CORPORATE GOVERNANCE

 The first priority of every corporate director throughout the COVID-19 pandemic should be the health and safety of the company’s stakeholders.  

 The board should ensure that the company has an effective succession plan in place for its senior management in case they are unable to fulfill their duties.   

 Many management teams have had to make difficult employment decisions by reducing wages, or laying off or terminating employees.   

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  Directors should work with management to ensure they are fully-informed of federal and provincial COVID-19 relief programs.  

Directors should inquire into any efforts by management to renegotiate material contracts. For instance, many companies impacted by COVID-19 are renegotiating commercial leases and in many instances, landlords may not be able to evict tenants or find new tenants.  

  Material adverse change (MAC) clauses typically have several parts:

• The first part provides a general definition of what constitutes a MAC for purposes of the agreement (i.e. what is the seller’s risk);
• The second part excludes or carves out certain specific matters that would otherwise be part of that general definition (the risks of the exclusions/carve-outs being assigned to the buyer); and
• The third part excludes or carves out matters from the exclusions/carve-outs in the second part to the extent that they disproportionately affect the target as compared to other companies in the industries in which the target operates (the risk of the disproportionate effect being assigned to the seller).

 In general, due diligence will need to take into account the effects of COVID-19 on the target in light of the target’s industry, location and jurisdiction, as well as those of its supply chain and customers.A buyer will need to consider the effects of COVID-19 and the containment measures on the target’s financial projections, including the potential cash-flow impact of an extended slowdown of economic activity. Any such analysis may require more than the usual time and expense, given the scope of the crisis and the uncertainties surrounding it.Similar consideration should be given to the target’s material contracts with a heightened focus on force majeure and other similar clauses in key customer or supplier contracts, as well as any potential liability that may occur as result of workforce or supply chain issues.Other areas of focus in typical due diligence that may require additional consideration as result of COVID-19 risks include employment and workplace safety as well as insurance coverage for pandemic-related losses, e.g. business interruption and employee health and disability insurance. 

 Standard purchase price adjustment mechanisms, notably the working capital adjustment, will be affected by the economic uncertainty caused by the pandemic response. The working capital adjustment target is usually determined on the basis of historical averages that may not be appropriate at a time of economic volatility, when many businesses face the possibility of interruptions to their business and adjustments to supply chains. As a consequence, more time and effort may be required to negotiate purchase price adjustments, with more complex mechanisms (such as floating targets) possibly required in some situations.COVID 19 may also cause a valuation gap between a buyer and seller. An earnout can be an effective means of resolving differences between buyers and sellers with respect to the future prospects (and, by extension, present value) of the target business. Earnouts achieve this by making the ultimate purchase price partly contingent on actual future performance – in other words, by breaking the payment down into an up-front component and a post-closing payment or payments, the amounts of which (or in some cases the very existence of which) are tied to agreed performance milestones during a specified post-closing period. With an earnout, some of the purchase price could be pushed out to a future time period after recovery. 

 An “outside date” is a specified date by which a transaction can be terminated if the closing conditions have not been met. Outside dates and termination rights should be carefully considered given that timing issues will take on added significance as all parties involved and, even third parties, are likely to be distracted by personal and business impacts of the pandemic. The delivery of financial statements, certificates, and consents may take more time. This is especially true for certificates, consents and approvals from regulatory authorities, as regulators face novel issues requiring new analytical approaches and, at the same time, deal with their own workflow issues resulting from staffing shortages and work-at-home policies.  

 Representations and warranties that can be uncontroversial in ordinary circumstances are now being subjected to greater scrutiny. Supply chain issues are leading to more detailed representations and disclosure on the issue of inventory maintenance, while general economic instability is focusing more attention on disclosure related to collectability of receivables. Other disclosure developments include sellers’ insistence on non-reliance on financial projections and a preference for frequent updates about the target’s current financial condition. Some parties are specifically adding representations and warranties regarding the impact of the pandemic on the business.  

 Interim period covenants are used to control what happens during the period between signing and closing to ensure the completion of the transaction and maintain the value of the asset or shares being purchased. One typical interim period covenant creates an obligation on the target’s part to carry on the business in the ordinary course until closing (this may be coupled with a series of negative covenants). Careful thought should be given to the ordinary course covenants as the parties will need to balance buyer’s desire to maintain the target’s business in the ordinary course and the seller’s need to respond rapidly to COVID-19 and the measures used to contain it during the interim period.