The ongoing global healthcare pandemic because of the COVID-19, the disease caused by a novel coronavirus, has created a business continuity risk at all levels and across all sectors. In a globally connected business environment, businesses often tend to be connected at their edges like a house of cards, and a domino effect of a supply chain disruption cannot be discarded.
Given that contagion containment requires work shutdown in affected areas (most notable thus far being China, Italy and the Washington state in the US), there are some clear challenges around dealmaking. India thus far has been less aggressively affected, but with the number of cases increasing, one needs to evaluate all possible scenarios. Here are a few points that dealmakers should consider while approaching new transactions.
Price
An opportunist may feel this would be the right time to see how valuations function. But in the real world, when valuations drop deals may not be available in the same sense.
For ongoing conversations, a thoughtful and well-advised seller would have prepared appropriate narratives to negate such points.
Based on how Indian targets may, more often than not, be owned by family businesses, it may be seen by a seller as more respectful and less offensive if a buyer did not try to use the current crisis to get a better deal or reduce price. Now, more than ever, might be a good time to build faith and trust and try to complete the deal at a “fair” value.
Impact of MAE or MAC clauses
Neither the Material Adverse Effect nor the Material Adverse Change clause is likely to protect much. Any thoughtful seller is likely to insist on a carve-out for the current pandemic, unless there is a specific identified risk that the buyer is keen (and able) to negotiate as a specific walk-away right.
Even before the crisis, thoughtful and well-advised sellers would negotiate general carve-outs for events that impact the market or the economy or the industry generally. Buyers would be known to push back for further fine-tuning events, which impact the target disproportionately compared to the market or the economy or the industry generally.
Impact on conditions precedent
If there is a significant risk that the buyer spots in the diligence (an exposed bank guarantee or a take or pay obligation with a supplier or a delay penalty with a customer) and wants that mitigated through a waiver or otherwise, it would be reasonable for them to expect that this be cleared as a condition precedent.
Whether a seller can resist such a condition will largely be a function of bargaining power. However, it is relevant to ensure that the language both on description and fulfilment is clearly drafted to be objective, and not subjective to the buyer's opinion.
Post-closing mitigation plans
Post-closing plans and conditions would be less relevant for 100% acquisitions and more pertinent to financial investments or joint ventures. Without these conditions being specifically in the contract, an investor would obviously be exposed to the equity risk of any lingering effects of business disruption caused by COVID-19.
There may also be certain other actions which in more normal times would be treated and dealt with as conditions precedent to closure, but require being pushed out to post-closing items to give the sellers some deal certainty.
Deal process
From a deal process perspective, India tends to be a jurisdiction where dealmaking inevitably involves faceto-face meetings. Given the travel bans and other consequent lack of availability of advisers or other deal factors, people should prepare realistic deal targets in terms of signing and closing.
Warranties, disclosures and indemnities
Under Indian contract law, information that could have been found through ordinary diligence by a buyer cannot be treated as the base of termination for misrepresentation by the seller. Whether such information could be the subject matter of a claim for damages arising from misrepresentation is a matter which is not completely tested through case law, unlike in other western jurisdictions like the UK.
As a result, it is typically recommended that any known risks that are quantifiable in damages should be made the subject matter of specific indemnities. Resultantly, any risks which the buyer believes could lead to a loss should be covered through specific indemnities.
For items which cannot be the subject of diligence, specific warranties may be considered.
However, it would be advisable for a seller to consider as to which warranties should be repeated on closing – depending on the time envisaged between signing and closing, and also looking at the potential disruption exposure of the business of the target to the pandemic.
Buyer delinquency risk
Unlike western jurisdictions, Indian transactions do not typically carry concepts such as pre-closing escrow. Even otherwise, more Indian transactions are done on the basis of buyer covenants and assurances (whether by way of covenants, equity commitment letters, letters of comfort, etc.) than there are through “hard cash” in the form of escrows or bank guarantees.
Therefore, as a matter of course, one would not typically seek “hard cash” comfort. Such items (escrow, bank guarantees, etc.) are more typical in hostile transactions and competitive deal processes or are usually linked to irreversible steps in the transaction. Nevertheless, it is a question that sellers should consider evaluating.
Revisit existing investments
Similar to new deals, it would be advisable for investors and company owners to also evaluate their current investments and also the preparedness and planning that their existing portfolio companies have implemented. Specifically for financial and other investors with further upcoming deal activities; for instance, tranched investments, earn-outs, call or put options, performance based conversions, etc.
It is relevant to assess the short-term and long-term impact of the pandemic over the time that it plays out. Such transactions are seldom covered from a force majeure perspective. Even otherwise, a force majeure on the target is unlikely to provide relief to dealings between shareholders.
Conclusion
This pandemic is unprecedented in almost all parameters – in size, magnitude, speed, scale, coverage and global impact. Therefore, it is only natural that this will affect dealmaking dynamics in a way nothing has before this.
It is worthwhile to note that all actors involved are taking necessary measures to ensure that this is a temporary setback to the global economy. For the time being, however, it does require a certain re-calibration to the dealmaking strategy.
Rabindra Jhunjhunwala and Sameer Shah are partners are law firm Khaitan & Co.
