Experts during the last quarter of 2019 predicted 2020 to surpass 2019 as the fourth strongest year for M&A on record. Since December, things have changed, rather dramatically due to the ongoing global healthcare pandemic COVID-19. It was in 2005 when the global M&A market saw this kind of slow pace in the first two months of a year. The impact of COVID-19 resulted in disruptions in supply chain and workforces, travel restrictions, reduced consumer spending and other commercial and logistical issues, consequently leading to such steep decline. This article provides an overview of how the outbreak impacts the M&A transactions in India and some key considerations in deal-making.
Pre execution – Considerations:
Some of the pre-execution on considerations are interspersed below:
Deal viability and Valuation:
While some businesses will be more exposed to the outbreak, few businesses may witness a short-term uplift. Hence, for the new transactions, the uncertainty in the market caused by the COVID–19 outbreak will pose a challenge to the purchaser and seller to align on the valuation. For this reason, one may witness transactions kept on hold or purchasers withdrawing from the transactions, even in the business sectors which are not adversely impacted by COVID-19. For deals, where the term sheets are executed, it is likely that the parties re-evaluate the valuations, adjust pricing mechanisms and implement strategies for interim operations at a target entity. Specifically, parties are expected to consider deferred consideration structures and escrow mechanisms by linking deferred payments to the valuation forecasts which, to an extent reduces exposure to COVID-19-related volatility.
Off late, India witnessed a surge in the due diligence process undertaken completely through virtual data rooms, specifically, when the targets involved are start-ups. However, where targets are non-start-ups, onsite visits are an essential part of the diligence. Hence, logistical issues will have to be considered in undertaking the diligence process, which will be more challenging especially if the target's operations are in a locality where shutting down the premises is mandated by the Authorities1. Secondly, it might be a wise idea to include how the target company is exposed to COVID-19 and the preventive measure adopted by the target in the scope of the diligence. The focal points of the review could be as follows:
- Whether the target company has adequately adopted the advisories issued by the Government of India, respective state governments and local authorities in terms of business functioning. This is important since few advisories issued, contemplate penal consequences including imprisonment to the directors and officers of the companies in the event of any default;
- Whether the data collected by the targets on the stakeholders is processed and stored in line with the Privacy Regulations of India. This is because the medical data pertaining to these stakeholders (which includes the employees) are treated as sensitive personal information for which detailed requirements are contemplated under the laws of India;
- Review of the termination and material adverse effect provisions ("MAE") in the material contracts entered by the target is crucial. Particularly, an in-depth review will have to be undertaken to see when the target or the other party can invoke Force –Majeure clauses;
- Target's compliance under the relevant employment and environmental laws of India;
- Whether the target has adequate information and system security measures in place for the employees who are working remotely. In this regard, an in-depth review shall be undertaken on the target's "Work from Home" policy and "Privacy and Disclosure of Information Policy";
- Coverage of insurance policies obtained by the target and contractual indemnification taken or provided by the target;
- Target's ability to pay its debt and its ability to fulfil the obligations contemplated under its debt documents, if any;
- Overall industry study and potential impacts of the outbreak to target's competitors; and
- Lastly, in addition to the other aspects of the diligence, one had to review the target's exposure to supply disruption and its impact on meeting its obligations contemplated under the business contracts.
Points to be considered in the Transaction Documents:
Some of the key clauses to be considered in the transaction documents in light of the outbreak are as follows:
- Condition Precedents to the Closing: Since the Central Government and State Governments have reiterated that only essential services will be functional, M&A transactions which rely on governmental approvals for the closure (as agreed by the parties), can expect delays. Thus, stakeholders should consider extending the closing dates. If the transaction documents contemplate for a long-stop date and the closing is unlikely to happen, stakeholders must either consider extending the dates or opt for the consequences mentioned thereunder. For transactions, which are in the documentation stage, stakeholders are advised to take up timelines involved in each of the condition precedents and shall consider providing extended timelines towards the satisfaction of each of the items. Our recommendations shall remain the same for the Condition Subsequent items as well.
- Enhanced Representations, Warranties, and Indemnities: Stakeholders are advised to carefully word the representation and indemnities clauses in the transaction documents in light of the outbreak. Inserting COVID-19 specific representations, warranties, and indemnities into the transaction documents in relation to the target's compliance with the advisories issued by the governments, labour laws and environmental laws will be necessary. Further representations, relating to the due diligence items highlighted above, in particular, target entity's cybersecurity and privacy measures and status (and enforceability) of the material contracts i.e., no party in the contract seeking to terminate on the grounds of Force Majeure shall be considered. In M&A transactions in India, parking part of the consideration amount in an escrow account is a common mechanism for purchasers to offset some of the risk associated with the seller's representations and warranties being untrue. Given the outbreak, stakeholders involved in the transactions are more likely to include this mechanism in the payment structure.
- Events between Execution Date and the Closing Date: Transaction documents in Indian M&A typically contain covenants for the targets regarding their conduct (which are mostly operational in nature) during the period between execution and closing. A common covenant mandates the target to continue to undertake its business "in the ordinary course of business" which signifies the target's business to operate on a day-to-day basis as in the past. However, given the outbreak, suitable exceptions to these clauses must be included which shall enable the target to implement the necessary steps required by the authorities.
- Material Adverse Change: MAE provisions in M&A transactions would typically allow a stakeholder to terminate the Agreement in the event of material adverse change in target, post-execution. The definition of MAE is often agreed by the parties depending upon case to case basis along with the exceptions to the definition. While it is not usual to include epidemics and public health events in the definition, one can expect this to be included in the ongoing and future transactions.
While one shall consider the aforementioned pointers for the transactions in progress, investors shall evaluate the current investments and mechanisms the investee companies have implemented, in light of the outbreak. We recommend the short-term and long-term assessment shall be carried out to understand the business impact.
Stakeholders in an M&A transaction should anticipate changes to deal with timelines and should address the concerns of the COVID–19 outbreaks in the transaction documents. While some measures have already been initiated by the regulatory authorities to facilitate the business, the multitude of issues on a daily basis created by the outbreak is expected to adversely affect the economy and in particular M&A deals.
We as a firm are closely watching situations to help you mitigate risks and liabilities from time to time.
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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.