By Oliver Hebdon, Corporate Solicitor.
The impact of coronavirus (COVID-19) is likely to lead to some uncertainty for anyone buying or selling a business.
However, the volatility of the current economic climate still presents opportunities for both buyers and sellers. We have summarised below some of the areas that might justify closer attention for anyone involved with or who might be about to embark upon an acquisition or disposal.
How can due diligence assist?
A focused due diligence process can help to alleviate some of the issues giving rise to uncertainty. If a buyer is able to ask precise questions which relate to areas of specific concern it will give the buyer a clear understanding of the business and it will provide the seller with some comfort that the buyer has an appreciation of the risks and liabilities within the business before it completes the purchase.
In particular, as part of its wider due diligence a buyer might want to establish: -
what supply agreements or key contracts does the business have?
has it met/ can it continue to meet its obligations under those contracts?
what ability does the buyer (or the other party) have to terminate those contracts?
have there already been any breaches or have any steps already been taken to terminate those contracts?
is a pandemic of the type we’re currently seeing provided for as a frustrating event or an event outside a party’s control?
consider the supply chain: -
how have other businesses that the target relies upon been affected?
are alternative suppliers available?
have any measures been imposed (e.g. travel restrictions/ furloughed workers) that would restrict the supply of goods/ services either by the target or anyone in its supply chain?
how has the target company responded to the government’s loans/ grant initiatives? Have any workers been furloughed?
what is the financial position of the company and what are its projections for the short and medium term? To what extent has COVID-19 been factored into those projections and is solvency a risk?
what policies of insurance are in place and what coverage do they provide (if any) in relation to the impact of COVID-19?
is the target company able to maintain productivity whilst it adheres to government guidelines and implements health and safety measures to protect staff.
What if we’re beyond the due diligence stage?
There may be transactions that are currently in between exchange and completion and during that period the impact of coronavirus on the business could have been considerable. It is common for a buyer to have insisted on the inclusion of wording to provide it some protection if the business does deteriorate between exchange and completion, i.e. if there is an adverse change.
If exchange of contracts has already taken place, a buyer will need to have been specific with the trigger events it wanted to rely on if, for example, it no longer wants to be bound to complete the purchase. If the buyer has been clear, it might be entitled to terminate the agreement or claim damages. However, the difficulty now is that the coronavirus (and the likely economic consequences of it) are becoming clearer and a seller is therefore unlikely to offer any specific coronavirus related protection on the basis that this risk is obvious and known to the buyer.
Can we review the price based upon the impact of COVID-19?
Where the parties are still negotiating, a buyer might be able to seek a price adjustment before it proceeds further. Alternatively, part of the purchase price might be conditional on certain financial performance criteria being met, which gives a buyer some certainty that (if projections are not met in these currently difficult conditions) the price will be reduced accordingly.
What other specific protection can be put in place?
Where shares or business assets are being sold, a buyer will not have any automatic protection for the business or assets that it acquires. A buyer will therefore need to include specific protection in the sale and purchase contract.
A buyer will normally insist on certain warranties being given by the seller about the business being acquired. These are general assumptions about the business that the buyer has made that relate to different areas of its operation, such as its employees, financial position, material contracts, disputes etc. A seller can look to exclude their liability by making a buyer aware of any exceptions to those warranties through a process of disclosure.
However, when conceding any warranties a seller should ensure that a buyer cannot (perhaps inadvertently) make a coronavirus related claim under any general or broad warranties. Instead the parties should attempt to agree specific warranties that relate to the impact of the coronavirus and the seller should make it clear that the buyer is only entitled to bring a claim (brought about by the coronavirus) under one of the specific coronavirus warranties, e.g. rather than a broad generic warranty about e.g. the financial position of the business.
A seller will also want to limit the warranties as far as possible (in the usual way) so that they only apply for a specific period following completion and for example, do not expose the seller to a liability which is greater than the overall purchase price they’re receiving. There are various other ways that a seller can limit their liability too (e.g. by carving out anything that the buyer is already aware of) which should also still be discussed as part of the sale process. If there is a gap between exchange and completion, any warranties given at exchange should of course be repeated again at the point of completion.
It is also worth bearing in mind that a buyer can typically only claim damages for a breach of warranty if it can show that the warranty was untrue when given and that the breach caused a reduction in the value of the company at that time.
An indemnity provides a buyer with a more direct form of recovering loss (compared to a warranty) and is a contractual promise by the seller to the buyer that it will reimburse the buyer (usually on a £ for £ basis), if a particular known liability arises.
If there are any known issues that are likely to cause a negative financial impact once the buyer has taken over (but relate perhaps to something caused by the seller before completion) then a buyer can seek to negotiate specific indemnities for those known risks. However, the relative bargaining power of the parties is also likely to influence what (if any) indemnities are realistic. If a seller is willing to provide an indemnity for something it would need to be specific and again appropriately time-limited.
For further information on the impact of coronavirus on your business or transaction, please do not hesitate to get in touch with a member of our Corporate and Commercial Team.
Disclaimer: The information contained in this article is for general information only and made available for educational purposes only. It is for a general understanding of the law, not to provide specific legal advice. This article should not be used as a substitute for competent legal advice from a regulated professional. You should seek appropriate legal advice for your own situation.