The COVID-19 outbreak continues to have a significant impact on public merger and acquisition transactions in Canada. With normal life around the globe coming to a screeching halt, one can only estimate the long-term effects on the M&A market. To assist buyers and sellers in the short-term, some of the immediate implications for transactions are discussed below.
Impact on M&A process
With uncertainty around long-term financial stability of companies and the economy, it has become more challenging to negotiate and structure deals. Buyers and sellers have to identify and address a myriad of issues that did not exist a few months ago, such as disruptions to supply chains, decreased consumer spending, enforceability of material contracts, health and safety concerns for employees and temporary store closures and mass lay-offs. Addressing these issues and planning around them will require more resources than is typical. In addition, buyers and sellers should expect that some transaction components, such as financing, third party consents and regulatory approvals, may become substantially more difficult to secure on favourable terms and could, in many cases, take longer to obtain.
The physical distancing also impacts negotiations, meetings, site visits and due diligence investigations. As countries around the globe are enforcing travel bans and people quarantine in their homes, the environment becomes less conducive to business. Buyers and sellers have to become creative and increasingly rely on technology to keep moving their businesses forward.
The difficulty in assessing value during a crisis
Market participants are experiencing increased difficulty in assessing the value of public issuers in this climate. This difficulty stems in large part from the uncertainty that the COVID-19 threat injects into many of the key assumptions underlying financial forecasts, as well as from the substantial deterioration in public market prices relative to inherent value. As a result of the rapidly changing situation and uncertain duration of the crisis, announced transactions may have to be repriced or terminated, and pending transactions may be suspended altogether until stability returns to the capital markets.
Challenges for boards and special committees in discharging their duties
This environment presents boards and special committees with unique challenges when trying to discharge their legal obligations in the context of a transaction. In transactions involving non-cash consideration, the difficulties inherent in properly valuing such consideration in this environment cannot be understated. In transactions involving cash consideration, boards and committees must balance the attractiveness of cash consideration in a volatile and less liquid marketplace against the concern that undue focus on the depressed current market trading prices may serve to undervalue the target to the long-term detriment of shareholders, which could expose the boards and committees to liability.
This environment also presents unique hurdles for financial advisors who are tasked with providing opinions to public boards as to the fairness of a particular transaction from a financial point of view, as well as independent valuators who are providing valuations in the context of National Instrument 61-101 transactions.
Outside date flexibility as a result of delayed regulatory and third party consents
The COVID-19 crisis has changed the business realities applicable to a wide swath of businesses in a very short time. This has often resulted in extended time periods being necessary in order to obtain routine third party consents. For many "customary" regulatory approvals, new business realities combined with delays in collecting, providing and reviewing updated information is often resulting in regulators taking extended periods to complete their review of transactions and imposing unique and challenging conditions that require negotiation amongst buyer, seller and regulator. This means that deal participants need to build flexibility into the transaction by providing for the extension of the "outside date" in the case of regulatory and other delay due, in whole or in part, to COVID-19.
Decreased effectiveness of "go-shop" provisions in a crisis environment
Parties need to be aware of the difficulty of effecting a market canvas in the current environment and should provide for extended "go shop" periods where target companies may canvass the market for superior proposals.
Specific contractual provisions to focus on
Parties to M&A deals must pay particular attention to specific contract provisions that are directly linked to the impact of COVID-19. Although the pandemic is unfolding daily, the below overview of important provisions provides a starting point for buyers and sellers to consider.
Force majeure
Force majeure clauses can provide the parties with a right of termination in circumstances where a party is unable to perform its contractual obligations due to reasons that are outside of its control. When drafting these clauses, buyers should assess whether they have the right to terminate the transaction if the target becomes unable to meet its obligations to customers, suppliers or other parties or experiences significant lay-offs or complete business shut-downs as are currently being experienced in the airline, hospitality and cinema businesses worldwide. Likewise, buyers and sellers are encouraged to negotiate force majeure clauses with COVID-19 in mind in case either of them becomes unable to proceed with the transaction.
Material Adverse Change
Material Adverse Change ("MAC") clauses typically require proof of a sustained decline in business as a result of a change that is specific to the business, or a wider change that affects the particular business in a disproportionate way.
Going forward, for new transactions, it may be difficult to make the case that a MAC has occurred due to the fact that COVID-19 is now assumed to be a well-known risk. Parties could still craft language or a mechanism respecting the specific allocation of COVID-19 risk or a material worsening thereof. In this regard, parties should carefully consider the risks (and how to allocate them), including whether to qualify certain matters with "disproportionate effect" language.
For example, a review of a random number of MAC clauses used in recent Canadian public M&A transactions (prior to COVID-19) shows that often such clauses have specifically excluded from the definition "outbreaks of disease" or "an escalation or worsening thereof" but often only to the extent that such event "does not have a materially disproportionate effect on" the subject entity.
Purchasers using third-party debt financing may be concerned about a lender's ability to terminate its funding obligations as a result of MAC clauses in financing commitment letters. However, depending on the wording of the commitment letter, the risk may be limited.
Interim operating covenants
Between the signing and closing of an M&A deal, sellers are generally required to operate the business in the "ordinary course," which is challenging due to COVID-19. Sellers want to have flexibility in operating their businesses in response to the health crisis, while buyers will want flexibility in exiting a deal if the target business fluctuates or the buyer disagrees with the decisions of the sellers in operating the business during the interim period. Therefore, interim operating covenants must be carefully considered and effectively tied to MAC clauses as they can be impacted rapidly from the time they are negotiated to the time a deal closes. Parties can also include exceptions to address the impact of COVID-19 for the interim period.
Long-term opportunities and the future
Many public issuers have watched their share prices decrease significantly over the past few weeks. In the short-term, issuers may face pressure to increase shareholder confidence, cut distributions or dividends to preserve cash-flow or look to M&A transactions as an alternative to insolvency proceedings. In the long-term, certain issuers that re-emerge after COVID-19 may find compelling opportunities and capitalize on the environment in order to acquire competitors or other strategic targets. As we have seen in past periods of economic turbulence, such low or undervalued share prices can often create new M&A opportunities once markets stabilize.
What COVID-19 means for the public M&A market on a go-forward basis is an open question. Market disruptions will create opportunities for opportunistic and well-funded buyers. Buyers may choose to put their offers directly to shareholders in the form of hostile bids as opposed to board-negotiated, "friendly" transactions. This may result in bids being made where fairness opinions cannot be delivered and boards and special committees are not able to provide a recommendation.
We shall continue to monitor this space and update our clients on trends as they arise.
Miller Thomson is closely monitoring the COVID-19 situation to ensure that we provide our clients with appropriate support in this rapidly changing environment.
April 1, 2020
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.
