In times like these, when states become islands and cities become households, also transaction lawyers have to think outside the box: Covid-19 poses great challenges, especially for cross-border company acquisitions (M&A transactions) as well as stock exchange and capital market deals.
M&A - End of a seller's market?
In the last five years or so, M&A transactions have seen a strong so-called "seller's market" in which sellers have been able to generate very high purchase prices and enforce seller-friendly contractual arrangements. This will likely change rapidly now and increasingly turn in the other direction. Buyers are currently gaining the upper hand, especially when potential targets or even the sellers themselves come under pressure. Government imposed quarantines and travel restrictions already have a negative impact on due diligence reviews, contract negotiations as well as signings and closings of transactions. Particularly affected by Covid-19 are industries that traditionally have particularly strong economic ties to regions currently and future affected by Covid-19, such as the automotive and automotive supply industries, chemical and pharmaceutical products, electrical equipment, machinery, metals and natural resources as well as food and animal feed.
Capital Market - New Trends?
Also with respect to capital market transactions it appears that no stone is left unturned. The recent dramatic price collapses in connection with Covid-19 on the domestic and international stock markets also pose challenges for current and planned capital market transactions. Standards developed over years in the implementation of capital market transactions are fundamentally questioned. This concerns both ECM and DCM deals. The Covid-19 related (effective) measures imposed by the Austrian Financial Market Authority on the ban of short selling of certain financial instruments in exceptional situations aims to prevent bets against shares of individual companies on the Vienna Stock exchange which would lead to an even greater fall of share prices of such securities. However, Germany can do without such a ban on short selling. Furthermore, announced government restrictions and recommendations on future dividend payments by listed companies that receive government aid are casting their shadow. The international capital markets have sensitive detectors regarding such issues, and institutional investors react quickly. All this is expected to have a rapid impact on the investment decisions of those long-term oriented institutional investors who are looking for equity investments with guaranteed high dividend pay-outs. Investment grade corporate bond issues with maturity of not more than three to four years by top-tier companies that are active in a corona-resistant industrial segments (e.g. utilities, telecoms or pharmaceuticals) represent attractive alternatives to such institutional investors compared to pure equity investments with questionable dividend outlook, at least for an interim period. Once unrestricted dividend payments are possible again, investments made now in such corporate bonds can easily be switched back into equity investments - the financial world is already talking in this context about the "Longer-Run Economic Consequences of Pandemics". This type of corporate bonds will be issued also by Austrian blue chip corporations. OMV AG has given the starting signal for such issues with its current bond issue.
Trend: More M&A deals after Corona
We anticipate that the financial and economic crisis caused by Covid-19 will, as the financial and economic crisis in 2009, also result in a significant concentration process in various industry segments. It is already foreseeable that large and economical resilient companies especially in the tech, telecoms, utility and pharma sectors, especially when having comfortable cash reserves will benefit from the current crisis and significantly increase their market share at the expense of companies that are under economic pressure. Simultaneously, the comprehensive government bailouts that are currently taking place will at the end of the day presumably also lead to all forms of nationalizations, including governments to hold stakes in rescued companies. Privatization - this theme was present prior to Corona. In times of Corona, nationalization seems to be the new mantra - and this no longer applies just to transportation companies such as airlines. There seem to be no limits when imagining what could happen. Also such deals with significant governmental involvement will not be closed without the involvement of top-class teams of transaction lawyers who can cover a wide range of legal areas. A noticeable increase in public and private M&A deals can, therefore, be expected at the latest when the national and international bailout programs end.
Questions and answers:
In the current situation, a distinction must be made as to whether an M&A transaction is in the (i) pre-signing phase or (ii) in the phase between signing and closing.
For the pre-signing phase, it can be expected that Covid-19 will cause buyers to suspend or reconsider key aspects of cross-border transactions during the re-evaluation of a deal. Often MOUs or LOIs are drafted as non-binding documents so that, with the exception of pre-contractual culpa in contrahendo aspects, buyers are usually relatively free to decide whether or not to further pursue the transaction. In addition to an up-to-date review of the buyer's own business model and its liquidity planning as well as share price development (especially in connection with planned share for share transactions) with regard to target companies, the following aspects will also play an important role:
In a first step, the purchaser's management/board of directors must address these issues internally. Subsequently, however, buyer's supervisory board, if its approval is required for the transaction, will also demand appropriate information and protection against possible risks in the contractual documentation: Fundamental adjustments to the representations and warranties as well as specific indemnities in SPAs will be just as indispensable as carefully drafted MAC clauses and closing conditions that provide the buyer with the best possible protection under the changed circumstances. Break-up fees in favour of the seller will be more difficult to be negotiated.
If public shareholders' resolutions are required as well for the execution of a transaction (e.g. resolutions on capital measures, merger or demerger resolutions or other reorganisation steps), management board and supervisory board will have to prepare themselves for probing questions from shareholders. In addition, in the interest of transaction security, the question will arise as to whether, in the light of Covid-19, in a particular situation the public general meetings required for the transactions can take place at all in a legally effective manner, since, for example, the presence of a certain number of shareholders at the general meeting may be exceeded. The question of the legally effective conduct of general meetings arises not only for transaction-related (extraordinary) general meetings, but generally also for all ordinary shareholder meetings of listed companies – the shareholder meeting season is about to start in Austria! While general meetings physically held in the USA can de facto be easily avoided (Warren Buffett just recently referred his Berkshire shareholders to proxy voting), this is not as simple in Austria. Some companies have postponed their general meetings until autumn, probably also in order to make a sound proposal for the dividend payment at that time. Other companies have decided to hold a virtual general meeting, thereby breaking new legal ground.
Austrian corporate law generally assumes physical presence of shareholders, which, however, is often not possible in times of a pandemic. The use of technical means of communication – in particular qualified video conferences – should make it possible to reach a relatively high quality decision even without holding a meeting in person. The Austrian legislator therefore created in light of the Covid-19 crises, at least temporarily, a legal basis for such virtual meetings and other forms of decision-making (e.g. written votes). The practical implementation of such virtual meetings takes place in accordance with a directive recently issued by the Federal Minister of Justice. At the same time, the period for holding ordinary shareholder meetings of Austrian stock corporations and limited lability companies was extended from eight to twelve months within the fiscal year of the respective company.
Overall, the pre-signing phase of M&A transactions presents a number of complex problems. In our opinion, deals will often be postponed or ultimately cancelled, but in any case modified with regard to their deal structure. On the other hand, the Covid-19 crisis is also a good opportunity for sellers to refrain from a planned sale without the risk of being charged for breach of pre-contractual obligations.
A (considerable) increase in distressed M&A transactions can be expected in the short and medium term. In such deals experienced buyers, financial investors and crisis-proof strategic buyers with cash reserves or a stable stock price, will acquire preferably those companies that have fallen into economic difficulties as a result of the effects of Covid-19 – even despite government support packages. It remains to be seen whether fast-acting and globally active private equity investors who can on short notice call significant purchase prices via capital calls and even without leverage, will have the edge here, or whether market consolidations are taking place by strategic buyers succeeding in purchasing competitors who have come under pressure. Tailor-made refinancing of the distressed target company including "hair cuts" with respect to existing financing lines of distressed targets as well as the consideration of aspects of insolvency law will play a major role in such deals. M&A transaction lawyers and finance lawyers must work closely together on such deals.
The Austrian legislator has now addressed the above mentioned insolvency law aspects. In times of Corona, it is very difficult for companies to determine when over-indebtedness is at hand, all due to the current difficult economic situation. Even valid forecasts for the continued operational presence of a company (Fortbestehensprognose) resemble, due to the instable and unpredictable situation, a glance into the crystal ball. Austrian companies are therefore currently exempt from having to file for insolvency for a period of the next three months until the end of 30.6.2020 because of over-indebtedness (this suspension of the obligation to file for insolvency does not apply, however, if the company is unable to make payments due). In our view, this may have the consequence that distressed M&A transactions in Austria may be partially delayed. From today's perspective, it can in any cases however be expected that at least as of July 2020 - after the end of this three-month suspension - distressed M&A transactions will increasingly take place with a phase shift.
Due to the dramatic fall in share prices on the international stock exchanges, an increase in the number of (attempted) public takeover bids for listed target companies can be expected as well. Naturally, targets with a high free float and without a stabilizing core shareholder base are particularly vulnerable. Hostile and competing takeover bids that do not have the support of the target company's management cannot be ruled out either. Particularly affected are sectors in which long-standing structural problems due to the current crisis will be further exacerbated and also lead to further dramatic price losses on the stock markets. In any case, an increase in such public takeover transactions will require experienced and professional support.
A completely different situation arises in transactions where the transaction documents were signed prior to the outbreak of the corona crisis and where the transaction is in the phase between signing and closing. In this case, it must be carefully examined whether there are possibilities for a buyer to still withdraw from the deal via MAC clauses in the agreement, force majeure arguments, conditions precedent or the claim of loss of the fundamental assumptions on the basis of which a deal has been signed. Or else to adjust the conditions of the transaction, in particular the amount of the purchase price. Finally, no buyer wants to be accused by his shareholders of having bought an overvalued target company at an excessive price. Acquisitions in which purchasers use own treasury stock as currency as well as share for share transactions are subject to completely new economic parameters due to the dramatic price falls of the last weeks on the markets.
It goes without saying that in all of the above-mentioned cases, attention must always be paid to the specific nature of a particular transaction and the existing deal documentation. The present statements are therefore only of general nature and cannot substitute concrete advice in an individual case.
Due to the turbulent last weeks on practically all stock exchanges around the globe, the fundamentals for capital market transactions have changed significantly. In particular, risk factors of prospectuses and offering circulars now contain extensive information on Covid-19 and its effects on the business models of issuers. The drafting of underwriting agreements between issuers and underwriters, legal opinions and comfort letters also take account of the changed circumstances. In the absence of sufficient authorised capital, we will take the changed circumstances into account in the future.. In the case of transactions launched prior to the outbreak of the "corona crisis", questions arose in particular as to how far offering or subscription periods can be extended, whether it is possible to adjust subscription prices or price ranges without triggering reporting requirements or prospectus updates, or whether obligations under takeover law – up to and including mandatory offers – are triggered when new shares from a capital increase have to be taken over by underwriters engaged in firm underwriting obligations pursuant to the terms of underwriting agreements signed prior to corona. In the case of transactions that have not yet been launched but are still being planned and for which no authorized capital is available, the required resolutions by the (annual) shareholder meetings pose considerable challenges for the practical reasons mentioned above.
Share buyback programs must be subjected to critical examination under the changed market conditions. The ban on short selling on the Vienna Stock Exchange which was recently extended until 18 May 2020 will, despite a certain relaxation (from now on only establishing new net short positions or increasing of existing net short positions are prohibited), have an impact on the liquidity of traded shares until further notice. Many board members of Austrian listed companies have made massive buybacks of shares in their own companies in recent weeks. This could be observed on the Vienna Stock Exchange, especially in the form of frequent director's dealings reports.
As liquidity is of utmost importance for companies especially in times of corona, but investors have vast amounts of investment capital waiting to be invested, it is to be expected that companies with top creditworthiness will increasingly try to raise debt via investment grade corporate bond issues with short to medium terms (in any case less than four years), thus securing liquidity reserves that may be needed during the corona crisis and in the period after, also to take over competitors via M&A deals. In our opinion, there will be an increasing number of bond issues of this kind, in which equity focused institutional investors who have so far been exclusively long-term oriented and focused on dividend payments will increasingly be prepared to provide such companies with debt capital as bondholders.
In Austria, the Federal Competition Authority is endeavoring to enable the submission of merger notifications by electronic means. A limited trial run is currently underway in cooperation with the Federal Cartel Prosecutor. Prior to submitting an urgent merger notification, it is advised to – without exception – contact the Federal Competition Authority. At the same time, an amendment to the law is expected to be adopted and enter into force shortly to adjust the deadlines for the examination of merger notifications to the current situation. In sensitive cases, merger notifications usually involve negotiations on additional requirements. In addition, the complexity of the subject matter and the often extensive file documentation are difficult to reconcile with representations or parties to the proceedings who have fallen ill. The legislator, therefore, intends to postpone the handlings of mergers as far as possible until after the pandemic (Explanatory Note 397/A XXVII. GP).
The European Commission calls on companies to postpone merger notifications to a later date if possible. It is expected that the pre-notification phase will take longer than usual.
With respect to regulated entities (in particular banks, insurance companies and investment firms), it is generally to be expected that, in the current situation, the regulatory supervisory authorities will pay particular attention to the financial soundness of purchasers and will closely analyze business plans. As the focus of supervision in the near future will be on securing the stability of the financial system, lengthened proceedings should be anticipated in this area as well. Other considerations will apply in particular to acquisitions, which serve to strengthen a target company in distress by way of financial means.
Special attention will also have to be paid to the regulatory practice of foreign trade investment control authorities. Here, the alleged recent attempt by U.S. President Trump to secure the rights to a corona vaccine currently being developed at full speed by a German research company exclusively to the USA has recently raised attention. Pursuant to the Austrian Foreign Trade Act, the acquisition of companies, company shareholdings and controlling influences by foreign (non-EU) investors may be prohibited provided that public order or security is threatened. This applies in particular to strategic sectors such as energy, telecommunications, infrastructure, health, defense and security. The German government recently decided to tighten foreign trade investment controls; similar measures are also expected for Austria in the near future. Foreign investors who are toying with the idea of acquiring Austrian companies of strategic importance in economic difficulties are therefore advised to seek professional support in obtaining a required special government permit.
Travel bans, quarantines and business interruptions massively affect the daily business operations of companies. This also affects on-site inspections and personal management meetings as part of due diligence audits. It can currently be noticed that buyers are waiting with their purchase decisions until the on-site inspections can be completed and the impact of Covid-19 on the business of the target company can be better evaluated.
From a buyer's perspective, it is advisable to prepare questionnaires to the sellers in order to carry out a concrete legal and economic evaluation of the risks associated with Covid-19. In this context, particular attention should be paid to whether and how the main commercial contracts of the target company cover a possible failure to perform due to an event such as Covid-19 and how this may affect the economic performance of the target company. Special attention should also be paid to crisis management at the target company, especially with regard to the effectiveness of measures already taken. For transactions in which the seller's guarantees, warranties and special indemnities are to be covered by a W&I-insurance, it can be expected that the insurers will set higher standards for due diligence and will likely also try to avoid or limit their liability for risks associated with Covid-19. Professional advice will be essential in this regard, both on the part of the seller and the buyer.
In the course of the due diligence process, buyers will be confronted with complex valuation questions when determining the purchase price, particularly in connection with the consequences of the considerable government support measures that many companies are currently claiming. For example, the Austrian government recently presented details of a 15 billion Euro emergency aid fund for companies that have suffered a drop in sales of at least 40 percent. In return, companies that make use of these aid payments which are to be capped at three months' sales or EUR 120 million are to be prohibited from making dividend payments within twelve months (moreover, companies with more than 250 employees are not allowed to terminate their employment contracts, but must instead resort to the Austrian corona short-time working regime). This regulation will be particularly relevant in due diligence reviews of those buyers who, when structuring the financing of the purchase price, expect that the target company is/will be in a position to pay dividends within the next year (for example by using proceeds received from sales of asset of a (distressed) target within this one year period) in order to help the buyer to refinance the purchase price.
A buyer should insist on the inclusion of provisions in the SPA that specifically address the risks associated with Covid-19. This can be achieved by warranties that explicitly guarantee certain characteristics of the target company as well as exemptions that provide for risk balancing with respect to risks already concretely identified (such as a significant interruption of the supply chain). In addition, purchase price mechanisms should be considered which take better account of the current uncertainty than, for example, a locked box price structure. For example, so-called earn-out clauses should be considered here which tie the payment of at least part of the purchase price to the further economic development of the target company. Special attention should also be paid to the timing required for the successful completion of a transaction, especially in times of crisis. In this context, the agreement of so-called Long Stop Dates, which provide for a realistic time frame for the fulfilment of conditions precedent (such as the obtaining of necessary official approvals), is particularly useful. Otherwise, there is a risk that transactions will automatically end prematurely. In such cases, a resumption of contractual negotiations usually involves considerable efforts of the parties.
As probably the most important precaution, a buyer should insist on a wide-ranging exit option if there is a significant deterioration in the asset, financial or earnings situation of the target company between signing and closing of the purchase agreement. MAC (Material Adverse Change) clauses derived from Anglo-American contractual practice are a useful tool in this respect. Such clauses are often included in the purchase agreements as conditions precedent. If certain material circumstances defined by the parties in advance occur in the period between signing and closing, agreements may be terminated or the parties may exercise a right of withdrawal.
The challenge when drafting MAC clauses in Austrian SPAs is generally to provide the most precise possible definition of the materiality threshold desired by the contracting parties. However, it should also be noted that both Austrian courts and international court practice, especially in arbitration proceedings, tend to apply strict standards when examining the validity of MAC clauses. This is especially the case if the scope of application of MAC clauses (also) refers to circumstances that occur only after the closing of the transaction. MAC clauses must therefore be formulated with great care. Otherwise, there is considerable risk that they will not be held valid by courts or arbitration tribunals in the event of a dispute.
In the interests of transaction security, a seller will attempt to ensure that events such as Covid-19, which are regularly outside its sphere of influence, have no or the least possible negative impact on its contractual position. Additional warranties and indemnification in favor of the buyer in connection with Covid-19 are often unavoidable at the moment. However, a seller should in any case try to limit the resulting economic risk to an economically reasonable extent by means of various permissible limitations of liability, such as maximum liability amounts, tax allowances and minimum thresholds. With regard to any MAC clauses, the buyer should ensure that their application is defined as precisely as possible. In order to minimize any misuse of such contractual provisions by the buyer, the seller should insist on an appropriate break-up fee. This can effectively prevent or counteract an unjustified exit of the buyer by referring to an alleged MAC.
Risk factors and other parts of the stock exchange and capital market prospectuses must take into account the changed circumstances. In particular, for the interest of the underwriters underwriting agreements must take the Covid-19 situation into account. For issuers, upcoming general meetings represent a major challenge. A careful and prudent preparation of such general meetings, which also takes into account the changed circumstances and legal framework, is even more important than before.