From working remotely to contact-free deliveries to video court appearances, COVID-19 is permanently changing the business and legal landscape, particularly in the sale or purchase of a business, whether via stock sale, asset sale or merger. Deals pending pre-COVID-19 are now proceeding to close; others terminated or are deferred due to the unforeseen changes caused by the virus. Many buyers are experiencing cold feet due to the market instability and uncertainty. Regardless, transactions are still taking place, particularly the purchase of assets of distressed businesses at a discount, strategic mergers and the sale of businesses as a result of early retirement. However, the approach of attorneys and clients alike to transactions have transformed; below are some key topics to consider when entering into a transaction in the time of COVID-19:
Consider how COVID-19 has impacted the viability of the business(es) or assets to be purchased. Be cautious as this topic may cause disconnect between the buyer and seller. Incorporate the use of purchase price adjustments relating to accounts receivable, working capital or even a post-closing earnout based on the financial performance of the business(es) during a defined post-closing period.
Representation and warranties
Representations and warranties of both parties should include a COVID-19 qualifier. Statements concerning employee salaries, continuing operations of the business(es) consistent with past practices, closures, and health and safety should include an exception for COVID-19-related matters. This is especially true for the “material adverse effect” provisions, under which the parties are not aware of any facts or circumstances that will have a “material adverse effect” on the assets/business(es) to significantly reduce the value of the assets to be purchased. Buyers should seek additional representations regarding the impact of COVID-19 on the business(es). Representations and warranties are scrutinized more than ever as a potential “way out of the deal,” so make sure to analyze them word-for-word to ensure accuracy as of the date of signing and as of the closing.
Add a force majeure clause that includes “epidemic,” “pandemic,” and orders and restrictions from state or local authorities such as quarantine or stay-at-home orders that excuse one party from suspending its obligations to proceed with the transaction(s).
Many of the benefits from indemnification provisions are tied to the representations and warranties of the parties contained in the agreement. Include COVID-19 specific conditions to narrow indemnifications and limit liabilities.
Due diligence/financing contingencies
Allow yourself more time than normal. Government office closures and travel restrictions will impact the buyer’s ability to conduct meaningful due diligence and for the sellers to obtain required permits and consents. For example, it may not be feasible to conduct traditional on-site visits or inspections. Additionally, key players may get ill and delay review. Lenders are constantly reassessing how to address the risk associated with COVID-19, resulting in updated financing terms and delayed underwriting. Seek clarification on the infrastructure put in place in response to COVID-19 (i.e., remote working, IT framework, strategies, revisions to employee handbook, etc.).
Pre-closing covenants are those conditions that must be satisfied in order for the parties to be obligated to proceed to close. Usually, a seller will want some flexibility for their business to be able to respond to the ever-changing COVID-19 climate, whereas a buyer desires certainty that the business continues to operate as expected. The result is one party’s flexibility to withdraw from the transaction to the detriment of the other party. Consider including COVID-19 specific covenants to limit terminations due to unfulfilled stipulations.
Closing and logistics
Consider whether the parties can close in person or remotely, whether wires can be initiated and received in a timely manner, and even whether the parties can find a notary.
PPP and EIDL loans
While these loans have been a savior to many businesses, they can cause complications in a transaction. The Economic Injury Disaster Loan (EIDL) requires repayment at closing by a borrower and generally is treated like any standard SBA loan. Unlike EIDL, the Paycheck Protection Program (PPP) loan is subject to forgiveness. If the transaction closes before the forgiveness occurs, the parties have the following options: (i) repay the loan at closing or; (ii) keep the loan outstanding post-closing, subject to forgiveness in whole or in part. If the loan remains outstanding, delineate each party’s obligation to obtain forgiveness for the PPP loan and incur risk for any portion not forgiven. Buyers should review sellers’ PPP loan applications for accuracy, the use of the loan proceeds, and eligibility for forgiveness. Structurally, the parties may desire to establish an escrow to cover PPP-related liabilities.
Client Alert authored by Christina M. Mermigas (312 855 4354), Principal.
This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.