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A year ago, the business community faced an unknown threat — COVID-19 — and there were a few weeks of what Sébastien Vézina, a partner at Lavery Lawyers, calls “a floating period” before “the new market fundamentals were better understood.”
“The business community rewrote the playbook with resilience and creativity — and that’s where we are today,” he says. “In order to complete successful transactions matters, impact and effects of the pandemic have to be clearly addressed in agreements.”
Any disruption in the market provides opportunity, but in an M&A landscape, “you want to ensure there’s some solidity in the assets you’re paying for,” Vézina notes. Due diligence, while always important, has become crucial over the last year to assess risk, the value of the transaction and your capacity to complete it.
Some examples of areas where due diligence has been ratcheted up are: when it comes to target companies, assessing the strength of cybersecurity measures for remote workers who were quickly switched to work-from-home at the start of the pandemic; estimating employee engagement post-transaction based on the austerity programs that were put in place; examining government subsidies to ensure compliance to the programs so the buyer isn’t required to pay anything back; and looking closely at insurance policies to determine exclusions with respect to the effects of a pandemic because it can be difficult to increase coverage for a risk that is now known to happen.
“In times of the pandemic, the agenda is diversified,” says Vézina.
Clauses also need “serious additional drafting” in the wake of the pandemic. For example, a pandemic is not necessarily a force majeure any longer — a simple reference nowadays won’t automatically allow parties to non-perform certain obligations or terminate an acquisition agreement. Before COVID, material adverse change clauses were subject to challenging negotiations but now “parties have to open their minds, be creative and address those situations.”
The effects of the pandemic created “a critical mass of cases” that have started to go before the courts to properly assess the impact of the clauses. For example, in the interim between the signature of the acquisition agreement and the actual completion of the transaction, you need to allow the target company to conduct in the ordinary course of business — but what does that look like when it has taken action to minimize the impact of a pandemic?
A good example of the importance of clearly defined clauses can be found in the proposed business combination between Cineworld, a U.K.-based company, and Cineplex. The value of Cineplex went down significantly due to governmental decisions in response to the pandemic, and Cineworld was able to convince the court that Cineplex was no longer able to comply with the covenants in the agreement and that the material adverse change clause was triggered. Those material breaches allowed it to rely on a termination clause, but, going forward, Vézina says, “any consequences flowing from the virus and response to it” may be seen as simply reflecting the current state of the world.
“In the line of fire as practitioners, we draft those clauses until they are subject to the test of courts, and until such time, we need to be cautious when addressing those matters in M&A contracts.”