Although relatively new to New Zealand, the impacts of COVID-19 are global and the efforts to reduce the spread of the virus are creating business disruption that should be considered from a legal standpoint. Whilst the impact of COVID-19 on M&A activity in New Zealand and around the globe is not yet known, there are certain steps that vendors and purchasers should consider.
If clients have any questions regarding COVID-19 and compliance with their transaction documents or the implications on potential transactions, clients are encouraged to contact their relevant adviser to discuss.
Consideration in Acquisition Documents
Transaction timelines are likely to be interrupted and delayed. Purchasers and vendors should expect and prepare for this.
Purchasers may be reluctant to commit to an acquisition given the uncertainty of the performance of the target entity as a result of COVID-19. Similarly, if there is any element of deferred consideration, vendors may be reluctant to commit.
There are also practical issues that may result in transaction timelines being delayed.
- It may be difficult to schedule in-person meetings and site visits due to travel restrictions and isolation protocols that have been put in place. Alternative arrangements should be considered, for example videoconferencing.
- It may also be difficult for vendors and target entities to promptly respond to due diligence requests if isolation protocols have disrupted the operation of the business in the ordinary course, particularly if the vendor or target entity does not have the technology in place to allow working from home or the information is not accessible remotely.
- Isolation protocols implemented by government bodies could impact the timing of regulatory approvals required in connection with transactions.
- The parties should consider these timing delays when determining the condition satisfaction date or completion date under the sale and purchase agreement, including the circumstances in which such dates can be extended.
Compliance with General Covenants
Purchasers should expand their due diligence investigations to cover potential issues arising as a result of COVID-19.
Representations and Warranties
- Purchasers should inquire about the expected impact of COVID-19 on key business relationships of the target entity. In particular, whether the target entity has received any notices from any material customers, suppliers or distributors regarding COVID-19 and/or any impact on the business relationship.
- Material contracts should be carefully reviewed in the context of COVID-19 to assess the ability for the target entity or the counterparty to terminate the contract (whether for force majeure or otherwise) as a result of COVID-19. Purchasers should also consider whether any counterparties can fail to meet their payment obligations without ramifications in reliance of force majeure.
- Any internal policies and procedures that are in place to address COVID-19 should be reviewed during due diligence. It is important to consider whether those policies and procedures are compliant with applicable laws (particularly, employment laws). Purchasers should also consider the quantum of potential costs to address any deficiencies and the impact on the operation of the target’s business in complying with such policies.
- Purchasers should also consider whether the target entity has sufficient insurance in place to cover any losses that may be experienced as a result of COVID-19. It is also important to determine whether this insurance will remain in place post-closing.
Both vendors and purchasers should ensure that they understand the risk allocation in the sale and purchase agreement for any losses the target entity may incur arising out of the spread of COVID-19.
- The parties should consider whether additional representations and warranties are required in the sale and purchase agreement in relation to COVID-19 and the extent to which any rights against third parties (for example, insurers) may limit the liability of vendors.
- Vendors should consider whether any impact on the target entity of COVID-19, including the target entity’s response, requires disclosure against any of the representations and warranties. In particular, any changes to customers or suppliers or the incurrence of additional indebtedness. Ordinary course of business qualifiers may be insufficient to address actions taken to address COVID-19.
- Purchasers should consider whether any specific representations and warranties should be included to address the impact of COVID-19 on the target entity, including in relation to its key business relationships, policies and protocols and employees.
Vendors typically have obligations in relation to the running of the business between signing and completion. As a result of swift responses needed to address COVID-19, a vendor may undertake actions between signing and completion that breach these covenants.
Material Adverse Change
- Whilst purchasers will be interested in preserving the value of the target entity, vendors should preserve the ability to their ability to take actions in response to COVID-19 without needing to obtain the purchaser’s consent or risk breaching their obligations. Accordingly, vendors should request that they are able to operate the business in compliance with requirements under applicable law or regulation and to protect human health and safety.
- Vendors that are currently party to a sale and purchase agreement should ensure that they and their key employees are cognisant of the scope of its obligations between signing and completion and ensure that purchaser consent is sought before undertaking any action that could result in a breach.
- A material adverse change (MAC) provision may permit a purchaser to terminate a sale and purchase agreement without liability to the vendor in the event that circumstances deteriorate further.
- COVID-19 is a well-known risk affecting businesses and therefore vendors should resist such protections. Vendors should seek carve-outs for any epidemic, pandemic, or disease outbreak (including COVID-19).
Consideration in Loan Documents
Availability of Financing
- Whether or not COVID-19 will be protected under a force majeure clause depends on the drafting in each contract.
Borrowers contemplating new committed or other debt financing should be aware of the evolving impact of COVID-19 and their ability to not only obtain debt financing but the impact on the negotiation and documentation of debt financing.
Expiry of Existing Financing
Borrowers should also consider any pending maturity dates and if they have facilities maturing in the next 12 months, bringing forward discussions with lenders about extending those maturity dates. Similarly, borrowers with a need to increase facility limits in the next 12 months should initiate discussions with their bank about their requirements.
On-Demand Overdrafts and Undrawn Amounts
In the case of any uncommitted financings, borrowers should consider the practical impact of tighter debt markets, including the ability to draw on ‘on demand’ overdrafts. Borrowers should also be aware that lenders will have the ability to decline funding existing committed lines in the event of a company’s material decline in performance or where a specific condition precedent cannot be met.
Financial Covenants and Equity Cures
We are expecting that many borrowers will incur some COVID-19 related expenses in the coming year. Borrowers should give due consideration whether such additional expenses create stress on testing financial covenants and whether there is any ability to treat such expenses as non-recurring, one-time or unusual charges and therefore outside the covenant calculation.
Many loan agreements also permit shareholders to contribute equity to cure a financial covenant default. If there is a risk of financial covenant default, borrowers should speak with their lenders and relationship managers as soon as possible as to whether such rights can be exercised.
We expect that many lenders will speak with borrowers about the potential impact of COVID-19 on their performance and almost all loan agreements will require borrowers to provide responses. A number of loan agreements will also require that borrowers make positive representations, including if they:
- replace, terminate or otherwise amend a material contract;
- propose to waive a default by a supplier; or
- make a business interruption insurance claim.
In addition, borrowers should review their loan documentation in the context of representations, material adverse changes, and other relevant provisions to avoid any potential default.
The New Zealand market is unique in that borrowers and lenders retain a strong personal relationship and banks try to work closely with their customers and maintain regular contact. Borrowers should however be aware that many loan agreements require, or permit lenders to request, companies to hold annual or quarterly meetings with lenders.
Management should anticipate that lenders will use these meetings as an opportunity to understand various risks and mitigation strategies, and should be prepared to describe such risks and strategies.
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