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Coronavirus – M&A transactions part 2 – Germany

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

27-03-2020

Coronavirus: withdrawal from the SPA - MAC clauses in the sales contract

What is the rule in the USA is rather rare in Germany; so-called Material Adverse Change clauses (or MAC clauses), which grant the buyer a right to withdraw from the purchase contract in the event of changes between signing and closing. MAC clauses can be designed as so-called Company MACs, i.e. MAC clauses where a (economic) change in relation to the target company is important, or as so-called Business MACs where a change in the economic environment or an industry is important. Possible, but less common, are so-called financing MACs, where the buyer reserves the right to withdraw from the contract if he does not receive (adequate) financing for the purchase price.

In the event of substantial changes, MAC clauses give the buyer the possibility of either withdrawing from the contract completely or forcing a reduction in the purchase price by threatening to withdraw from the contract. In Germany, such clauses are only accepted, if at all, if the buyer at the same time undertakes to pay a substantial contractual penalty in the event of withdrawal.

It is rather unlikely that despite the current market environment, sellers are willing to accept MAC clauses. This may change if the crisis lasts for a longer period of time. Should the parties nevertheless agree on a MAC clause, then from the seller's point of view it is essential to ensure that the circumstances triggering the MAC are defined as precisely as possible.

From the buyer's point of view, a MAC clause should be insisted on as a matter of principle. However, it cannot be ruled out that a seller will only accept a MAC clause in return for a high penalty payment in the event of withdrawal from the purchase agreement, as otherwise he will not only be left with consultancy costs but also have a target company that can either no longer be sold at all or only at a significantly lower valuation.

Coronavirus: Reservations of right of withdrawal financing

It is often overlooked that financing agreements by which a buyer (partially) finances the purchase price for the target company may contain MAC clauses or similar reservations of withdrawal. As the M&A market had offered a rather seller-friendly environment in recent years, sellers were usually not prepared to bear the risk of the financing of the purchase price, but rather this risk was exclusively on the buyer's side. For this reason, sellers were usually not prepared to accept a right of rescission in company purchase agreements in the event that the buyer was unable to obtain financing until the closing or the financing banks withdrew their credit commitment.

Loan agreements usually entitle the financing banks to terminate the agreement if the borrower's net assets, financial position or results of operations have changed or are expected to change significantly to the detriment of the buyer. In addition, standard MAC clauses in loan agreements provide that a MAC occurs if events occur on the international or national syndication markets for corporate loans that disrupt or negatively affect these markets. The MAC clauses thus formulated are based on the borrower's current and expected future creditworthiness, but also on the situation on the financial markets. Whether the COVID-19 pandemic will lead to a MAC event will have to be examined carefully in each individual case.

The decisive factor will be whether, according to the specific clause, the deterioration must have already occurred or is only imminent. Even if the respective MAC clause is also based on future expected developments, it must be carefully examined in each individual case whether this forecast will occur with sufficient certainty, or whether the termination is inadmissible because the expected deteriorations turn out to be short-term and not significant in terms of the result.

But even outside of so-called MAC clauses, lenders could possibly withdraw from a financing. A lender has the right of extraordinary termination pursuant to section 490 German Civil Code (BGB) if a significant deterioration in the financial circumstances of the borrower or in the value of collateral provided for the loan occurs or threatens to occur, which jeopardises the repayment of the loan (if necessary by realising the collateral). Similar regulations are also found in the general terms and conditions of many banks. If it is to be expected that the effects of COVID-19 will lead to a significant deterioration of the financial circumstances of the borrower (e.g. slump in sales due to plant closures, production restrictions due to lack of goods deliveries, sickness related loss of large parts of the workforce, etc.), the lender may have a right of termination according to section 490 German Civil Code (BGB) or based on general terms and conditions.

According to the current status (23 March 2020), only consumers and micro-enterprises shall be entitled to a right to refuse performance under loan agreements concluded before 1 April 2020. Thus, the legal changes will probably have no impact on already concluded financing in the context of M&A transactions.

Coronavirus: W&I insurance

Usually, sellers make certain declarations in the SPA regarding the condition of the business operations and the freedom from defects of the target company, for the existence of which they vouch to the buyer (so-called guarantees or warranties). In recent years, it has become more and more common that sellers make these declarations of guarantee but no longer want to take responsibility for the incorrectness of the guarantees. Therefore, liability for breaches of guarantees has been shifted to insurance policies that either the sellers (or more commonly) the buyers take out (so-called warranty and indemnity Insurance or W&I insurance). Guarantees are usually issued at the time of signing ("signing warranties") and/or closing ("closing warranties").

The commencement of insurance cover for the Closing Warranties is subject to the condition that all of the following are fulfilled:

  • the buyer makes a declaration to the insurer that no claims of the buyer exist at the time of the closing (so-called no-claims-declarations)
  • a declaration is made by the seller on the closing if new circumstances have occurred between signing and closing which could lead to a breach of warranty (so-called bring-down certificate)
  • an updated disclosure letter is submitted

The risk that the closing warranties will not be insured because the insured is unable to make a corresponding declaration, the bring-down certificate or the updated disclosure schedules are not accepted by the insurer or because breaches of warranty have already occurred between the signing and execution of the sale and purchase agreement is borne by the insured.

It will therefore be necessary to examine each individual closing warranty to determine whether it is affected by the consequences of COVID-19. For example, the catalogue of warranties often contains a guarantee that certain material contracts for signing and closing have not been terminated and that there are no grounds for termination. As a consequence of COVID-19, it is possible that certain financing loans, supply contracts or customer contracts have been or may be terminated, so that the corresponding warrant is no longer applicable at the time of closing.

Coronavirus: interference with the basis of the transaction?

Due to the changed framework conditions caused by COVID-19, it would be conceivable to withdraw from a concluded purchase contract by invoking the principles of disruption of the basis of the transaction or at least to demand its adjustment.

However, in order to apply the principles of disruption of the basis of the transaction, the parties would have to both:

  • have made a specific circumstance for 2020 (or beyond) the basis of the contract which has changed significantly after the contract was concluded
  • according to the statutory or contractual risk allocation between the parties, a concrete risk would have to materialise for one party, which is why this party can no longer be expected to adhere to the purchase agreement on the basis of a comprehensive balancing of interests between the parties

However, the hurdles are quite high, so that a withdrawal from the contract or an adjustment of the contract can only be considered in exceptional cases.

On the one hand, it is probably doubtful in most cases whether the parties have declared the absence of a pandemic (or specific COVID-19-related influences on the target company) as the contractual basis. On the other hand, it is doubtful whether the occurrence of this pandemic can be unilaterally attributed to one of the parties; rather, it is likely to be a risk that affects both parties equally, and usually purchase agreements provide for a separate system of risk allocation between the parties (e.g. if a locked box mechanism was agreed, the parties clearly wanted to shift the risk of changes after the cut-off date to the buyer).

Moreover, most SPAs are likely to have explicitly excluded the reference to the principles of disruption of the basis of the transaction.