Securing M&A transactions during the COVID-19 pandemic

The COVID-19 pandemic has lead to first postponements or cancellations of corporate transactions. Sellers are apprehensive of not being able to realise the sales price they expected before the COVID-19 pandemic. In particular, finance investors fear that they have to pay a purchase price for a target company which will not reach the target ratios they used as a basis for their earnings planning for the time after the closing.

However, corporate transactions, in particular for strategic investors, do not need to be put off or cancelled if attempts are made to bring about a fair balance between the interests of parties to the purchase agreement in drafting the contract, especially the MAC clause. Material adverse change clauses (MAC clauses) are known from US American and international transactions. As a rule, classical MAC clauses only describe a contractual rescission right or – which is hardly ever the case – a party's purchase price adjustment right if the assets, liabilities, financial position and financial performance of the target company change materially in the period between signing and closing the contract.

In consideration of the implications of the COVID-19 pandemic, the classical characteristics of MAC clauses may be extended to the conditions before those conditions materially affect the agreed key ratios of the assets, liabilities, financial position and financial performance of the target company. Here, in particular the national and international market developments (such as new pandemic developments or other cases of force majeure), going concern considerations or securing intact supply chains, or the availability of raw materials come to mind. Laying down the conditions for the application of the MAC clause is of particular importance for drafting the contract, with a clear distinction from the other closing conditions agreed. This is possible only on a case-by-case basis in consideration of size, profitability, financial power, product development stage, market strength, and diversity of the target company.

Defining thresholds for application

In MAC clauses, thresholds for application are to be defined before the agreed legal consequences can arise. It is relatively easy to define thresholds relating to the assets, liabilities, financial position and financial performance and to subject them to an objective review by a third party (usually an auditor). Agreed parameters outside of the operative business of the target company are to be established e.g. on the basis of the findings of a relevant association, an international organisation, or a political institution.

Any reliance on the MAC clause and its inherent legal consequences (rescission of the contract or purchase price adjustment) should always be understood as the ultimate appeal and should be agreed as such in the contract. The parties, who have a joint interest in the performance of the transaction agreement, should previously negotiate a solution which is wider than a purchase price adjustment. So as to ensure this, an obligation of the parties to amend the contract and the priority of the legal consequences can be defined in the legal regulation mechanism of the MAC clause: first the contract amendment, then the purchase price adjustment, and finally the rescission of the contract.

The legal concept of contract amendments is set forth in the legal institution of interference with the basis of the transaction pursuant to section 313 of the German Civil Code [Bürgerliches Gesetzbuch - BGB] and would take effect if no MAC clause has been agreed. Opinions in legal literature and in case law are varying in terms of the prerequisites and legal consequences of this legal institution, which are hence difficult to predict. The parties to corporate transactions are therefore recommended including the obligation to contract amendment in the transaction agreement with a certain parameterisation of the MAC clause definition on one's own autonomy.

The original application in time of the MAC clause extends to the period between signing and closing. This period may also be extended to a period after the closing date. A 12-months' period after the closing would come into consideration – but also this period needs to be defined on a case-by-case basis. In order to maintain the principle of transaction certainty, however, the legal consequence of rescission from the transaction agreement should either be excluded or limited to extreme changes in this case.

Of course, the parties to the purchase contract have differing interests on defining the conditions (both in terms of content and time) and the legal consequences of the MAC clause. Furthermore, the degree of complexity of MAC clauses will increase owing to the COVID-19 pandemic. If, however, the transaction agreement is thoroughly negotiated, there is no need to postpone or cancel M&A transactions in the interest of both parties.

Practice note

One of our main fields of activity is national and international mergers and acquisitions and corporate law. We will be pleased to assist you with all questions around mergers and acquisitions in the COVID-19 crisis.