Fresenius Kabi AG et al did the Delaware courts uphold a buyer’s ability to terminate a merger based upon a determination that a material adverse change had occurred.
Second, for transactions that have a financing overlay (either traditional debt or third-party equity financing), buyers may wish to keep two primary considerations in mind: (i) symmetry of the MAC condition contained in both the definitive acquisition documents and the financing documents and (ii) to the extent applicable in the post-SunGard world (a transaction that materially transformed the overall acquisition financing market by limiting conditionality in the underlying financing documentation) the impact on any condition tied to the financial performance of the business being acquired. With respect to the first item, so long as there are no substantive gaps in the material adverse change definitions and corresponding conditions across the acquisition and financing documents, buyers should not find themselves in a scenario where the relevant condition to the acquisition is satisfied, but the corollary definition in the financing documents fails to be satisfied. The second consideration outlined above, however, may pose a greater risk to buyers under contract in the post-COVID-19 M&A market. More specifically, given the far-reaching impact that COVID-19 has had on local, national and global economies, the financial performance of targets across industries may be negatively and materially impacted. Accordingly, it is possible to foresee scenarios in which the impact of COVID-19 causes a target’s financial performance to fall outside of the financial metrics on which the transaction and the related financing were priced, thus causing any “financial performance conditions” contained in the financing documents to be unsatisfied. However, for the reasons described above, it is also possible that the underlying elements may not be sufficient to rise to a material adverse change in the context of the definitive acquisition documentation. As a result, a buyer may be contractually obligated to close, but its financing sources may not be obligated to fund. In such a scenario, the parties will likely need to explore the dispute resolution and contractual remedies available (e.g., a reverse termination fee or specific performance) or otherwise renegotiate the terms of the transaction.
Third, despite any negative interim operating covenants contained within the definitive acquisition documentation, the buyer and seller will need to recognize the practical impact that COVID-19 will have on the target’s business and the necessity of adjusting operations accordingly. For example, targets may need to incur indebtedness, defer capital expenditures or reduce production beyond contractually agreed-upon metrics in order to avoid material harm to operations and liquidity.
Fourth, when parties under contract are prepared to close, they should remain cognizant of any post-closing purchase price adjustments and the potential that such adjustments may be in excess of the pre-signing expectations of the parties. Accordingly, to the extent that a buyer has agreed to any form of cap on adjustments, a buyer may close into an incremental negative adjustment to value. Furthermore, in anticipation of closing, the parties should be aware of the potential limitations of historical financial data as a guidepost for current and future financial condition and performance; in preparing adjustment estimates, it may be necessary to build in additional cushion to account for the economic consequences, both known and unknown, from the COVID-19 outbreak.
Finally, with respect to transactions under contract intended to be financed with committed debt financing, if the debt markets are dislocated as a result of the COVID-19 impacts set forth above, lenders may experience greater difficulty syndicating the debt prior to closing. As a result, the committing lenders could exercise flex rights under the fee letter, which would result in higher pricing than the buyer had expected to receive at closing. Buyers are encouraged to model out worst-case scenarios from the financing perspective under their commitment agreements to understand the resultant potential decrease to the return on equity. If a buyer is not prepared for an increase in financing costs and the closing still occurs, we many see an increase in covenant and payment defaults within a short time following closing.
While it is far too early to understand or evaluate the true impact that the COVID-19 outbreak may have on the M&A market, participants in the market are encouraged to be mindful of their rights and obligations under all related agreements to avoid unintended consequences.