Among the many transformational changes caused by the coronavirus (COVID-19) pandemic, the way lawyers and clients approach the sale or acquisition of a business unquestionably will change forever. This article is not about any business sale or acquisition disrupted by the pandemic but about looking forward. How will sellers and buyers protect themselves against this happening again? Health care experts and scientists are convinced pandemics will continue happening, perhaps with more frequency. We certainly hope not. However, how will this unprecedented pandemic situation change the agreements underlying the sale of a business? Sellers, of course, will want to not undo the sale (if the terms are favorable), whereas the buyer will want out in many circumstances.
Force Majeure to Include “Pandemic”
First, the easy one. “Force majeure”—the clause that excuses one party from suspending its obligation to proceed with the transaction—(such as acts of God, etc.) will now include “epidemic,” “pandemic,” and orders, mandates, or even recommendations from civil authorities such as “stay-at-home.” Currently, we are aware of at least one case where the court refused to apply a force majeure clause to a deal which was stopped in its tracks because of the pandemic. In the future, force majeure clauses may have to set time limits or deadlines to excuse the affected party from finalizing the deal. They may also need to address the parties’ right
s if the force majeure-causing situation continues for too long.
“Material Adverse Change” or Pandemic?
Agreements in a business sale typically have a provision where the buyer assures the seller that the buyer is not aware of any facts or circumstances that will have a “material adverse change” in circumstances that will significantly reduce the value of the company or assets sold or a “material adverse effect” on the company or its business in general or any particular aspect of the company or its business. There will be disputes in negotiations whether or not to carve-out pandemics from that clause or to include them. If a pandemic is included, “material adverse change” or “material adverse effect” will not be applied automatically. What is “adverse” will have to be litigated. For example, if the company being sold made face masks, one could hardly argue the pandemic was “adverse,” but what about a company that needed to shift its business focus from something non-essential to essential where the shift led to profitability, just not the same level of profitability as before?
Sale Representations and Warranties: Pandemic Business Contingency Plan
There is no question that representations and warranties will have to address preventive measures and whether the target company has an epidemic/pandemic contingency plan to deal with infections, closures, and re-openings. Health safety and environmental experts will have to evaluate those plans. Expect any due diligence to focus on that.
For transactions where there is a period of time between when the buyer and seller sign the purchase agreement to when they actually close, they will need to think about how to address these situations if they were to happen during that period before closing. It is not unusual for agreements to address parameters for how the target company will continue to operate during this interim period, but now the parties need to think about whether they want to specifically address these situations. What rights will each side have? Will either side be able to walk away, reduce the purchase price, or receive any other remedy?
Business Interruption Insurance
Insurance is the other issue. There will be an avalanche of business interruption lawsuits against insurance carriers. It has started already. In deals, insurance policies of the target company will be essential. Carriers will come up with exclusions, such as the pollution exclusion in environmental matters. But, with time, carriers will write pandemic interruption insurance (just as pollution insurance is being written now) but at a hefty cost. All such coverages will have to be investigated in due diligence and negotiated.
Updates to Schedules and Disclosures
Schedules and disclosures dealing with the pipeline of the target company and how suppliers and customers will be impacted by a pandemic will probably have to be included and provide more detail. Of course, health care policies and expenses of the target company, as well as employee benefit plans, will also have to be examined carefully to deal with sick leave, family leave rights, etc. Also, we mentioned those transactions that close at a different time later than when the parties sign their agreement – schedules and disclosures may need to be updated based on changing circumstances. What rights will each side have as a result of any effect from the information that is subsequently disclosed?
Business Sale Indemnification
Indemnification is another critical provision which will be forever transformed, as it will have to deal not only with third-party claims but also with government action shutting down the target business, or impacting personnel or even products. This is highlighted even more so in the business purchase and sale context because much of the indemnification benefit is tied to the representations and warranties contained in an agreement. If the agreement does not appropriately address relevant areas or update those representations and warranties, it could affect the risk each party takes in an unfair manner.
The Pandemic Effect on a Business Sale
These are just some of the many changes we expect. What you want is to anticipate as many situations as possible. If you are the seller, you want maximum disclosure and good faith reasons to get out of what may become a bad deal. As a buyer, you want to disclose as much as possible as well to avoid a claim of “fraudulent inducement” which will circumvent any indemnity you negotiate, and of course, preserve the deal as much as feasible.
We will be writing more of these, looking to the future, not dwelling on the themes that hundreds of other blog posts address about the current crisis. Stay safe and healthy. If you have any questions about this post or any other related matters, please feel free to reach out to us at email@example.com or firstname.lastname@example.org. For other topics related to COVID-19, visit our Coronavirus Thought Leadership Connection.
Oren is a member of our Business Law Practice Group. He represents both sellers and buyers in mergers and acquisitions. Dan is the Co-Chair of our Litigation Practice Group, and he represents sellers and buyers (and litigates) in sales that have “gone bad.”
The information contained in this post may not reflect the most current developments, as the subject matter is extremely fluid and constantly changing. Please continue to monitor this site for ongoing developments. Readers are also cautioned against taking any action based on information contained herein without first seeking advice from professional legal counsel.