With significant developments on the regulatory front suggesting that long-stop periods will need to increase in the post-COVID-19 world, parties will need to address not just the obligations surrounding the satisfaction of regulatory and other conditions, but also the consequences of failing to satisfy these conditions.
In this third out of four blog posts, Global Transactions partner Jochen Ellrott looks at conditionality in SPAs, as well as how MAC clauses might evolve in the aftermath of the global pandemic as the tension between buyers seeking optionality and sellers aiming for deal certainty becomes particularly acute.
It is safe to assume that even the traditionally more seller-friendly markets in Europe will see a resurgence of regulatory conditionality in M&A contracts. With foreign investment control regimes globally becoming more encompassing and stringent by the minute – a movement that has only been exacerbated by the pandemic – a blanket acceptance of regulatory risk is unlikely to go down well with buyers.
Merger control risk seemed to be fairly predictable despite prolonged review periods at the beginning of the crisis. However, the EU’s plan to create a new screening system of foreign state backed/financed investment into Europe may be indicative of a trend of tightening merger control regimes, which parties might have to extrapolate when discussing regulatory conditionality.
It may be even more difficult to predict the outcome of foreign investment control reviews that are ever more driven by increasing protectionism and politicisation. It goes without saying that this is particularly acute in industries traditionally deemed of national strategic importance, though it is worth acknowledging that the COVID-19 crisis has also shown that disruptions in myriad areas can give rise to significant domestic issues, potentially broadening the scope of transactions that may catch the eye of foreign investment control regulators.
As a consequence, buyers will resist blanket “hell or high water” clauses much more frequently, perhaps in exchange for sizable break fees. As a compromise, parties can refine customary regulatory conditionality clauses such that, for example, any material changes to the underlying regulatory regime between signing and closing convert a generic “hell or high water” clause into a buyer’s walk-right with a break fee.
Conversely, given the regulatory uncertainty and the perceived increased risk of buyers backing out of transactions, sellers might request tighter obligations on buyers to the point where buyers are urged to agree upfront on possible remedies to facilitate merger clearance. Where such remedies are to include divestments, buyers will need to be mindful of a narrower M&A market where it may be difficult to sell “remedy packages” to a third party at a reasonable price.
In any event, the fact that the time allowed by regulators and indeed needed for regulatory review processes has been extended in many jurisdictions will require more relaxed long-stop dates, lengthening the pre-closing period – and preventing buyers from ‘gaming’ the regulatory process to use the long-stop date to get out of transactions.
Ensuring that acquisition financing remains available during lengthy pre-closing periods may be a challenge for buyers. The financing markets have stayed surprisingly robust and acquisition financing appears to be generally available. Accordingly, sellers will continue to insist on certain funds at signing. However, financing may take longer to arrange or may only be capable of being arranged after signing, e.g. in fire sale scenarios. If the regulatory review process is expected to take longer than before the pandemic, financing sources might be expected to only commit their funding if the terms of the debt can be flexed depending on market developments.
Consequently, buyers may need a financing-out if financing is no longer available at acceptable terms. Any such condition should be clearly defined and will in all likelihood only be acceptable to the seller if it comes with a meaningful break fee that may need to be collateralised by a bank guarantee, escrow or similar payment.
It is arguable whether a request for a so-called “bring-down” of the seller’s representations and warranties, where the buyer is entitled to deny closing in case of a material breach of certain representations or warranties (and possibly covenants) – as is often seen in US-style SPAs –, is more justifiable now compared with prior to the pandemic, but such conditions might become more common with market dynamics shifting in favour of buyers.
It is important to note that the time pressure, demands and complexities of running a business in a pandemic may have led or lead to a certain disregard for legal compliance and governance procedures during the height of the crisis. Accordingly, such a condition is going to be more attractive from a buyer’s perspective, but conversely much less palatable on the seller’s side.
The lengthier pre-closing periods may at least provide buyers with stronger arguments for a repetition of business warranties at closing, alongside the more fundamental-type warranties buyers would traditionally expect to be repeated.
Buyers’ insistence on MAC clauses will be ubiquitous in the post-COVID-19 world. However, the customary “business MAC” will not help, as explained in our earlier blog piece. If buyers want the right to walk away from the deal if the pandemic (or other related systemic shocks) entails further unforeseen consequences not exclusive to the target business, the definition will need to be broadened to include so-called “market MACs”.
If sellers are actually willing to entertain the notion of such a clause, they will surely insist on limiting its application to market developments triggering a defined measurable impact on the target business. Again, the parties may want to consider sketching out certain scenarios that would trigger the walk-right, e.g. a shutdown of the target business’s operations for a certain period, an interruption of vital supply chains, or the loss of revenue or EBITDA by more than an agreed amount or percentage or, alternatively, in excess of the industry average.
In this respect, parties will need to stay alive to the current business conditions and ensure the drafting of such clause is sufficiently encompassing as the after-effects of the pandemic percolate through the markets (e.g. while initial disruptions have been caused by government-mandated shutdowns, as many countries start to move on, different obstacles to conducting business may begin to arise).
To avoid protracted uncertainty around the applicability of the MAC clause, parties will be well advised to provide for an accelerated MAC determination mechanism where an independent expert or group of such experts decides whether a MAC has occurred in a short period of not more than a few weeks. In a volatile world, neither party will want to rely on, and wait for, a court or arbitration tribunal to render its decision after lengthy deliberations and appeals.
Deposits / break fees
As buyers push back on shouldering the enhanced regulatory risk and argue – with recent historic justification – for more tailored market MAC provisions, sellers will need to address the consequent decrease in certainty of completion.
Deposits (or earnest money) may be the price of sellers agreeing to open up their books to due diligence processes which, as a result of the pandemic, may be increasingly thorough and invasive and demanding of senior management’s time in a period where many targets will need close monitoring and operational oversight.
Similarly, termination rights in the guise of more permissive MAC clauses, financing-outs, or less arduous regulatory undertakings may be paired with obligations for buyers to pay a substantial break fee in order to walk away.
(For those who wish to continue reading, the consolidated version of all four blog posts is available in the attached/linked PDF.)