M&A in Times of COVID-19 – The Impact of the Corona Legislation on M&A Transactions

1. Introduction

Less than six months have passed since the first officially confirmed case of SARS-CoV 2 (the coronavirus) was identified in Germany in late January. The coronavirus crisis has rapidly become a global economic crisis, the consequences of which – unlike the 2008/2009 financial crisis – directly affect the real economy. In early June 2020, the OECD forecast the worst recession in almost 100 years.¹

While Germany has succeeded in reducing the number of infections, and while contact restrictions are increasingly being relaxed and social life is slowly returning to normal, an economic recovery is nowhere in sight. This also has obvious repercussions for the M&A business: Although strategic investors have not disappeared from the scene entirely, they have at best postponed acquisitions, either because of the uncertain macroeconomic environment or because prospective buyers or target companies have encountered financial adversity as a result of the coronavirus pandemic.

The government has moved expeditiously and boldly to stem the crisis: Extensive measures – from suspending of the so-called debt brake on March 25, 2020,² passage of the Coronavirus Impact Mitigation Act (Coronafolgenabmilderungsgesetz)³ and creation of the Economic Stabilization Fund⁴ to the EUR 130 billion economic and crisis management package recently adopted by the coalition committee ⁵ – have been implemented to alleviate the financial effects of the pandemic, protect jobs and get the economy up and running again.

This article provides an overview of the changes in law enacted in the wake of the coronavirus pandemic as they might affect M&A transactions, and also examines the impact of the pandemic itself on current and future transactions.

 

2. Legislation

In support of the government’s comprehensive financial aid package, the legislature expeditiously passed Coronavirus Impact Mitigation Act⁶.

The Coronavirus Impact Mitigation Act of March 27, 2020 is an omnibus law, article 2 of which⁷ recognizes the fact that the pandemic makes it difficult or impossible to hold physical shareholder meetings. The Act provides for several measures to facilitate corporate decision-making, clearing the way for virtual corporate shareholder meetings with a truncated notice period and allowing limited liability companies to consider resolutions by circulation with approvals requiring only a majority vote of the shareholders, which in our view also applies to resolutions to amend an entity’s articles of association.⁸

Article 1 of the Coronavirus Impact Mitigation Act contains the so-called COVID-19 Insolvency Suspension Act,⁹ which is particularly relevant to M&A. In this context, the protective shield procedure as an instrument for reorganizing companies in crisis and the topic of distressed M&A in general are discussed below.

The Fifteenth Amendment to the Foreign Trade and Payments Regulation (Außenwirtschaftsverordnung) promulgated by the federal Government on May 20, 2020 in response to the coronavirus pandemic can be expected to have a direct effect on M&A transactions¹⁰.

 

2.1 Insolvency Law

(1) COVID-19-Insolvency Suspension Act

The COVID-19 Insolvency Suspension Act (COVInsAG), which entered into force with retroactive effect to March 1, 2020, suspends the obligation to file an insolvency petition until September 30, 2020, with the possibility of an extension by the Ministry of Justice until March 31, 2021, if necessary.

The purpose of the Act is to allow companies whose sales have collapsed as a result of the pandemic and that otherwise would be required to file an insolvency petition to continue operating. The objective of the Act is, first and foremost, to afford such companies the time needed to avail themselves of state aid programs. Without this change, there would have been a wave of insolvency proceedings, even in the face of generous aid programs, because it would have been impossible for many companies to maintain the liquidity required to avoid triggering the obligation to file an insolvency petition and/or because, in the absence of reliable planning necessary to substantiate projections supporting the prospective continuation of the business, many companies would have been required to file a petition due to over-indebtedness.¹¹ However, the COVID-19 Insolvency Suspension Act expressly does not suspend the petition filing obligation if the grounds for insolvency are not based on the consequences of the pandemic, or if there are no prospects of overcoming an existing insolvency. In such case, the statutory provisions of section 15a of the Insolvency Code continue to apply, pursuant to which a petition must be filed without undue delay, no later than three weeks after the presence of grounds for filing an insolvency petition. The pandemic as the “cause” of the insolvency is interpreted broadly; it need not be the sole cause but only one essential factor giving rise to the insolvency.¹² In addition to the broad sweep of the statute (“no obligation to file a petition, unless …”), the COVID-19 Insolvency Suspension Act also establishes a presumption in favor of the insolvent company: If a company was not insolvent on December 31, 2019, it is assumed that insolvency was caused by the COVID-19 pandemic and that there are prospects of curing the insolvency. However, the legal presumption is rebuttable: If it is established that solvency cannot be sustainably restored, such as where a bank definitively denies financing, the debtor must file for insolvency immediately.

Specifically, the prohibition of payments that reduce the size of the estate that applies generally to management upon de facto insolvency¹³ is suspended, given that payments made for the purpose of maintaining or resuming business operations or implementing a reorganization concept are always deemed consistent with the care of a prudent businessperson. Moreover, in addition to according privileged status to the grant of loans, the Act also limits the ability to contest proceedings: As a rule, congruent and various incongruent legal acts undertaken during the suspension of the obligation to file for insolvency are generally not contestable.¹⁴

The constraint on creditor insolvency petitions provided in the COVID-19 Insolvency Suspension Act, which permits such petitions only if the grounds for filing were already existent on March 1, 2020, applies only until June 28, 2020. If the Ministry of Justice does not exercise its authority to extend this provision, a creditor would be able file for an insolvency petition beginning in July in accordance with § 14 of the Insolvency Code, even if the grounds for insolvency did not materialize until after March 1, 2020.

(2) Restructuring Process

The Key Issues Paper issued by the government coalition on June 3, 2020¹⁵ announces the creation of a pre-insolvency restructuring process, but it provides no details. Although the European Restructuring Directive¹⁶ provides for the standardization of approaches to pre-insolvency restructuring proceedings, it has not yet been implemented in national law.¹⁷

Pursuant to § 18 of the Insolvency Code, a borrower in Germany has the option to file an insolvency petition in the event of imminent de facto insolvency. Moreover, an insolvent company continues to have the right to file a petition for the initiation of insolvency proceedings, even though the obligation to do so has been suspended by the COVID-19 Insolvency Suspension Act. This may be an option worth considering, for example, to benefit from potential insolvency payments or streamlined labor law measures.

As part of a reorganization, the protective shield procedure, adopted in 2012 in the Act for the Further Facilitation of Reorganization of Companies (Gesetz zur weiteren Erleichterung der Sanierung von Unternehmen), codified in § 270b of the Insolvency Code, affords debtors the chance of a clean slate. The protective shield procedure is a special form of self-administration in the preliminary insolvency proceeding, i.e. the period between the filing of the insolvency petition and the initiation of the proceeding. Under the protection of this particular construct, a debtor can prepare a reorganization plan within a period prescribed by the court, which may not exceed three months, which can then be implemented pursuant to an insolvency plan. In contrast to (provisional) standard insolvency proceedings, the company’s managers retain management and disposal authority during (provisional) self-administration and – with ongoing support of a restructuring adviser (chief restructuring officer) – continue to manage the company’s business. Instead of a provisional insolvency administrator, a trustee is appointed to oversee the managers.¹⁸

Use of the protective shield procedure is possible only under certain conditions. Most importantly, the procedure can be utilized only in cases of over-indebtedness and impending de facto insolvency, but not if de facto insolvency has already materialized. Furthermore, the prospects of the reorganization cannot be futile.

The insolvency plan, which is mandatory as part of the protective shield procedure, can be used to implement corporate restructuring measures, such as conversions, capital reductions or debt-equity swaps. Potential investors can thus benefit from the practically unlimited structuring possibilities afforded by this procedure. For example, parts of the company can be divested or certain contractual relationships can be hived off without the consent of the other parties to the respective contract. These assets can then be sold separately to an investor.

With the clear aim of reorganizing the company, the protective shield procedure thus offers a true alternative to standard insolvency process and is gaining acceptance among debtors and the general public.

(3) Distressed M&A

Essentially, the concept of “distressed M&A” refers to transactions to avert impending insolvency before the start of proceedings (“fire sale”) as well as transactions after the initiation of insolvency proceedings.¹⁹

The current suspension of the petition filing requirement relieves the immediate pressure on the management and shareholders of a company facing crisis as a result of the coronavirus pandemic to quickly locate an investor in order to avert insolvency through a sale of assets or shares. A sale of the company prior to initiation of insolvency proceedings always entails a risk that the insolvency administrator may contest the contract at a later date if insolvency nevertheless materializes. In the worst case, this could lead to the buyer being forced to return the company and, with regard to its claim for repayment of the purchase price, being limited to its share of the estate as an insolvency creditor. Although the risk of contestation is currently diminished during the suspension period, particularly where congruent consideration has been paid,²⁰ the risk remains present where, for example, de facto insolvency was not caused by the pandemic and thus negates the suspension of the obligation to file a petition and, as a result, the defense to contestation does not apply.

For the buyer, a transaction entered into before the initiation of insolvency proceeding also entails liability risks. In the case of a share deal, all liabilities of the target company are by definition transferred to the buyer. Even if structured as an asset deal with a contractual exclusion of liabilities, mandatory statutory liability applies. Thus, in the case of a going concern, the buyer is generally responsible for all liabilities incurred before closing in accordance with § 25 para. 1 of the German Commercial Code (Handelsgesetzbuch – HGB) and, moreover, business taxes incurred since the beginning of the most recent calendar year before closing pursuant to § 75 para. 1 of the German Tax Code (Abgabenordnung = AO) as well as in the event of a transfer of the business in accordance with § 613a BGB of the German Civil Code (Bürgerliches Gesetzbuch – BGB).

By contrast, an acquisition from the insolvency estate – leaving aside the provisions of an insolvency plan²¹ – can take place only as an asset deal (“in-court sale”), with the advantage that the aforementioned statutory liability standards are largely inapplicable. In the case of such a transferred reorganization, the buyer acquires the essential assets of the insolvent company from the company’s owner.²² What remains is an “empty shell” that is liquidated. In the case of an acquisition after the initiation of insolvency proceedings, there is also no longer any risk of the insolvency being contested. However, the stigma of insolvency remains. This continues to be true even though self-administration, particularly in the context of the protective shield procedure, is increasingly recognized in the public eye as a means of restructuring the company and insolvency law is increasingly moving in the direction of a reorganization scheme.

(4) Summation

The comprehensive government aid programs and accompanying legislative measures will not be able to rescue all companies hard-hit by the coronavirus pandemic from insolvency in the medium to long-term, particularly the companies that were experiencing financial difficulties before the crisis hit. The number of insolvency petitions will swell, at the latest when the suspension of the filing obligation expires.

Even if investors remain cautious for now, they will certainly watch the market closely for signs of declining valuations of potential targets, which in turn can be expected to bolster hopes of increased M&A activity beyond distressed businesses.

 

2.2 Foreign Investment Restricitions

In addition to the planned amendments to the Foreign Trade and Payments Act (Außenwirtschaftsgesetz – AWG) pursuant to the EU Foreign Investment Screening Regulation and the general tightening of investment restrictions which is currently under consideration by the legislature,²³ the federal government, as an immediate response to the COVID-19 pandemic, adopted the Fifteenth Amendment to the Foreign Trade and Payments Regulation (Außenwirtschaftsverordnung – AWV)²⁴ which entered into force on June 3, 2020. The “Coronavirus Amendment”, which focuses on the health sector, was expanded to other sectors in the face of the existing pandemic but also “with a view to potentially comparable future crises” in accordance with § 55 AWV. Domestic companies that develop, manufacture or sell products such as personal protective equipment, essential pharmaceuticals, medicines for life-threatening and highly contagious infectious diseases or in-vitro diagnostic medical devices have been included in the group of companies relevant to public safety.²⁵ This entails a reporting requirement and a lowering of the relevant reporting threshold from 25% to 10% with respect to acquisitions of interests in such companies by non-EU investors.

The amending regulation does not contain any transitional provisions, so that transactions involving business in these sectors will be subject to review by the Federal Ministry of Economics.

Given the envisaged ban on execution of unreported transactions otherwise subject to the reporting requirements, violations of which are subject to penalties, it can be assumed that the reporting obligation will have a significant impact on transaction assurance and timing in the future. Company acquisition agreements involving the relevant industries will need to provide for governmental clearance requirements accordingly.²⁶

 

3. Effects of COVID-19 on M&A transactions

Given the effects of legislation passed in the wake of the COVID-1 pandemic described above, the following addresses considerations of the direct effects of the pandemic itself on M&A transactions. A distinction is made between current and future planned transactions.

3.1 Potential Effects of COVID-19 on Current Transactions

With regard to current M&A transactions, it must be determined whether the impending recession may also have a legal impact on the object and possibly even on the advancement of an ongoing M&A process.

Negotiations in the pre-signing stage can be broken off at any time without statement of reasons, subject to a contractually agreed break-up fee. A different result obtains if signing has already taken place but the transaction has not yet been consummated (the pre-closing stage). At the stage where contractual obligations have already been entered into, a specific justification is required to disengage from the contract.

Cancellation of a transaction before closing is conceivable, in particular, (i) by application of a material adverse change (MAC) clause, (ii) due to force majeure, (iii) due to frustration of contract (Wegfall der Geschäftsgrundlage) or (iv) in connection with confirmation of financing upon deterioration of a bidder’s financial condition in a public tender.

(1) Material Adverse Change (MAC)-Clauses

MAC clauses are intended to protect the buyer from significant adverse changes affecting the target company between signing and closing by allowing the buyer to withdraw.²⁷ As a purely contractual instrument, the structure of MAC clauses is not subject to legislative changes emanating from COVID-19 legislation but has recently gained significant importance: One reason is the recent decision by the Delaware Court of Chancery in Akorn, Inc. v. Fresenius Kabi AG (pre-coronavirus), in which a buyer’s right to withdraw based on a MAC clause was upheld for the first time.²⁸ Customarily, the business of the target company (business MAC) as well as the economic effects touching on an entire industry or the global economy (market MAC) are included in the clause.²⁹ As to the legal consequences, rights of withdrawal are customary in the market, but contract adjustments are not. In addition to the increased legal significance supplied by the Akorn judgment, MAC clauses will take on greater de facto importance than in the past.

(2) Force Majeure

The concept of force majeure does not play a major role in German contract law because of the strict principle of fault, and is only used sporadically in the statutory text.³⁰ In the absence of a legal statutory definition, courts have developed comprehensive case law as to the meaning of force majeure.³¹ Contractual force majeure clauses that allow for rescission in the event of a an unacceptable impediment to performance due to force majeure are closely related to MAC clauses in the M&A context. In this respect, therefore, reference is made to the discussion above. Aside from contractual provisions, the civil law relies not so much on force majeure but rather on the doctrine of frustration of contract.

(3) Frustration of Contract 

A prerequisite for rescission pursuant to § 313 paras. 1 and 3 BGB is a serious change in circumstances that form the basis of the contract.³² In the case of the coronavirus pandemic, these are circumstances that extend beyond the contractual relationship of the parties and affect society (and the global economy) as a whole.³³ Frustration of contract, therefore, can constitute grounds for rescission after the signing.

(4) Financing Confirmations

Pursuant to § 13 para. 1 sentence 1 of German Securities Acquisition and Takeover Act (Wertpapiererwerbs- und Übernahmegesetz – WpÜG), a bidder is required to ensure that the funds needed for the full performance of the bid are at hand before the offer document is published. In the case of cash offers, an independent investment services company is required to present a financing confirmation and certification of its accuracy in accordance with § 13 para. 1 sentence 2 WpÜG.³⁴ According to the prevailing view in legal commentaries and BaFin practice, the financing confirmation must be unconditional.³⁵ In view of the economic upheavals that the coronavirus and the associated lockdown measures have entailed, it does not appear unreasonable that a bidder’s situation will deteriorate after the confirmation of financing has been submitted. The relevant consideration as to the liability of the investment services company, in our view, is the time of publication of the offer document; there is no obligation to continuously monitor and adjust the financing confirmation.³⁶ Moreover, the COVID-19 legislative package did not introduce such an obligation. In the event of serious changes, the bidder may need to obtain a new confirmation on its own initiative.³⁷ From a contractual point of view, it would appear sensible to impose an obligation on a bidder to give notice in the event that the certain economic parameters have changed as a consequence of the pandemic. Such an obligation to give notice can be contractually imposed on the relationship with both the certifying investment services company³⁸ as well as the potential seller in the letter of intent.

 

3.2 Potential Effects of COVID-19 on Future Transactions

With respect to future M&A transactions, in addition to the financial capacity of buyers, focus will need to be directed especially on the business performance of the target companies, although buyers will have a greater need to hedge due to the uncertain economic situation. COVID-19 legislation will facilitate the settlement of transactions to some degree.

(1) Due Diligence

In the future, due diligence will focus more on pandemic contingency plans, insurance policies, supply chain stability, and liquidity and insolvency risks.³⁹ If pandemic-specific risks are identified, these should be reflected in the amount of consideration and, if necessary, the scope of contractual rights, warranties and guarantees.

(2) MAC-Clauses

As discussed above, MAC clauses will be seen more frequently in the future because of their increased importance, both in terms of fact and law. In this respect, it is critical to draft a precise description of a “material adverse effect” that is tailored to the business model of the target company because the threshold for successfully enforcing a MAC continues to present a high bar.⁴⁰

(3) Determination of the Purchase Price

A fixed purchase price (locked box), typically flanked by extensive no-leakage provisions, appears inappropriate in uncertain economic times. A more sensible and practical approach would include pricing mechanisms with variable components, such as closing accounts, earn-out provisions or milestones.⁴¹

(4) Transaction Incentives in Connection with the Economic Stabilization Fund

Aside from the many considerations that weigh on M&A in the wake of the coronavirus crisis, several statutes offer relief for investments in businesses: § 22 of the Stabilization Fund Act (Stabilisierungsfondsgesetz – FMStFG) provides for a recapitalization measure that applies to, among other things, the acquisition of shares of companies and the assumption of other equity components. §§ 7e and 7f of the Economic Stabilization Acceleration Act (Wirtschaftsstabilisierungsbeschleunigungsgesetz – FMStBG) provide that such recapitalization measures can be undertaken by the stabilization fund together with third parties or even by third parties alone. If a buyer succeeds in arranging a takeover in coordination with representatives of the stabilization fund in such a way that the transaction is regarded as recapitalization within the meaning of § 22 FMStFG, the buyer will benefit from several concessions in connection with the corporate decision-making process, accompanied by restrictions of the rights of the shareholders, some of them drastic.⁴² For example, in the case of corporate recapitalizations in accordance with §§ 7 et seq. FMStBG, a simple majority of the votes present suffices, regardless of any provisions to the contrary in the articles of association.

 

4. Conclusion

The coronavirus crisis has led to broad legislative mitigation measures, which were adopted in a comparatively short time. These measures rely in many ways on state intervention as the favored approach, but in some cases also on reducing formal hurdles and reducing or suspending certain obligations for businesses. Although it can be postulated that the M&A market as a whole will decline in the face of the impending recession, it must be noted that in certain crisis-related areas such as distressed M&A or joint ventures with the Economic Stabilization Fund – numerous investment opportunities exist for flexible buyers, and Corona legislation also offers indirect incentives.