Planning mergers and acquisitions in a pandemic

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The rapid outbreak of Covid-19 has resulted in the largest global disruption to human life in much of recorded history. This also poses a grave risk to continued business activity across sectors and creates new and varied challenges for any deal activity being planned in the near future. Set out below are some key considerations that investors and corporates may keep in mind while planning any mergers and acquisition (M&A) deals in India or global deals that have an India angle.

Challenges in target diligence
Physical site diligences are going to be a challenge, considering travel restrictions imposed by the government. Labour-intensive sectors such as power, energy, iron and steel, and chemicals that require detailed environmental assessments, may face delays in deal timelines as environmental and social impact assessments may need to be deferred.

Deal valuations
The Covid-19 outbreak has caused record intra-day falls in stock market indices as well as individual stocks in almost every sector and industry. For M&A activity in listed companies, investors must bear such volatility in mind while planning any share acquisitions (through private placements or open offers/takeover attempts). Sebi regulations account for the average price of a share over a 26-week period in several instances. Investors should generally re-look at financial models to take into account the economic disruption to the target’s business, sector-wise exposure to coronavirus-induced disruptions, impact of macroeconomic volatility on the target, etc. and should consider post-closing adjustments, lock-boxes, etc.

Labour concerns
Labour-intensive industries are facing considerable disruption in their day-to-day workings. This may have a short-term impact on the goods’ demand-supply chain, labour shortages and medical costs borne by employers as well as a long-term impact on general operations of the business. While industries such as consultancy, IT and finance have been functioning smoothly for now—based on remote work —any prolonged impact of the virus outbreak can lead to incipient stress in even these areas. Employers can face greater insurance costs for their employees, as insurers may start taking epidemics like Covid-19 into account. Investors must keep these concerns in mind while valuing potential targets.

Supply chain disruptions and force majure concerns
Several sectors are facing tremendous supply-chain disruptions. Oil and natural gas are some of the worst hit sectors, heavily dependent on the global supply chain coordination. Telecom has been effectively adapting to increased bandwidth usage, but may face a strain on infrastructure if the situation persists. Other non-mechanised sectors heavily hit are tourism, air travel, and food and beverage (non-essentials). M&As in these sectors must be carefully planned and adequate safeguards put in place. This may be done by ensuring that the target company has sufficient indemnities and damages with their counterparts to protect against such disruptions.

Further, Indian law permits parties to excuse themselves from defaulting on their obligations by invoking principles of frustration of contract or force majeure clauses—both of which offer different remedies. While Indian courts have dealt with several such cases on both principles, investors must remember that any such action may be heavily litigated, and associated legal costs will add up.

Force majeure clauses are a creation of contract and usually provide a list of events labelled so. Parties may need to demonstrate the Covid-19 outbreak as actually falling within the confines of the force majeure events listed in their contractual clauses (such as natural calamity / act of God etc.) to be able to seek its benefit. The Ministry of Finance had earlier issued a notification on 19 February 2020 declaring Covid-19 as falling within natural calamity and to be treated as a force majeure event for procurement of goods etc. Similarly, the Ministry of New and Renewable Energy had also issued a notification dated 20 March 2020 declaring Covid-19 as a force majeure event for the purposes of supply chain disruptions in renewable energy projects with the government. In both instances, necessary qualifications have been given for parties following due procedure and showing proof of actually being affected by such supply chain disruptions.

In case contracts do not contain any force majeure clause, parties may utilise the remedy under section 56, Indian Contract Act, 1872. Section 56 incorporates the common law principles of frustration of contract and absolve parties from performance of obligations in case the contract becomes impossible or unlawful to perform due to an event which the party could not prevent. The present Indian jurisprudence on frustration have given precedence to actual, physical impossibility of performing obligations as a result of such events, and has thus in a way, disregarded party intention while agreeing upon such clauses. Courts have held that parties need to demonstrate their inability to honour their obligations as an actual consequence of such events. The performance of the contract should have become impossible owing to change of circumstances that have totally shaken the very foundation upon which the parties have entered into the agreement; rather than due to mere financial hardship arising as a consequence of these disruptions. Parties may also seek recourse to principles of frustration if the performance of an act may not be literally impossible, but it may be impracticable and useless from the point of view of the object and purpose of the parties.

Given Indian courts’ propensity to favour their unique socio-legal jurisprudence, parties may also seek to demonstrate the impact of the Covid-19 outbreak on disruption of general life in the country and its immense social impact, especially in cases among companies involving significant labour-related implications. Domestic and foreign companies will accordingly need to closely evaluate their legal strategies. Deal documentation must feature MAE clauses that list out such disruptions that can allow parties to avoid their obligations without incurring financial obligations—though investors can expect such clauses to be heavily negotiated. Investors must ask target companies for adequate representations and warranties to safeguard themselves of any systemic or local risks from such disruptions.

Deal timelines
Apart from general disruption in various industries which may impact counterparties’ responsiveness and general availability to close out M&A deals, deal timelines can also be expected to be delayed as various regulators and courts are limiting their workload. Most of the courts (including lower courts, high courts and Supreme Court) and tribunals in India (such as NCLT, NCLAT, tax tribunals etc.) are functioning on skeletal staff and have issued administrative order to only entertain urgent matters for the near future. This will impact time taken for regulatory approvals for M&A deals—such as antitrust, SEBI, RBI, NCLT approval. Distressed assets undergoing corporate insolvency resolution process under the IBC are expected to be delayed and breach the 330-day time limit introduced by recent amendments to the IBC. Bidders taking part in the IBC process will have to factor in such delays in the resolution timeline.

About authors: Ankush Goyal is a Partner and Rohan Kohli is an Associate in the corporate practice at Trilegal

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