As the number of novel coronavirus (COVID-19) cases continues to climb, and health officials consider the means of counteracting its spread, private equity professionals and their counsel need to consider the impact this outbreak may have on their firm and its portfolio companies, and what measures they should consider taking, contractually and otherwise, to potentially mitigate that impact. While it is impossible to fully assess how this may play out and protect you from all business risks related to the outbreak, here are a few suggestions to consider:
- If you are on the sell side of a portfolio company sale process, consider negotiating a more specific carve-out from the material adverse effect (MAE) clause so that events stemming from the coronavirus do not constitute an MAE. While it is not clear that a specific carve-out for the coronavirus would be necessary because courts require a long durational change or impact to constitute an MAE (and hopefully any consequences of the virus’s impact will be recoverable in the short-term), it is certainly worthwhile to review the standard carve-outs for general financial and economic conditions (or add specifics concerning any anticipated impact to the business relating to the virus) to ensure that a buyer cannot claim an MAE and terminate a deal based on effects that should have been anticipated. Conversely, if you are on the buy side of a sale process, you may want to push for the opposite position in your MAE clause. In other words, you may want to consider negotiating for a broad walk-away right from the transaction if the business suffers even a short-term (but materially adverse) impact owing to the virus. Ultimately, this comes down to an allocation of risk between buyer and seller as the ramifications of the outbreak, including how deep and how long the effects will persist, remain unknown and unquantifiable at this stage, and any specific pandemic clauses such as this will be hotly negotiated.
- Similarly, for the buy side in a leveraged acquisition, it remains even more important than ever that the MAE clause in your acquisition debt agreement (including any coronavirus-related carve-out) mirrors the one in the purchase agreement. If the buyer is required to close an acquisition even in the event of a business downturn owing to the outbreak, the buyer will want to ensure that the banks are similarly required to fund and not be able to abandon the deal on an MAE-out. You may also wish to consider evaluating any pending transactions to ensure that there is no risk or exposure relating to the MAE clauses in your financing documents being out-of-sync with the underlying purchase agreements.
- In addition to the MAE clause, additional deal provisions in a purchase agreement to assess in considering how the coronavirus could impact your transaction include the consideration and any price adjustment mechanism, the outside date and the interim operating covenants. Indeed, the uncertainty surrounding the short- and long-term impact of the virus’s outbreak renders any valuation challenging in these circumstances, especially if a locked-box or inflexible consideration model is used to value a target company in an industry or geographic area likely to be impacted by the virus. With respect to outside dates and interim operating covenants, parties should evaluate whether the potential disruptions and extraordinary measures prompted by the outbreak necessitates some flexibility in interpreting, or modifications to, the outside date or interim operating covenants.
- For any major contracts entered into by your portfolio company, assess whether the force majeure provision can be invoked as a result of the virus’s impact on your business. The commonly-accepted principle behind the force majeure provision is that a party should not be held to perform its contractual obligations if it is unable to perform as a result of unforeseen events or circumstances outside of its control. But it would be a mistake to assume that an adverse impact from the virus would or would not constitute a force majeure. The interpretation of what constitutes a force majeure will vary case by case depending on how the provision is drafted, as well as the case law and jurisdiction to which that particular contract is subject. If there are important long-term contracts for your portfolio company’s business, a specific review of the force majeure provisions of those contracts might be worthwhile.
- Check existing insurance policies to confirm (or anticipate) whether any losses arising from the outbreak, including any business or travel disruptions, are covered. You should understand your existing policies and their exclusions with respect to the virus’s impact, and be aware of changing market conditions or exclusions that arise as a result of the outbreak.
- If you are considering representation and warranty insurance for your deal, the outbreak is quickly becoming a heightened risk area. You should expect that insurers will start to consider including exclusions for losses solely arising from the outbreak and any government response thereto.
- Be cognizant of federal, state and local employment laws when creating or implementing policies or responding to employee concerns regarding the outbreak. For example, the Americans with Disabilities Act prohibits employers from requiring medical examinations or inquiring about an employee’s perceived disability, unless doing so is job-related and consistent with business necessity. Moreover, the Occupational Safety and Health Act prohibits employers from retaliating against employees who refuse to perform tasks likely to result in serious injury or death, which may include employees refusing tasks likely to cause exposure to the virus. The National Labor Relations Act prohibits discrimination against employees who engage in protected concerted activity, which may include employees who band together to demand accommodations in response to concerns about the virus. Lastly, for those employees infected by the virus themselves, or whose family members are afflicted, the Family and Medical Leave Act and other state laws related to family and sick leave could be implicated.
While a growing chorus of global health authorities has likened the coronavirus situation to unchartered territory, there are certainly identifiable precautions, in both your contracts and your operations, that you can take to help mitigate the impact of whatever that unchartered territory may bring.