In Part 1 of our coronavirus checklist for U.S. businesses, we listed certain important practical steps and issues for businesses as they attempt to navigate through the many hurdles and challenges that they may confront during the current health and economic crisis, as well as after it abates. Part 1 included key provisions in contracts, workplace and business insurance concerns and regulatory considerations. In the following Part 2 of the checklist, we include considerations relating to communications with investors, financial reporting documents and mergers and acquisitions.
As we noted in Part 1, businesses need to analyze each issue carefully, and we encourage them to contact us with any questions or concerns they may have.
Financial reporting & disclosure considerations
The coronavirus outbreak has occurred while many companies have been releasing earnings and finalizing their annual reports filed with the U.S. Securities and Exchange Commission (“SEC”) as well as other regulatory agencies.
- The SEC and the Public Company Oversight Board (“PCAOB”) issued a joint statement regarding, among other things, the effects of coronavirus on financial reporting.
- The joint statement emphasized that, while the effects of coronavirus on a particular company may be difficult to assess or predict, information regarding the company’s plan and response to the outbreak could be material to an investment decision and may need to be disclosed.
- Companies were urged to work with their audit committees and auditors to review their financial reporting, auditing and review processes in light of the circumstances in meeting the applicable requirements.
- To the extent companies are filing annual or quarterly reports, companies should evaluate the current and potential effect of the outbreak on their business operations and work with internal and external counsel to consider appropriate updates to risk factors, management’s discussion and analysis (“MD&A”) and subsequent event disclosure.
- Companies and, if applicable, their investment advisers should review their and their vendors’ business continuity and disaster recovery plans, which would include pandemic procedures and plans.
- The SEC has publicly stated it is monitoring, and, to the extent appropriate, will provide guidance and other assistance regarding, disclosures related to the current and potential effects of coronavirus.
- Companies that are, or plan to be, active in the capital markets will need to continue to review the situation and their disclosures in the context of their capital raising activities. It will be especially important for companies to work closely with their underwriters and deal teams to plan ahead for any potential offerings, understand when the window for transactions might be available, and be prepared with contingency financing plans to the extent the market for deals is unavailable.
- To the extent a company has a trading window open, it will need to continually evaluate whether it is necessary to close its trading window as the situation progresses and the potential that material non-public information about the effect of the coronavirus outbreak on the company and its business becomes available to management.
Investor communication considerations
- As companies engage with their investors, both at investor presentations and conferences, and in their one-on-one conversations, they should be prepared to address the effect the coronavirus outbreak has had and might have on their business.
- Companies preparing to seek capital from investors should carefully consider the impact the Coronavirus pandemic may have on all facets of its business strategy, adjust financial projections and estimates as needed, and consider what additional disclosures should be made to potential and existing investors in light of the Coronavirus outbreak.
- Given the dynamic nature of the situation, companies should continue to evaluate whether public disclosures remain sufficient to address these concerns and, to the extent additional disclosure is required, companies should consider and comply with their obligation to make that disclosure.
Financing documentation considerations
- Both borrowers and lenders should identify the potential consequences of a breach and/or default under their loan and financing agreements and documents.
- Borrowers must actively evaluate the impact any such breach or default may have on liquidity and affirmatively undertake contingency planning initiatives to extend runway and minimize disruption.
- Borrowers should consider discussing possible defaults and possible “work arounds” with their lenders during the crisis.
- Similarly, lenders must conduct an ongoing review of their portfolio to identify which credits may suffer value degradation or covenant breaches and/or defaults and be prepared to manage those relationships.
Mergers & acquisition transaction considerations
To assist companies in navigating the M&A process in this unprecedented environment, we have focused on areas of particular risk and uncertainty. This checklist is intended as a starting point, as the analysis of each deal-making situation will be highly fact-specific.
Due diligence and representations and warranties:
- Due diligence in the COVID-19 context confronts both buyers and sellers with challenges. Some of the information that a buyer would seek, such as how a target has weathered similar conditions in the past, may simply be unavailable, even from the most well-informed seller.
- Projections, which always carry a fair element of uncertainty, will be particularly difficult to prepare and assess.
- Site visits and in-person meetings may be inadvisable or impermissible, particularly in a cross-border deal or where the target business has multi-national operations.
Delays in obtaining shareholder/board approvals and regulatory approvals:
- Deals that require shareholder approvals and filings with (and clearances from) the SEC and/or state securities regulators may face particular delays, as these implicate risks of slower governmental action and potential challenges of obtaining shareholder approvals.
- In the U.S., the government has already suspended the early termination option for Hart-Scott-Rodino Act antitrust review (meaning that clearance will take at least thirty (30) days in all circumstances), and other agency review and clearance processes may be delayed or uncertain, due to staffing shortages, teleworking and prioritization of resources to crisis demands.
Financing conditions and contingencies:
- With continued volatility in the financing markets, transactions that depend on third-party debt financing can present particular challenges. As a result, both buyers and sellers should explore and understand the added risk and volatility in order to address these factors appropriately in decisions about whether, and on what terms, to proceed.
- In the current environment, buyers and sellers should consider whether this risk is greater and whether the “standard” financing-failure arrangements fairly allocate that risk between the parties.
Material adverse effect/material adverse change provisions:
- Whether the impact of the virus will be considered a “material adverse effect” (“MAE”) or “material adverse change” (“MAC”) will depend on both what is known at the time a transaction is signed and what the relevant agreement’s MAE/MAC definition says about the inclusion or exclusion of the virus.
- Both buyers and sellers would be well-advised to negotiate explicit language to address COVID-19 risk-allocation in the context of an MAE/MAC provision. Whether excluding it completely or specifying a quantitative or qualitative level of financial or operational impact from COVID-19 that, if reached, would give rise to an MAE/MAC, specificity will guard against unexpected results.
Interim operating covenants:
- Between signing and closing of an M&A transaction, buyers generally want sellers to operate the target business in the “ordinary course” to protect the value of the business they have agreed to purchase (with any deviations requiring buyer’s consent). However, interim operating covenants do not constitute an obligation to maintain the financial condition of the seller, but only to operate the business consistent with the ordinary course of business and past practices.
- Buyers should consider drafting with specificity if they want to have additional protections relating to the virus.
Representation and warranty and business interruption insurance:
- If either the seller or the buyer is seeking to obtain representation and warranty insurance as a source of post-closing indemnity on a deal, they will need to focus on how exclusions and limitations will apply to the impact of the virus.
- Because COVID-19 is a known risk, expect the possibility of insurers specifically excluding coronavirus-related losses from their policy coverage and, for pending deals signed prior to the COVID-19 outbreak, insisting on a blanket exclusion of COVID-19 impact when the representations made as of the signing date are “brought down” to closing.
- In addition, the scope of virus-specific or ancillary diligence, as well as any requirement for post-signing “updates” from a seller, and their effect on the insured party’s knowledge, should be carefully addressed with counsel in the context of representation and warranty insurance, since an insured’s “knowledge” of a situation typically excludes that situation from policy coverage.
- Business interruption insurance also may be worth considering – if it is available at a reasonable cost. However, the definition of a covered “business interruption” within the scope of the policy must be carefully reviewed, as well as any bacterial/virus exclusions.
Purchase price considerations and adjustments:
- The impact of the COVID-19 crisis may necessitate a deviation from the customary approach to purchase price adjustments. What constitutes “normalized” working capital may need to be adjusted given the impact of the virus. In particular, customer payments may be seriously impacted by the crisis.
- Sellers may need to take drastic measures to maintain acceptable liquidity at the target company level and may want to seek floors or collars in their purchase price adjustment mechanisms to avoid being unduly penalized during the crisis.
- Conversely, buyers will be understandably focused on ensuring they will be acquiring a business with levels of working capital and liquidity that are within defined parameters.
- With the partial shutdown and closures of numerous state and federal agencies, there may be delays in making government filings and obtaining business licenses and permits, from relevant government authorities such as the secretary of state.
- Parties should be mindful of possible delays in obtaining corporate documents such as “Good Standing” certificates, which are often required as a condition to closing transactions.
Termination rights and fees:
- Always a heavily negotiated deal term, these provisions merit particular attention in the current environment.
- In addition to MAE/MAC termination rights, parties should give extra attention to the seemingly routine “outside date” termination provision, since requirements for third-party consents and/or government approvals and other closing conditions may be substantially more difficult or take far longer to achieve under current conditions.
As we are all experiencing, the coronavirus pandemic has evolved both locally and globally. As a result, the challenges and related issues that families, businesses, institutions and entrepreneurs are facing continue to change constantly so we will continue to update and make additional information available as appropriate.
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