As the number of COVID-19 cases continues to escalate, the pandemic has tightened its grip on financial and business markets worldwide. Lockdowns globally have resulted in MNCs and SMEs alike facing severe supply chain disruptions and seemingly insurmountable operational costs. Mandatory quarantine orders and travel restrictions have prohibited travel and in-person meetings, adversely affecting deal-making. Due diligence on factories, and management interviews, have to move online. Big-ticket merger and acquisition (M&A) transactions have been shelved or deferred as pricing assumptions have difficulty keeping up with falling valuations, and uncertain revenue projections.

The pandemic is not affecting businesses equally. Those of our clients who supply to essential industries, such as medical equipment parts, are experiencing a surge in requests from customers wishing to move or diversify their supply chain, for example, from China to Malaysia and other South East Asian countries. Some food for thought for the opportunistic, who are pressing ahead with M&A transactions during the circuit breaker period and global lockdown.

Due Diligence – new considerations

Apart from the usual risks to be assessed as part of buyer due diligence, it is important to identify areas of the target’s business which are or may be affected by the COVID-19 pandemic, such as:

• Supply disruption – Buyers should review the target’s supply chains to understand the geographic scope of its operations and dependencies. Buyers should consider whether there are appropriate mitigation or contingency plans in place to ensure business continuity.
• Performance of contracts – Buyers should review the target’s contracts to assess the parties’ rights and obligations, and identify the ability of the target to invoke termination and/or force majeure rights (and conversely, the counterparty’s ability to invoke such rights). Buyers should keep in mind that Singapore’s COVID-19 (Temporary Measures) Act 2020 provides temporary relief to parties who are unable to perform obligations under certain specified contracts, where the inability is to a material extent caused by COVID-19. Is the target operating a business that can or is likely to invoke temporary moratoria against litigation or enforcement of security for failing to pay rent, or honour its contractual obligations, during the control period?
• Insurance – Buyers should consider if there is any possible insurance coverage for aspects of the target’s business that may be affected by COVID-19 and similar global or regional health crises.
• Employment issues – Buyers may price the target based on reduced costs, including employee costs. Irrespective of whether the deal requires the target company to deliver a trimmed work force, or manpower or salary cuts are to be made post-closing, many jurisdictions have labour law protections to be navigated. In Singapore, the Ministry of Manpower (MOM) requires employers who implement cost-saving measures during the circuit breaker period (from 7 April to 4 May 2020) to notify MOM if the cost-saving measure result in employees’ salaries falling below 75% of gross monthly salary for local employees or 75% of basic monthly salary for foreign employees. The deadline to notify is one week after the cost-saving measures are implemented. This is in addition to the usual considerations to retain key management and putting in place transition measures to mitigate interruptions to business operations in the immediate post-acquisition period. Buyers have to review the target’s internal policies around COVID-19, such as telecommuting and safe distancing measures to ensure compliance with new laws and regulations.
• Solvency risks – In these uncertain times, buyers have to assess the ability of the target to withstand liquidity crunches and the impact of COVID-19 on the target’s financing sources, including new sources made available by Singapore’s central bank.

The Monetary Authority of Singapore (MAS) and Enterprise Singapore (ESG) announced on 20 April 2020 that it is offering near-zero interest rate loans to eligible banks - just 0.1 per cent per annum for a two-year tenor - in a move to support SME lending. The initiative is to help lower the cost of loans for the Enhanced Enterprise Financing Scheme - SME Working Capital Loan and the Temporary Bridging Loan Programme. These initiatives are intended to pump cheap credit to SMEs. The lower borrowing cost will apply to such loans taken between 8 April this year and 31 March 2021. The Temporary Bridging Loan Programme is aimed at helping local companies manage their immediate cash flow needs. Companies that require more working capital beyond the programme can apply for the Enhanced Enterprise Financing Scheme - SME Working Capital Loan. The latest initiative, which will be in place until April 2021, was first announced when the MAS rolled out baseline measures for banks and financials to support companies during the pandemic.

Warranties – shifting sands

We expect that specific warranties relating to risk management and contingency planning to deal with COVID-19 and similar crises will become standard fare. Buyers would want to negotiate for specific warranties around the adverse impact of the COVID-19 pandemic on the target’s business, including those relating to human resource, risk management and contingency planning. 

Conversely, sellers should seek to insert relevant knowledge and materiality qualifiers in disclosure letters, and as far as possible, make disclosures generally around the impact of COVID-19, including effects on supply chain, contracts, financing arrangements and human resource. Given the ever-changing circumstances with regard to COVID-19, warranties should be reviewed to assess if they should be (or can be) repeated at closing and where possible, negotiate to include updated disclosure letters prior to closing.

Warranty and Indemnity (W&I) Insurance

W&I insurance has become increasingly commonplace in M&A transactions. It is often required by sellers as a strategic risk management tool, to allow sellers to make a “clean exit”. It is worth considering that W&I insurance policies generally do not cover known issues. Insurers may also request for exclusions to policies in relation to business interruptions caused by the COVID-19 pandemic or like situations.

Pre-Closing Undertakings – new exigencies

Typically, there is a gap between signing and closing for conditions precedent to be fulfilled. Sellers should negotiate carve-outs to pre-closing undertakings to ensure that their businesses can adapt to the COVID-19 pandemic without having to seek buyer’s consent at each turn. The general carve-out to allow the target to operate in the ordinary course of business may no longer be good enough. The carve-out should cover new situations such as:

• Ability to impose “emergency” measures for compliance with new laws and regulations around COVID-19, including making changes to internal policies to provide for telecommuting and safe distancing measures;
• Taking appropriate mitigation and contingency plans for business continuity;
• Incurring short term or emergency indebtedness to tide through the tough months of lockdown;
• Necessary right sizing/retrenchment of employees and reducing labour costs;
• Shutdown and/or conversion of certain underused facilities or warehouses, for example, accommodation for recovered COVID-19 patients; and
• Disposal of non-core assets to free up short-term operating cash flow. 

Walk Away

At the end of the day, buyers will want a right to walk away if the target’s business deteriorates to such an extent that it bears little semblance to what was presented at term sheet stage. Sellers typically resist giving buyers a unilateral right to terminate the transaction. Existing provisions such as force majeure and material adverse change may have to be expanded or amended to reach a desired equilibrium that is acceptable to both sides.

Force majeure

Force majeure clauses generally operate to excuse or suspend performance of particular contractual obligations on the occurrence of certain specified events beyond a party’s control. While force majeure clauses are not typically seen in M&A transaction documents, sellers may insist upon these in current unprecedented times. Given that the application and scope of force majeure clauses depend on the precise language used, consider using specific wording such as “pandemic” or “epidemic” to cover the COVID-19 situation, rather than only relying on generic terms such as “act of God” (as the jury is still out on how the virus originated).

In relation to the outcome of application of the force majeure clause, sellers should consider not just suspension of obligations but the consequences of termination of the transaction, and in this regard, loss and/or financial allocation issues brought about by termination will have to be dealt with.

Material adverse change

M&A transaction documents contain clauses allowing termination or adjustment of obligations in the event of a “material adverse change” or a “material adverse effect”, affecting performance of the contract. These clauses allow buyers to terminate a transaction due to a supervening event that adversely impacts the nature of the business or value of the target. However, material adverse change clauses tend to be generally worded and lack specific language identifying a particular event or loss as a “material adverse change”. It may also be difficult to prove that a “material adverse change” or a “material adverse effect” was caused solely by the COVID-19 fallout.

Where a party wishes to rely on a material adverse change clause to terminate the transaction, the clause has to be carefully crafted to include a situation brought about by COVID-19.

Signing and Closing

Where signing used to be a simple exchange of emailed scans of signed documents, lawyers now go into detailed logistical planning around printing and arranging multiple courier runs to the homes of directors, signatories and company secretaries. With non-essential work places closed or operating with limited exemptions, closing deliverables such as execution of share transfer forms, witnessing of signatures, collation of originals with wet ink signatures etc., all now require more time and coordination.

Brave New World

COVID-19 may not go away in the summer, or autumn, or winter. M&A lawyers the world over may have to accept that everyone needs to find new ways to originate, negotiate and close deals. Life and business will go on, surely, except more slowly.