M&A in Times of COVID19 Pandemic

Executive Summary.

• The crisis caused by COVID19 will generate a change in the typical M&A concerns, obligations and guarantees from now on.
• The pandemic has a different impact on the acquisition agreements already executed pending closing, from those that are in the process of being negotiated.
• Due diligence requirements and questionnaires must be reviewed and adapted to this pandemic.
• It will be fundamental to define if the COVID19 qualifies as an event that triggers a MAC or MAE provision.
• In the current context, it will be a challenge to manage and operate the target business, in accordance with its ordinary course of business and without material changes in order to achieve closing.
• Valuation and pricing is difficult in the face of current uncertainties. Mechanism for fixing the price in the future or for making price adjustments will have to be implemented.
• The restrictions and temporary shut-down of government offices pose obstacles both in the due diligence process and in the fulfillment of conditions precedent to closing and post-closing obligations.
• Due to the isolation, it is not possible to carry out face-to-face encounters, therefore alternatives must be used to enter the agreements, hold board and/or shareholders’ meetings, and exchange documents.

M&A in Times of Pandemic Conventional wisdom considers that in times of market crisis, M&A activity increases, as opportunities for strategic buyers or private equity funds to purchase undervalued or vulnerable companies appear due to lack of liquidity. Relying in past economic crisis may not be advisable since this global crisis is different in nature and therefore its outcome is still uncertain. Likewise, this conventional wisdom does not apply directly to Argentina due to its regular economic imbalances. On the other hand, the impact of the pandemic is different in those acquisition agreements already executed, whose terms will be subjected to more severe tests; while in the agreements under negotiation the challenge will be to will have to provide mechanisms to define currently open variables.

1.     Due Diligence

COVID19 will be a critical factor in carrying out a due diligence process. With current regulations limiting circulation and setting social isolation[1], it is essential to develop due diligence remotely, enabling videoconferences with management, and circulation of documents only through virtual data rooms. Although this practice has been quite accepted by the market for several years, it will imply a challenge regarding the security and confidentiality of certain information. Likewise, before the temporary closure of governmental offices, obtaining official documents and certificates to validate the information of the target business will be hindered, such as Good Standing certificates, injunction certificates and real estate property reports. The latter is also inconvenient for obtaining the authorizations or notifications required at the closing of the transaction. Due diligence requirements and questionnaires should be adapted in order to carry out an exhaustive analysis regarding the impact of COVID19 on the target. Among the relevant considerations we can mention: •       Analysis of main contracts and identify the possible existence of circumstances that give the parties the right to modify their terms or their termination, by virtue of the theory of unpredictability (teoría de la imprevisión); the enrichment without cause and the balance of mutual obligations, or the frustration of the purpose of the contract, etc.[2] •     Analysis of the existence and evidence of force majeure, or other figures by which the performance of obligations could be suspended. •     Application of sanitary precautionary measures, potential liabilities and contingencies. •     Analysis of IT security measures and sensitive information management through remote work channels. •     Impact on the privacy and data protection of employees’ information and other HR issues.

2.     MAE / MAC Provisions

Referred to in acquisition agreements as Material Adverse Change (MAC) and Material Adverse Effect (MAE), these provisions set a threshold for acceptable negative effects on a business and are primarily used in two ways: i) to qualify the representations and warranties of the seller and/or the target in the agreement; and ii) as a condition for closing the transaction (that is, the buyer is excused from closing the transaction if a MAC or MAE occurs before closing). In the agreements under negotiation, it will be essential for the buyers to include in the MAC/MAE clauses the risks related to the changing economic and business outlook as a consequence of the COVID19; while sellers, by contrast, will want to expressly exclude the effects of the pandemic, or other potentially related events. Special attention should be given to the “disproportionate effect” exception clauses, which would allow considering specific causes excluded from a MAC/MAE, if they have a disproportionate effect on the target business compared to other market participants. In those acquisition agreements already signed and with respect to which the closing of the transaction is pending, determining whether the COVID19 qualifies as an event related to a MAC or MAE will depend on the definition included in its clauses. Attention should be paid to the interpretation made by the courts before any conflicts that arise in this context. There are limited partially related local predents, although courts have recognized that the sale price of the shares is understood agreed taking into account the net worth conditions of the target at the time of executing the sale agreement and not subsequent conditions.[3] Leading cases outside Argentina, as Akorn, Inc. v. Fresenius Kabi AG[4], where in 2018 the Delaware State Supreme Court first found that a material adverse event occurred with respect to a target business, and allowed a buyer not to close the acquisition transaction. However, said court clarified that, to do so, a MAE must substantially threaten the target business the over-all earnings potential significantly over time. With regard to COVID19, it will be difficult to estimate how significant its long-term effects will be.

3.     Pre Closing Covenants and Conditions.

Interim covenants. The fulfillment of the commitments assumed prior to closing also represents a challenge for the closing of the transaction. For example, it will be complex to sustain the management and operation of the target business was according to an ordinary course standard and without substantial changes, as is usually agreed in the clause of temporary obligations or interim covenants. This, considering that many companies will have to take urgent measures to adapt its business to the new regulatory restrictions, preserve personnel, reduce costs and protect cash-flows. Cooperation and coordination with buyers will be key to making joint decisions that preserve the condition of the business in this critical context. It would be different in the case of agreements under negotiation where this problem can be anticipated and mechanisms for decision-making and solving issues can be discussed and included. Circulation limitations could hinder the decision-making of the parties’ administrative and governing bodies, required for closing the transaction. In the case of the Public Registry of Commerce of the Autonomous City of Buenos Aires, this obstacle could be settled by virtue of the regulations recently established by the Inspección General de Justicia for remote board and shareholders’ meetings[5]. In the case that they were other jurisdictions without specific regulation, the possible consequences of celebrating them under Article 158 of the National Civil and Commercial Code should be analyzed, which establishes the possibility that “if all those who must participate in the act consent, they can participate in an assembly or meeting of the governing body, using means that allow participants to communicate simultaneously with each other … “.[6] In addition, mechanisms should be analyzed to evidence third parties’ consents, i.e. which might be required by in contracts with change of control provisions, and may potentially result in the third party’s reluctance or refusal to accept, depending on the impact that the pandemic may have had on their contract performance.

4.     Representations and Warranties

There could be difficulties for sellers to bring-down the representation and warranties made on the target business at the time of entering the agreement, such as lack of claims, contracts performance and lack of performance suspension risks, readjustment or termination of key contracts, or the sufficient insurance coverage. Sellers should set the closing date while they can bring down these representations and warranties in order to avoid reopening the negotiations to readapting their original scope to the new reality.

5.     Price

The price determination is challenging in the light of current turmoil and uncertainties, future fixing or adjustment mechanisms should be implemented, such as payment in shares of sellers, not so common in Argentina, or an earn-out mechanism setting the price balance based on to the future economic or financial outcome of the target business. As for the payment of the price in executed agreements pending closing, it will be necessary to coordinate operationally with the financial entities the transfer and receipt of the funds, in times of restrictions and limited services. In case the purchase price was to be paid out of third party financing, it is possible that pursuant to its own terms said financing may no longer be available, with the consequences that this fact may entail.

6.     Conclusion of the Agreement and Closing of the Transaction

Given the circulation restrictions and the social isolation requirements, the acquisition agreement cannot be concluded in person, nor could the physical documents be exchanged, or notary’s certifications granted and deposit in escrow of documents or securities. To sort out these obstacles, different provisions in the Civil and Commercial Code should be considered and/or adapted, such as consent formation and offer acceptance manners[7], or consumer contracts remote execution.[8] The same limitations affect closing, with the aggravating circumstances of certain acts that have to take place regardless, such as that the payment of the price (or a substantial part thereof), and the delivery of the share certificates in the case of corporations, corporate books, real estate property titles of the target business.

7.     Post-Closing Obligations

It will be necessary to analyze the filing mechanisms and suspension of deadlines that affect the governmental offices before which it is necessary to notify or submit authorization requests. For example, in the case of the Comisión Nacional de Defensa de la Competencia (Antitrust Authority), the suspension of procedural deadlines or the fact they are not open to the public does not affect the requirement of digital notification filing in the event of an acquisition within seven calendar days from closing. The COVID19 pandemic will undoubtedly generate a change in the typical M&A concerns, obligations and guarantees from now on.

[1] Mandatory Precautionary Social Isolation Regime and Exceptions

[2] Covid19. Contractual issues. Practical matters to be considered.

[3] Corrales, Francisco v. de Rosso, Celestino L. s/cumplimiento de contrato National Commercial Court of Appeals, Chamber A ABELEDO PERROT Nº: 30001264

[4] https://courts.delaware.gov/Opinions/Download.aspx?id=282110

[5] General Resolution 11/20 of the Inspección General de Justicia https://www.boletinoficial.gob.ar/detalleAviso/primera/227212/20200327

[6] Managing Legal Entities in Times of Social Isolation

[7] Civil and Commercial Code Sections 971 and 979

[8] Civil and Commercial Code Sections 1105 and 1106.