Much has been written about how the COVID-19 pandemic is impacting mergers and acquisitions activity with respect to transactions that have not yet closed. However, not as much has been said about what you may want to be thinking about if your transaction, or your client’s transaction, closed before the crisis hit the United States. Here, we will cover a few of the issues you may want to consider about your M&A transaction that has already closed in light of the COVID-19 pandemic.
Earnouts
Even in the best of times, earnouts are often the subject of disputes between buyers and sellers. It is very likely that the number of disputes will increase in the coming months and years as earnout periods impacted by the pandemic come to an end. Of course, the primary risk to sellers is the negative impact of the COVID-19 leads to missed financial targets. This impact can come not only from lost sales, but also from contract and tort claims relating to government-imposed shutdowns. While buyers will likely be in a better position, buyers are exposed to potential legal claims from sellers relating to missed earnout targets. The unprecedented nature of the current situation may give room for sellers to argue that buyer responded improperly to the pandemic. As buyers and sellers contemplate how to deal with an earnout, they may want to consider the following:
- Having the earnout period start later in exchange for a lower maximum payout, waiver of potential claims by seller, relief from post-closing operational covenants that may restrict buyer’s ability to operate the acquired business or other benefit to buyer.
- Buyers can fully document decision making processes/considerations for significant matters and how the decisions are expected to benefit the business in the long run in the event decisions need to be defended in the future.
- To the extent the owner exited the acquired business, she could return to assist through the crisis, especially with respect to relationships with customers, suppliers and workforce.
- If the owner remained an officer or director of the business after closing, he should be mindful of fiduciary obligations to the company and its owners.
- Buyers and sellers should communicate in an attempt to avoid disputes.
Debt Financing
If the buyer used seller financing to pay a portion of the purchase price, it is likely that buyer’s and seller’s interests are well aligned in that both want to avoid a payment default. A payment default would likely trigger a default under any revolving line of credit or senior loan agreement in place for buyer. With respect to bank lenders, borrowers are most likely to first run into a problem when they seek to borrow under a revolving line of credit as this usually requires a certificate by borrower that there be no breaches of covenants and that representations and warranties remain true.
As buyer and seller are likely aligned, if buyer needs relief from payment obligations to seller, buyer and seller should be able to reach a compromise. This is especially true where this is also an earnout, as buyer can provide seller an accommodation on the earnout in exchange for a deferral of required payments or similar relief. If a bank provided the financing, the buyer should reach out to the lender as soon as possible. Lenders will likely have many troubled loans and may be willing to cooperate with borrowers to avoid having loans go into default.
Business Insurance
Most business interruption policies require some sort of physical damage before there will be coverage for a business interruption claim. Further, after earlier epidemics, standard policy forms were revised to exclude coverage for losses caused by viruses, bacteria and the like. But, you should not give up. Governmental intervention is possible. Several states have introduced legislation that would require insurers to pay certain claims and there is likely to be strong regulatory and political pressure on insures to pay claims. Further, as virus exclusions are relatively new, the law surrounding these exclusions is not particularly well developed. For now, consider:
- Keeping track of losses and expenses related to the pandemic; consider a separate general ledge account for this purpose.
- Reading your policy – it may contain a “civil authority” provision providing coverage for losses incurred in connection with certain government prohibitions.
- Filing a notice of claim or loss with your insurer to protect your rights. If a claim or loss is not reported timely, coverage may be lost.
- Keeping up to date with legislative and regulatory developments in your state regarding insurance.
Representation Warranty Insurance
While COVID-19 exclusions are now reportedly common in representation and warranty insurance (RWI), that was not the case before the COVID-19 epidemic started. For transactions that have already closed, there could be an uptick in claims made under RWI as buyers look for ways to recover some of the losses they are suffering as a result of the economic impact of the pandemic. In addition, companies issuing RWI may be slower to pay claims. They may be slower to pay claims because the unprecedented nature of the current economic situation may require more careful analysis of claims and insurers may feel pressure to be more careful with their own financial resources. These considerations may start to erode insurers’ desire to maintain a good claims-paying reputation in the marketplace.
What to do Now
While much of the focus has been on transactions that have not yet closed, there is likely much to be done on transactions that closed, especially if the transaction is still in the earnout period. Buyers and sellers should be proactive as they probably have good reason to cooperate. Do not give up on making a successful claim under your business interruption insurance. And, finally, talk to the professional advisors that assisted with your transaction as they will undoubtedly be able to offer suggestions and assistance.
