by Gregor Pannike

Considerations for M&As during COVID-19

The COVID-19 pandemic (“COVID-19”) has tremendous social, political and economic implications. Plant shutdowns due to quarantine measures, delivery delays and threatened contractual penalties create legal challenges for many companies.

On the other hand, German entrepreneurs are currently also recognising opportunities for favourable acquisitions. Companies around the world are now carefully observing the M&A market. According to the latest “Capital Confidence Barometer” by EY, 26 percent of those surveyed see opportunities to expand their market share through mergers and acquisitions, while 40 percent hope for declining valuations of potential takeover candidates.

What effects does COVID-19 have on Merger & Acquisition transactions? How can associated risks be addressed in contracts? How can investors / purchasers be protected if the financial condition of the target company deteriorates significantly due to the COVID-19 crisis after signing the sale and purchase agreement? Of course, the focus is now on creating respective possible protection clauses in such agreements.

Possible rights of withdrawal result from contractual clauses that protect against material adverse change (Material Adverse Change “MAC Clause”). MAC clauses offer additional protection to the purchaser in the interim phase between the conclusion of a sale and purchase agreement and the completion of the transaction by giving the purchaser the opportunity to rescind the agreement if a material adverse change in the target company to be acquired occurs during the interim phase.

A MAC clause basically has two components. On the one hand, the so-called MAC-events have to be agreed upon, which can trigger a right of withdrawal of the purchaser. These are usually military conflicts, natural disasters or other events that can seriously affect a sector or industry. On the other hand, a materiality threshold must be defined, which must be exceeded in the specific case in order to identify a material adverse change in the target company. So far, MAC clauses have been the exception for M&As in Germany. Could this change fundamentally during the COVID-19 pandemic?

Questionable is here to what extent the spread of COVID-19 and the associated economic consequences for the target company to be acquired opens up the scope of application of the MAC clause. It is worth mentioning that pandemics are often explicitly excluded in the traditional clauses.

But can the virus be compared to a natural disaster? Probably not! Therefore, it is significant to ensure that the MAC clause is worded correctly so that COVID-19 can be concluded under such clause. In particular, the scope of this clause should be explicitly broad and should cover, for example, the mass spread of a pathogen/viruses or a significant decrease of purchase orders of the target company. COVID-19 and the resulting consequences should be included in this clause independently.

However, it remains challenging to determine to what extent COVID-19 and its economic consequences can be considered as “unforeseeable risk” if MAC clauses are currently negotiated, because here it can be argued that the investor / purchaser is aware of possible deteriorations. This point should be clarified if a MAC clause shall cover the COVID-19 crisis.

The MAC clause represents obviously a substantial risk for the seller, as the purchaser has the possibility of rescinding the contract at any time, even after the transaction has been completed. In this case it would therefore be advisable for the seller to negotiate an appropriate contractual penalty in the event of withdrawal.

There are numerous points that require attention in current M&A transactions considering the present COVID-19 pandemic crisis. Anyone wishing to mitigate a corona-related risk here should therefore negotiate a legally secure contract that reflects the current uncertainties by means of clearly formulated clauses.

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