Walking Away From M&A Transactions Will Not Be an Easy Task Despite Covid-19 Circumstances

Company buyers may seek to back out of deals, citing the “material adverse change” clause. However, exercising the clause requires buyers to prove that the crisis had a much greater impact on the target company than it did on the relevant industry as a whole and that will not be easy to do.

Sarit Moussayoff 13:3213.04.20
The uncertainty caused by coronavirus (Covid-19) poses a threat to several recently announced merger and acquisition transactions for publicly traded companies in Israel and has already led to the postponement and even cancellation of TASE and global initial public offerings.


It is still too early to evaluate the full impact of the pandemic, but based on current market tendencies, it is safe to assume that even if some of the said transactions indeed close, they will be subject to major amendments on pricing, financing terms, and other material terms and conditions.


Office workers wearing masks (illustration). Photo: Shutterstock Office workers wearing masks (illustration). Photo: Shutterstock
Naturally and perhaps particularly in challenging times, the distress of one company can pose an opportunity for another. Companies whose supply chains have collapsed and have brought their production to a near halt are now attractive buying targets, due to the sharp and drastic decline in turnover and cash flow. Preferential loans or government aid do not necessarily pose a feasible solution for them, since the reduced market share and a steep decline in manufacturing capacity have severely impaired their cash flow, weakening their repayment capabilities.


The best way to keep these companies alive, in one form or another, is by initiating transactions (mergers and acquisitions) for distressed companies. In such deals, the crucial question is: how will the buyer know that the price reflects the full valuation potential before taking it over, managing it and making the necessary turnaround? On the other hand – how will the seller know that the asking price is accurate and that there is a high degree of certainty that the deal will be closed at the planned date, so that between the time they sign the deal and the time that all the conditions of the transaction are met, there will not have occurred a material adverse event leading the buyer from enacting a ‘walking away?’



Here’s a recent example: the Union Bank/Mizrahi-Tefahot Bank merger was supposed to reach closure this May, but the coronavirus crisis caused a shift in plans while the target valuation was determined before the ‘Covid-19 affair’. Mizrahi Bank was supposed to pay 1.4B NIS, but it became apparent that the Union Bank’s share price decreased drastically, as its credit portfolio, like that of the entire banking system, was cut significantly due to the outbreak. This is, with a doubt, a material adverse change that requires the parties to renegotiate the fundamentals of the deal or enable Mizrahi Bank to reconsider its next steps.


So how can this entanglement be solved? By applying the material adverse change (MAC) clause, which relates to a material adverse change in the target company’s business operations or profitability caused an event occurring between the time of signing the deal and its financial closure. MAC provisions aim to distribute the risk between the sides, where normally risks derived from material changes in the target company remain with the seller, apart from cases of predefined exceptions, which shift the burden and the risk back to the buyer.


In cases that target company business operations are subject to a material adverse change that broadly impacts its entire industry, such risk will remain with the buyer, who is obligated to complete the transaction under the original terms. On the other hand, a risk that disproportionally affects the target company relative to the broader industry - will enable the buyer to reopen the deal and claim the remedy available under the MAC provisions (price adjustment or the right to walk away).


This being the case, a pandemic of Covid-19’s scope will not necessarily grant the buyer an automatic right to call off the merger and acquisition deal. If the buyer wishes to exercise the MAC provisions, citing the ‘Corona argument,’ the buyer will have to prove that the crisis’ potential impact on the target company is much greater than its effect on the industry as a whole.


In addition, if the buyer makes an informed decision to enter the transaction while aware of the market conditions caused by Covid-19, it will be even harder to prove that a MAC event had occurred. The conclusion: buyers willing to enter merger and acquisition deals in the near future and secure the correct price for a deal under the special circumstances caused by the pandemic, will find it difficult to ‘walk away’ based on a ‘material adverse change.’ The knowledge principle is expected to play an important role.


The solution, under these circumstances, is to set the transaction price at the fair value of target company business operations during normal activity while concurrently agreeing to a discount that grosses up the long-term effect of Covid-19 and takes into account target company reorganization measures that will be necessary to achieve cost reduction, measures whose fruits the buyer will enjoy once the target company is put back on track.