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Coronavirus – M&A transactions part 1 – Germany

  • Germany
  • Coronavirus
  • Coronavirus - Country overview
  • Mergers and acquisitions

27-03-2020

 

Coronavirus: effect on M&A sales process

The implementation of sales processes is currently facing particular challenges: bidders are dropping out, financing can no longer be implemented, the business plans of the targets can no longer be sustained, and it is unclear when the remaining parties to the process will even be able to sit down together again at the negotiating table, as borders have been closed and exit restrictions imposed.

Many sales processes therefore raise many practical questions:

 

  • can the schedules for due diligence, management meetings, etc. set out in the process letters be adhered to?
  • which governmental entry or exit restrictions have to be observed and how does this possibly affect the timing for signing and closing a transaction?
  • how can certified signatures and apostilles for powers of attorney or other documents be obtained?

 

Special problems may arise in the case of sale processes by the public sector (e.g. infrastructure projects). Due to the strict legal frame-work for state aid, the public sector must make the procedures transparent and non-discriminatory. If a bidder is subject to purely company-internal (travel) restrictions and is therefore unable to comply with the (time) specifications of the bidding process, this bid-der will probably not be able to successfully defend itself against its exclusion by arguing that it is in breach of a non-discriminatory procedure. This could be different, however, if a bidder is subject to a governmental restriction on entry or exit or a quarantine ordered by the government.

Coronavirus: importance of due diligence

In addition to the purely economic questions regarding the stability of the business model and the influence of COVID-19 on the operating results, from a legal perspective the question arises as to what negative effects the COVID-19 situation will have on the supply and service chains in the short and medium term. For this reason, increased attention should be paid to the following questions in particular within the framework of the legal, but also economic due diligence:

 

  • what (unilateral) contractual or statutory rights of termination or withdrawal do the contractual partners of the target company have?
  • how are supply chains secured and is there a risk that suppliers themselves will no longer be able to deliver?
  • how dependent is the target company on individual suppliers, do suppliers come exclusively from high risk areas? Are there substitute suppliers who can completely or partially cushion supply bottlenecks with individual suppliers?
  • what labour law measures has the tar-get company taken: short-time work compensation, plant closures, home office possibilities or, if applicable, re-location of production? What further measures have been agreed with works councils etc.?
  • which hygiene regulations have been implemented and can be complied with?

 

If the due diligence reveals such risks, the purchaser will realistically only have the choice between terminating the transaction or reducing the purchase price, as it is not expected that a seller will assume these risks under the guarantees or an indemnity.

However, a premature break-off of the con-tract negotiations should be avoided. Even if possibly concluded Letters of Intent or other agreements are generally not binding, mutual fiduciary duties may prevent a unilateral, premature break-off. This should definitely be checked in advance.

Coronavirus: effect on purchase Price

Neither the short-term nor the long-term con-sequences of the current crisis can yet be seriously assessed. If the SPA has already been signed (signing) but possibly not yet been closed (closing) due to antitrust or other approval requirements and if the buyer does not have the possibility to withdraw from the SPA (to so-called MAC clauses please see below), the question arises to what extent the risk of a reduction in value of the target company can be cushioned in the purchase price provisions.

Coronavirus: fixed purchase price (“locked box”)

In recent years, sellers have frequently been able to enforce fixed purchase prices (so-called "locked box" purchase price clauses), according to which the purchase price was fixed on the basis of an effective date in the past (usually the date of the last annual financial statements) and thus the economic risk of changes in the economic situation of the target company after this effective date was shifted unilaterally to the buyer.

As a result of the transfer of risk to the buyer, the buyer remains obliged to pay the agreed purchase price even if the economic situation of the company deteriorates significantly after the effective date. At best, if a so-called MAC clause has been agreed (see part 2) or according to the principles of disruption of the basis of the business (see part 2), an adjustment of the purchase price or a withdrawal from the purchase contract as a whole could be considered.

Coronavirus: purchase price calculation based on closing accounts

If the final purchase price to be paid by the buyer is calculated on the basis of financial statements/balance sheet to be prepared at the closing, any changes that may now arise may be taken into account at least in part in the context of a purchase price adjustment, because under this method the cash position at the closing is added to the agreed enterprise value, net financial debt is deducted, and any excess of or shortfall in working capital is offset (up or down).

Although a seller will no longer be prepared to accept a lower enterprise value for the target company after a purchase agreement has been concluded, it is to be assumed that the cash position will decrease, net financial debt will increase or current assets will be significantly reduced as a result of supply bottlenecks, a slump in customer sales, plant closures, the creation of provisions, the raising of new loans/guarantees and other measures.

If an SPA has not yet been signed, a seller may be tempted to ignore the special effects caused by COVID-19 when calculating the purchase price. However, it is questionable how this should actually be implemented, as it would be extremely difficult to determine which economic consequences result from COVID-19 and which, if any, are inherent in the target company.

Coronavirus: earn out clauses

Some purchase agreements contain so-called earn-out clauses (i.e. the purchase price in-creases if the target company achieves or exceeds certain targets, e.g. sales, EBIT or similar, within a certain period of time).

If an SPA has already been concluded, a seller must expect that the effects caused by COVID-19 will make it impossible to achieve the defined target figures.

If an SPA has not yet been concluded and the parties intend to continue the transaction de-spite COVID-19, they can consider bridging their different purchase price expectations by means of an earn-out clause. However, negotiations on the earn-out period (i.e. the period in which the target figures must be achieved) are likely to be difficult, as it is completely unclear how long the consequences of the COVID-19 epidemic will be.