Legal Implications of COVID-19
The rapid spread of COVID-19 - characterised by the World Health Organisation on 11 March 2020 as a pandemic - continues to spread across the globe, companies and transaction participants are facing increased risk and uncertainty posed by COVID-19.
How will COVID-19 potentially affect the fundamental aspects of a transaction and the deal-making process?
The outbreak of COVID-19 potentially cause buyers and sellers to postpone and rethink some of the fundamental aspects of a transaction, such as (i) expansion of traditional universe of due diligence, (ii) adjustment of pricing mechanisms, (iii) alteration to interim operating covenants, and (iv) crisis response management at the target company.
As the outbreak could affect the core elements of the deal-making process in numerous ways, transaction participants should take steps to mitigate the potential disruption to deal processes and timelines caused by COVID-19.
- Restrictions on Physical Meetings. Timelines and expectations should be adjusted given the current factual ban to hold physical meetings, i.e. it will be challenging for everyone “to get in a room” any time soon to push a transaction across the line.
- Due Diligence. Consider whether extra time will be needed to perform due diligence on, among other things, target company’s supply chain, IT systems, presence of any force majeure clauses in material commercial agreements, or responses related to the outbreak from an employment law perspective.
- Key Information and Financing. COVID-19 and its related market impact could delay the delivery of key information (e.g. audited or interim financial statements, financial models or projections), which may also delay the availability of financing. Market uncertainty may also increase the difficulty in obtaining committed financing (including limited conditionality).
- Timeline and Key Dates. Key dates in the transaction documentation, such as financing or regulatory filing requirements, timeline for any purchase price adjustment mechanism (e.g., an adjustment based on closing date financial statements or a post-closing earn-out), and longstop dates, should be reviewed.
- Closing Mechanics. Parties and their advisors should think through contingency plans if travel disruptions or office closures (including those of regulators or government agencies) delay or prevent required approvals or closing processes, in particular in light of any closing documents to be delivered in hard copy or to be filed with any regulator or government agency.
How will COVID-19 affect the period between signing and closing?
The parties regularly agree on pre-closing covenants. Among others, the seller is usually required to conduct the business between signing and closing in its ordinary course, subject to a range of actions that require the buyer’s prior approval (to the extent permissible under gun-jumping rules). In the case of any breach of pre-closing covenants, specific performance could be claimed or non-satisfaction of a closing condition could be invoked (if so agreed upon).
In the current situation, sellers or buyers may need to take decisions between signing and closing that fall out of the scope of their ordinary course of business to deal with the outbreak of the COVID-19 despite a contractual commitment not to do so without obtaining the prior approval of the other party. In accordance with Swiss law, any party to an agreement that faces such a situation must comply with the principle to act in good faith pursuant to which contracts must be negotiated, entered into and performed in good faith. This entails a duty to cooperate with the other party during the performance of the share purchase agreement, in particular the timely disclosure of information or difficulties that could have an impact on the closing of the transaction.
Generally, parties should check the terms of their share purchase agreement in order to determine the actions to take and the extent to which consent of the other party is required prior to making a decision. Sellers should be able to rely on specific carve-out clauses in an emergency or disaster situation, which are often included in share purchase agreements. Independently, sellers should try to minimise any adverse effect of the situation and of the decisions made to remedy the situation. Share purchase agreements may also include provisions whereby the consent of the buyer may not be unreasonably withheld or delayed, which enables the seller to execute decisions in a timely manner if reasonably needed without the buyer’s prior consent.
In the Swiss market, locked-box structures or purchase price adjustments with closing accounts are both seen. There is currently a certain preference for locked-box structures whereby the price paid by the buyer on closing is determined based on the accounts of the target company available at the time of signing the share purchase agreement. Therefore, the changes in the financial situation of the target company between signing and closing are not captured, except for “leakages”. Generally, leakages are payments made by the target company to the seller, or seller-related parties, between signing and closing (e.g. distribution of dividends or the payment of fees) that should have been borne by the seller and that therefore are deducted from the purchase price paid by the buyer. In other words, in locked-box structures the value of the target company is secured by means of no leakage covenants, the usual remedy being a Swiss-franc-for-Swiss-franc payment claim for every leakage without any de minimis deductibles or other limitations.
Given the impact of COVID-19 on the financial situation of many companies, buyers are likely to be reluctant to agree to determine the price of a transaction based on a locked-box structure. Buyers will want to capture such financial impact on the net debt and working capital situation of the target company on closing, and will want the price to include a net debt and working capital adjustment based on closing accounts.
COVID-19 is also likely to have a negative impact on the multiples paid by buyers, given the current uncertainty and that competition in processes is likely to decrease because financings may be more challenging to secure. Parties may also try to bridge their possible disagreement on the price of a transaction resulting from the current crisis through earn-out clauses or other forms of post-closing adjustments meant to capture the future financial performance of the target company.
Can COVID-19 trigger the application of MAC clauses?
Purpose and forms of MAC clauses
Material Adverse Change or Material Adverse Effect (“MAC”) clauses are provisions which aim to entitle a buyer to withdraw from closing a transaction (walk-away right) if events arise which are materially detrimental to the target company (and/or its subsidiaries). In reality, the MAC clause also gives the buyer the opportunity to demand an adjustment of the share purchase agreement in the event of a MAC. MAC clauses are one of the contractual mechanisms to allocate risk between the parties prior to closing and typically receive greater attention following events, which affect the economy at large (such as the terrorist attack on 11 September 2001 and the financial crisis in 2008, which saw an increase in parties seeking to invoke MAC clauses).
The MAC mechanism can be a stand-alone MAC clause, which expressly provides for the absence of a MAC as a closing condition in favour of the buyer. Alternatively, it is a combination of (i) a representation and warranty that no MAC has occurred, and (ii) a general closing condition that all representations and warranties must be true at signing and closing (bring-down condition).
In order to qualify as MAC event, MAC clauses typically provide that an event – in this case the COVID-19 outbreak and/or the quarantine and lockdown measures ordered to mitigate it – must be non-foreseeable at the time the share purchase agreement was concluded, and must have a long-term and material impact on the target company taken as a whole. Some MAC clauses refer to a materiality threshold in terms of financial impact on the target company, which renders the analysis less subjective.
MAC clauses are often combined with certain carve-outs, i.e. a list of events or circumstances that cannot be deemed to cause a MAC event. Epidemics and disease outbreaks are sometimes included in such list of exceptions. Absent an express exception, a seller willing to force a buyer to close may argue that COVID-19 falls within more broadly defined carve-outs for changes in general economic condition, financial markets, events generally affecting an industry, natural disaster, or emergencies. In addition, certain carve-outs only apply if the target company is not disproportionately affected as compared to others in the same industry.
No Swiss court has so far ruled on the existence of a withdrawal right based on a MAC clause. Thus, it is not clear whether Swiss law would also require a long-term impact to determine the existence of a MAC event (like in a court ruling in the U.S. (Delaware) in 2018). In any event, the outcome in court will largely depend on the wording of the considered clause and the specific circumstances of the target company.
Will COVID-19 have an impact on MAC clauses going forward?
We expect that transaction parties will put additional thought and effort into the wording of MAC provisions to address and allocate the risk of the potential impact of global business disruptions (health related – such as COVID-19 – or otherwise) on transactions and buyers are likely to seek to offset these risks where possible.
With this in mind, it seems likely that we will see in the foreseeable future (i) a greater prevalence of MAC clauses in share purchase agreements (including in lower value transactions); and (ii) more prescriptive MAC clauses attempting to address the risk of disruptions similar to COVID-19.
Drafting tips for MAC clauses
For parties considering incorporating MAC clauses in their share purchase agreements, the following points may prove beneficial:
- Depending on the target company’s key geographies, supply chains and trading links, a buyer may want to make loss of orders or of meeting orders underpinning the target company’s business, production interruption or business interruption, or a more general fall in profits, specific MAC triggers or to expressly bring them within a more generic MAC definition. A MAC trigger linked to a specific drop in meeting orders or loss of contracts or to a specific materiality threshold (such as a specified fall in profits) will bring more certainty than a formulation tied to the consequences of COVID-19 more generally.
- By contrast, a seller should try to expressly exclude such events and, more broadly, general economic and market conditions, including epidemics, pandemics or outbreak of disease such as COVID-19 and their effects, as a basis for withdrawal from a transaction. In addition, the seller should try to resist a prospective element to the MAC (so that it is limited to the actual, current impact of an event, not likely or potential future impacts). Finally, the seller should try to limit the scope of the MAC definition so that only a single event can trigger the MAC (which would mean no aggregation of a number of consequential effects of the COVID-19 outbreak).
Alternatives to MAC clauses?
Clausula rebus sic stantibus
The principle of clausula rebus sic stantibus has developed primarily in the context of long-term contracts and its ongoing obligations. However, it can basically be applied to any contract where there is no immediate performance of the contract after execution. Therefore, the principle also applies to transactions and their share purchase agreements if there is a longer period between signing and closing.
Clausula rebus sic stantibus means that a contract can be terminated or adapted if the following requirements are fulfilled: after the execution of the contract, the circumstances relevant to the performance of the contract by the parties change so fundamentally that a serious imbalance arises, such that insisting on fulfilment of the contract would constitute an abuse of rights. The event that triggers the imbalance must be unforeseeable and unavoidable. In addition, the change in value must significantly exceed the fluctuations in value that arise during the normal course of business.
The bar to evoke the principle of clausula rebus sic stantibus in a share purchase agreement is high, in particular as the required significant change in value is only attributable to truly exceptional circumstances, such as a natural disaster. An unexpected event such as the global COVID-19 outbreak may qualify as such exceptional circumstances (comparable to a natural disaster) but ultimately remains to be seen.
Force Majeure Clauses
A force majeure clause stipulates that a party must not fulfil its contractual obligations if external circumstances prevent such party from fulfilling its obligations. According to Swiss law, the force majeure clause is essentially a specification of the concept of impossibility (Art. 119 and 97 of the Swiss Code of Obligations). The definition of impossibility is often being expanded to also cover cases in which the fulfilment of the contractual obligations is not impossible, but is made considerably more difficult.
Within the context of COVID-19 some buyers may argue that a force majeure event prevents them from fulfilling their payment obligation, particularly in cases in which they might not have access to financing to meet their closing obligations (i.e. payment obligations).
In Swiss M&A practice, force majeure clauses in share purchase agreements are rare. Moreover, it is generally difficult to rely on force majeure in a transactional context under Swiss law as, the typical force majeure clause does not protect the buyer from a negative change in value of the target company based on circumstances after signing but before closing. In addition, the payment obligation of the buyer is usually not made considerably more difficult by such circumstances (which would be only the case if a country's overall payment system is seriously impaired or payments are prevented due to government measures) and definitely not impossible (the mere performance of payment obligations is never impossible under Swiss law).
Therefore, if buyers are seeking protection for material changes between signing and closing of the transaction, they will request and negotiate a MAC clause and not a force majeure clause.
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