Despite headline deals such as Yinson Holdings’ purchase of the majority stake in Ezion Holdings worth US$532 million and the US$8 billion merger between CapitaLand Mall Trust and CapitaLand Commercial Trust, the first quarter of 2020 has seen a decrease of 22.4% in M&A deal value and a 30% decrease in M&A deal count as compared to the first quarter of 2019, which have been attributed to COVID-19 and the anticipation of potential issues arising from COVID-19.
Notwithstanding the overall decrease in M&A activity early this year, some regional surveys had indicated that 61% of respondents are expecting more acquisitions to be carried out in 2020. Marketwatchers have also observed industry trends such as buyers considering acquisitions in sectors more heavily affected by COVID-19 (such as international travel, hospitality and tourism) that may provide a bargain, and a shift towards a “buyer friendly” M&A market as compared to “seller friendly” in previous years.
We have also observed clients with concluded deals coming back to discuss the way forward in these uncertain times. This is especially so where the sellers still hold a stake in the business and are involved in its operations. Significantly protracted negotiations have also become increasingly common as parties deal with new issues and uncertainties arising from COVID-19.
In terms of market practices, the use of digital technology has been significantly accelerated due to lockdowns and telecommuting requirements. Negotiations and due diligence have moved to online spaces, the requirement for hard copy original documents has been reduced and the use of electronic signatures is now commonplace.
A common question now is whether parties to a contract are expected to continue to fulfil the contract as contemplated pre-COVID-19, or whether they may be excused from the performance of certain obligations in view of the pandemic. There is no standard answer as this will depend on the transaction in question and factors such as whether the terms of the particular contract have provided for the situation and even if so, whether they are sufficiently clear, the applicable governing law of the contract, and whether other provisions may prevail or otherwise affect the application of such terms.
Lockdowns and telecommuting are likely to result in delays in obtaining third party consents, regulatory approval and fulfilment of contractual obligations and hence lengthier longstop dates for closing and the satisfaction of completion deliverables. In the event of an extended longstop date for closing, representations and warranties (including those related to business operations and business continuity) should remain accurate and disclosure letters should be updated if necessary.
As international travel is still limited and restricted, parties are prevented from physical and on-site inspections thus hampering the conduct of due diligence. Buyers may negotiate for longer contractual time to conduct due diligence and evaluate the impact of COVID-19 on the target company and potential liabilities. New laws and practices that have to be complied with to prevent the spread of COVID-19 may require that businesses adjust and modify their operations and are likely to result in delays.
Parties should also take note of the effect of COVID-19 related legislation implemented in various countries especially in cross-border transactions.
In Singapore, the COVID-19 (Temporary Measures) Act 2020 was passed which allows for temporary relief in the event of a party’s inability to perform contractual obligations due on or after 1 February 2020 for certain contracts entered into before 25 March 2020. This was then expanded by the COVID-19 (Temporary Measures) (Amendment) Act 2020 (“COVID-19 Amendment Act”), which enhances and provides relief (including rental relief for small and medium enterprises) for those who are unable to fulfil their contractual obligations due to COVID-19. The COVID-19 Amendment Act also introduces a limit on late payment interest or charges for certain contracts, and provides relief for certain parties affected by breaches or delays in construction or supply contracts, where such breach or delay is due to COVID-19.
COVID-19 has changed the considerations involved in the drafting of contracts. For a start, parties and their counsels will find it all the more important to ensure contractual terms clearly reflect their commercial intentions and the mechanisms regulating the transaction, to avoid disputes at a time with heightened business risks and uncertainty. This is particularly important in common law jurisdictions such as Singapore, where our Courts are reluctant to interfere with commercial contracts negotiated in good faith.
Parties and their counsels may also need to consider how Material Adverse Change / Material Adverse Effect (“MAC/MAE”) clauses should be structured. Sellers are likely to negotiate for COVID-19 impacts to constitute MAC/MAE events, whereas buyers would want to caveat for COVID-19 impacts that are foreseeable and in the ordinary course of business.
Although widely acknowledged to be uncommon in M&A agreements, Force Majeure (“FM”) clauses are now often considered for reducing the risk that a party is exposed to. A chief issue to consider for FM clauses apart from crafting them to capture COVID-19 events and not just use the typical “acts of God” wording, is whether they provide for temporary suspension and/or termination of the entire agreement. Such clauses will have to be drafted clearly and carefully to cater for a variety of relevant scenarios, for instance, to limit the ability to rely on COVID-19 related events to make claims or exit from deals.
Given the imposition of lockdowns and safe distancing measures, it is no longer always possible to execute and sign contracts in the usual manner as parties find it harder to be present at one location. Provisions that provide for signing in separate counterparts and electronic signatures are now key for inclusion, and signature pages should also allow for such arrangements.
Financial information and risk allocation
In the face of the pandemic, various issues arise with respect to financial information used in M&A transactions. Pro forma financials and valuations may become inaccurate or require adjustment. Financing and investment plans may be prolonged and sources of funding may become less readily available. COVID-19 is also likely to increase costs to account for delays, changes in business operations and other impacts, which will adversely affect financials and future plans.
Locked box mechanisms and other pricing mechanisms that rely on historical financial data may be less favourable given the financial and economic impact of COVID-19. On the other hand, deferred consideration mechanisms to obtain financing and ensure liquidity or price adjustment mechanisms may be considered to allocate risks.
As parties also look for ways to apportion or mitigate risks arising from M&A transactions, warranty and indemnity insurance become increasingly relevant as a means to apportion risk and reduce losses arising from breaches of warranties and other claims. However, there are limitations as insurers generally do not provide coverage for issues disclosed or already known, so COVID-19 related claims on policies purchased after the onset of COVID-19 may not be successful, and insurers are also beginning to specifically carve out and exclude COVID-19 situations from their insurance offerings. Parties may also consider mitigating risks of potential payment defaults by requesting for parent or personal guarantees or with escrow arrangements.
It has been a year like no other and the market for M&A deals is still largely subdued. But with the crisis comes opportunity, and despite the overall decline in M&A activity, deals are still being done and there are new ways of transacting and ways of mitigating the uncertainties. Given the volatility and unpredictability of COVID-19’s impact on transactions, it is key for documentation to be closely reviewed at each stage of a transaction and to ensure that parties work through any new issues arising with mechanisms in place to meet their intentions and expectations. With the situation constantly evolving, it remains to be seen how M&A activity will pick up in the new normal.
The above commentary is for general information only and should not be relied on as legal advice. Please feel free to contact Mark Wong, Jacinda Wong or Yun Neo if you require more information, or to discuss how we can support you in your transactional needs.