Recent press reports suggest that "the trade war, social unrest and coronavirus outbreak will make it harder for individuals and companies to stay afloat this year". Business and individuals have had to struggle against multiple challenges this year, and it is not clear whether or when the tide will turn, and if so in what direction things will take in the future. The challenges differ for each case and for each company, but a number of themes are emerging from the market overall.
In this article we will be looking at issues relating to:
- M&A Transactions;
- Commercial Contracts;
- Survival, Growth and Rebalancing,
in these challenging times.
1. M&A Transactions
We expect to see a number of issues relating to M&A Transactions.
Due Diligence is often (but not always) done virtually so the basics of this are likely to be able to proceed as normal during the Coronavirus scare or a similar event. However, any interruption to normal business and travel is likely to impact the timetable of deal making and this should be factored in. The main issue will be with management presentation meetings, which may be held up or move to become virtual discussions. Similarly there may be challenges with any on site or physical inspections that are required.
More importantly is these types of events may have an impact on the parties to the transaction and the subject matter of the transaction. So a careful review of the matters being disclosed is required to see if any additional matters need to be included in the data room. This can be challenging, particularly if the situation is fast moving and/or uncertain.
There are many potential issues, some of which include the impact the event has had been included in the financial results, and business plans, the changes the event will require to the business model and any existing or anticipated issues with customers or suppliers, including breaches of contract terms, any triggers of provisions in contracts for force majeure, or claims of frustration or similar under applicable law (choice of law or mandatory law). Similarly there may be issues relating to employment (redundancy, unpaid leave, redeployment, working from home, resignations, other changes). Care also neds to be taken in considering changes in law (quarantine, medical restrictions, travel restrictions, sanctions, foreign ownership restrictions, anti-money laundering) and their impact on the business, including applicable health and safety and insurance implications. Many organisations will have recently implemented Business Continuity Planning and will be able to comment on how it has worked in practice and what changes are needed. Clearly handling situations well or badly can have a significant public relations impact politics - has anything occurred to put the business on the wrong side of a government, its workforce, its customer base or parts of the general public?
There have already been a number of such affects including:
- Companies working with staff on unpaid leave, reduced working days/hours and reduced pay;
- IT systems coming under strain to handle the volume of workers operating remotely;
- Suppliers declaring force majeure and potential arguments about whether the trigger event is covered and affected the obligation;
- Parties unable to declare force majeure, as they can supply but facing increased difficulties or increased costs to continue to do so;
- Significant price changes in certain markets, as demand and supply is drastically affected.
The SPA may include a wider variety of terms that may be impacted by events, some of which are discussed below:
- Conditions Precedent
- Will there be specific conditions precedent included relating to the event in question?
- Will any approvals take longer than usual, due to regulators being closed or preoccupied?
- Should the Long Stop Date be extended?
- Will any conditions precedent not be able to be satisfied?
- Material Adverse Change Clause
- What is the scope of the clause?
- Are there any express carve outs or exclusions for the event itself, or for matters not within the seller/target's control?
- Has the event itself (or its consequences e.g. resultant government or private sector action) impacted the target business?
- Will it be reasonably expected to impact the target business?
- Is there an impact on the parties' ability to consummate the transaction?
- What impact has the event had and has that impact been on the specific target company or more widespread?
- Pre-Closing Conduct Obligations
- Where pre-closing conduct obligations require a business to be run pre-closing in the manner it was run pre-signing and to obtain approval from the Buyer for specific actions, a smooth mechanism will need to be in place to comply with these provisions (or obtain a waiver of them) to respond to events as a target may need to take unusual actions in unusual times – please also see articles 2 & 3 below)?
- Are there any specific plans the parties want to adopt jointly to deal with the event?
- Warranties & Indemnities
- Are these repeated at Completion (or even every day up to Completion)?
- Review the Warranties again to consider if any further disclosures are required and what the process is.
- Are specific warranties provided in respect of the event, or are the suite of warranties amended to cover off a wider range of eventualities>
- What is the basis of the knowledge qualifiers?
- Are there any limits or exclusions which are applicable?
- Are there specific indemnities relating to the event?
- Do both parties still want to close the deal, or is there one party with remorse?
- What if one party does not close? What are your rights? How can you practically exercise them?
- Are both parties in a position to close?
- Where are the signatories and can they/do they wish to proceed to a physical closing?
- Will there be a virtual closing or a physical closing?
- Is the transaction a locked box, or completion accounts and how does this event impact on the pricing?
- Where a valuation is required or an adjustment, how easy is it to do that with the uncertainty relating to the event (what assumptions should apply etc)?
- Will the parties take more of a risk share through an earn out or some other mechanism?
- There is a potential for an increase in disputes as to valuation and warranties & indemnities.
- If there is a dispute, will you counterparty remain a financially sound recourse or do you need to build in security for meeting warranty claims such as retention amounts, bank letters of credit, guarantees, warranty and indemnity insurance?
- Consider the impact on boilerplate provisions such as the number of Business Days could be extended if additional public holidays are added or deemed notice provisions may be unrealistic in the event of closed facilities or delayed post.
2. Commercial Contracts
Many businesses will as a result of an event be revising their existing commercial relationships and considering risks and opportunities that exist. The better placed a business is to understand the relationships and the interdependencies between them, the better placed a business will be to react.
Many articles on this subject delve immediately into the technical legal and evidential issues around the drafting of force majeure clauses, the possibility of claiming frustration, or failure of consideration and rights with similar effects under civil law regimes. These are very important issues that have been covered in some detail. In addition to these, there are some more holistic points that a business needs to consider.
What is your current position, that of your commercial counterparties, and your respective dependencies on third parties. Similar to the medical advice, work out what you do know, what you don't know and how you are going to learn what you don't know, in what is often a dynamic environment with imperfect information.
Try to understand what is each able to do, what the contracts oblige them to do, and whether this still makes commercial sense for the parties involved given the changed circumstances. This will inform your strategy as to how to consider the more technical legal issues. Practical issues such as maintaining relationships, servicing customers, obtaining components and raw materials, logistics challenges, and the cash flow and solvency positions of all the parties in the supply chain will be important to determining your overall commercial and legal strategy.
As part of this analysis an understanding of your existing contractual terms helps. This should be looked at in the round, for example:
- Do you still want the goods/services?
- What if your supplier can no longer supply the goods/services you need?
- Can you still supply the goods/services?
- Are you or your customer or supplier dependent on a sub-contractor or supplier/customer up or down the supply chain?
- Will you get paid? Should you be asking for cash on delivery? Should you be mitigating the risk in some other way?
- Do you have the funds to make the payment? What is going to be the impact on your cash-flow?
- Is there an obligation to accept orders? Or to make orders?
- Is there a forecasting procedure - how does it work and what are the procedures and deadlines?
- Are you subject to exclusivity, or can you source/supply elsewhere?
- Do the contract terms allow for the delivery dates/volumes to be flexed – if so what are the procedures?
- Can you reschedule, defer or reduce orders?
- What are the liquidated damaged for late delivery or the interest due for late payment?
- Are the logistics in your industry operating normally, and if not what changes do you need to accommodate this?
- Are there variation and/or change control procedures that need to be considered?
- Have the termination provisions been triggered – e.g. through an insolvency related event?
- What are the provisions regarding steering committees and agreeing/revising business plans?
These are but some of the questions that may be relevant in your particular circumstances and will inform your strategy.
There have been a number of articles on the classic provisions you look at in terms of contract provisions which are available at our coronavirus information hub, such as force majeure and frustration and equivalents under similar laws and these need to be considered in respect of your contracts. These should be considered in conjunction with the exclusions and limits and liability under the contract and any liquidated damages provisions. However, when doing so we also need to be sure that we are not also triggering restitution claims based on for example a total failure of consideration, which may make the contractual provisions less relevant and prevent you from availing yourself of some of the defences contained in the terms of the agreement.
3. Survival, Growth and Rebalancing
Some businesses are focusing on weathering the storm, through a combination of prudent cash-management, cost reductions, restructuring debts and changing business footprints. Other companies may be forced to take on new investors, exit market entirely or retrench the footprint.
Well positioned companies with good liquidity or access to finance may be able to take advantage of the situation to consolidate market share, through acquiring a distressed competitor, hiring a team, or gaining greater control through vertical integration of acquiring a supplier or customer. For example we have seen cases (from previous events) where a company has had to acquire a business critical supplier that entered into difficulties, as they were entirely dependent on them. We have seen others take similar moves to improve margins.
In each case there will be a number of complicated, often cross border, legal, financial and commercial issues to content with. The earlier you engage with advisors to assist you in this endeavour the more likely it will be successful.
In all cases companies are reviewing their operations to see what changes need to be made to adapt to the new circumstances going forward. It is likely that there will be a review in particular to ensure that there is better diversification (this may be considered decoupling or not depending on the circumstances) both in terms of customers and suppliers and routes to market.
A key to doing this successfully will be to move rapidly before your competitors do. For example a frequently quoted alternative to China is Vietnam but many companies (particularly Korean ones) have been moving production there for some time and there are capacity limits in its scale and infrastructure, and dependencies on raw materials and parts.
It will be important to ensure that new arrangements include and existing ones are reformed to ensure that there is a greater alignment of interests between the parties, agreements consider risks in more detail including how they are borne, allocated, mitigated and insured. For example, if there is a significant change in demand or supply, where do the fixed costs lie, and how can they be reallocated or reduced. How can you ensure continuity of supply? Do you have enough visibility on how your suppliers are going to be affected and how they plan to handle situations? This will inform how resilient you are, or any weaknesses you have in the ecosystem.
Where possible contracts will need to be built with flexibility in mind and appropriate incentives and provisions to ensure that in times of stress and difficulty there is greater transparency and the terms allow for adjustments in pricing, and cost incurred based on changes in benefit or cost resulting from external events. To do this there will need to be a more detailed analysis and understanding of your own position, that of your counterparty and the supply chains and routes to market on which you rely.
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.