The current times of a global pandemic (COVID-19) raises many legal issues and questions in many varied areas of the law. Thus, legal proceedings in the form of negotiations and even contracts which were already signed, and which execution had already begun, are significantly affected by the change which has occurred in the business world, and which naturally affects both the examination of transactions and their pricing.
In this paper, we will briefly present the effect of the COVID-19 pandemic on transactions in the field of mergers and acquisitions, as well as the main considerations which must be taken when preparing the agreement system in the framework of transactions of mergers and acquisitions in light of the insights of the past few weeks.
Mergers and Acquisitions – Background
An M&A transaction is a complex transaction which takes many months to prepare. In terms of the acceptable agreement system, after the initial negotiations the parties sign a term sheet which defines the main principles for executing the transaction, as well as the legal framework which is supposed to apply between the parties between the time of signing the term sheet and the completion of the transaction.
After completing the negotiations between the parties and holding a due diligence to the satisfaction of the purchaser/investor, the definitive agreements (Definitives) for the execution of the transaction are signed. These comprehensive and binding documents define the signing date for the transaction, after which the parties must continue and perform certain actions, including receiving regulatory approvals, and at the end of an additional period of time, the closing date for completing the transaction is determined.
The uncertainty due to dramatic and unexpected events, such as the COVID-19 pandemic occurring these days, may affect the aforementioned process on a number of levels: firstly, between the time of signing the term sheet and signing the definitive agreements. Secondly, between the time of signing the definitive documents and the time of completing the transaction (the Closing). Finally, even after completing the transaction, the uncertainty in the markets could affect the pricing of the transaction (in as much as there are varying payments which are conditioned upon performance) as well as its worthwhileness.
The Israeli legislation does not comprehensively refer to situations where circumstances amount to thwarting the execution of a contract. Thus, Article 18 of the Contracts Law (Remedies for Contract Violation), 5731-1970, refers to circumstances in which an exemption is allegedly given to upholding a contract due to circumstances which thwart its execution. However, the article is phrased in a very rigid manner. Furthermore, the article was interpreted in a very minimizing manner by the courts, in a way that even dramatic security circumstances which have dramatic consequences on the Israeli market, were perceived as expected, and therefore Article 18 did not apply in their regard.
Contractual Mechanisms for Handling the COVID-19 Pandemic
The foregoing reasserts the manner in which the parties choose to phrase the agreement system in merger and acquisition transaction in a way which shall attempt to express on one hand the complexity of the negotiations between the parties, and on the other hand, also express external circumstances such as the COVID-19 pandemic and its effect on the negotiations and the transaction in general.
The No Shop Term
In the framework of the term sheet, the parties define a no-shop term for negotiations, which usually ranges between 90 and 150 days. Needless to say, in light of the current situation in the market during the past two months, it is very difficult to promote the examination of transactions, and it seems that term sheets which were signed several days prior to the COVID-19 crisis, in face remain effective without any real ability to promote the transaction. In our opinion, a condition should be set that period when the market is under restrictions, including quarantines and such, shall not be included in the count of days of the no-shop term.
Ordinary Course of Business
During the no-shop term, the target company undertakes that it shall continue its business in an ongoing manner and shall not make any material change to its business, out of the view that the nature and the scope of its business as it is expressed in the framework of signing the term sheet, cannot change in an initiated and dramatic manner until the completion of the transaction. However, the COVID-19 pandemic is naturally not the result of such initiative or another, and in our opinion it should be clarified and conditioned that external processed which are not in the control of the company shall not amount to a violation by the target company or the provisions of the articles as stated.
Material Adverse Change (“MAC”)
The MAC clause is intended to settle the risk system which may develop between the parties between the time of signing the transaction and the time of its completion. The parties need to reach an agreement, according to which there should be an examination of the nature of the changes which shall form in the schedule as stated, and which affect the price of the transaction, in order to determine which of the parties shall bear the risks as stated, which, in extreme cases, could result in the termination of the transaction.
In our opinion, material changes which are out of the control of the target company should not affect the transaction and cannot grant the purchaser/ investor an excuse to remove itself from the transaction. For further details in this regard, see the newsletter of our firm from March 2019.
In the framework of the agreement system, the parties define what “force majeure” is, in terms of what is a thwarting event, for which a certain party to the agreement is entitled to not uphold undertakings pursuant to the agreement, and sometimes even to terminate it. The manner in which the parties shall choose to phrase the provisions of the section as stated, shall determine the extent of the consideration which they wish to grant to either of them upon the occurrence of an event such as the COVID-19 pandemic, and whether this can constitute a justification for terminating the transaction.
Payment of the Consideration – Fixed Payments Compared to Varying Payments
Oftentimes, the payment of the consideration pursuant to the transaction is divided into payments of a different nature, emphasizing fixed payments and varying payment which is conditioned upon performance. Thus, the implications of the COVID-19 pandemic on the varying payments could be dramatic, and naturally could affect the economic results of the target company/the selling party. In our opinion, it is important to try and handle unexpected events by setting minimum mechanisms for the varying payments as well, and in addition, set longer periods of time for reaching certain goals given disruptive events such as the COVID-19 crisis.
Merger and acquisition transactions are complex from different and various aspects. The ability of the parties to anticipate dramatic events such as the COVID-19 crisis, and alternatively, significant security events and more, is very limited. However, there should be an attempt to determine sufficiently expansive mechanisms in the agreement system, in order to give the parties the flexibility to also attempt and apply dramatic changes in the framework of the agreement, which could not have been anticipated in advance, in order to reach agreed upon solutions out of the agreement system, and not outside of it.