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Mergers and Acquisitions is a corporate strategy wherein the assets of a company is consolidated in order to buy, sell or combine two companies thereby helping a growing or sinking company to grow rapidly without having to create a different business entity. A merger is something which is carried out between two companies of relatively the same size, who combine their assets[i] and present a united front in the market. The stocks of such companies are forfeited and they issue a new company stock in the market. For example, Vodafone India and Idea Cellular, two of India’s top companies in the telecommunication sector in 2018. On the other hand, acquisitions are unfriendly deals per se, wherein the target company does not want to be bought, however, the acquiring company obtains a majority stake of the target company and declare themselves to be the owner of such a company. In the past few years India has seen both a rise and fall in the Mergers & Acquisitions sector. For instance, in the year 2014, transactions worth $33 billion had been carried out between Indian Companies through Mergers and Acquisitions. However, in the year 2015, the number took a $13 billion dip and the transactions in the M&A sector was seen to be only $20 billion.
However, with the entry of BJP as the ruling party, the M&A sector was once again trending and a tremendous growth was seen in the sector as companies from the United States of America, Germany, Canada etc., started showing interest in doing business with Indian Companies. Industries like Pharma, IT, Energy, E-Commerce and Banking have been the center of attraction in the Mergers & Acquisitions sector.
With the novel COVID-19 spreading like wildfire, the M&A sector in India is once again facing a road where one lane is filled with the potholes of risks. However, the lane parallel to every risk, is laced with opportunities, the question is which side is the M&A sector of India going to be on?
Scenario of Mergers and Acquisitions during COVID-19:
According to many experts, M&A was set to have seen an all-time high in the year 2020. However, the novel Corona Virus has altered the dynamics of the M&A sector significantly and has led to the rise of exceptional challenges for companies all around the globe. The impact of COVID-19 has not just been on the financial system. The valuation of the sellers, the need for the buyers to indulge into M&A and a plethora of other factors affecting Mergers & Acquisitions. The organizational lockdowns and travel restrictions have hindered the performance of due diligence and have even led to the nonperformance of previous deals. So, the question arises, what are the clauses and provisions that we should be focusing on in the light of COVID-19?
Force Majeure has been defined as “an event or an affect which can neither be anticipated nor be controlled. It is a contractual provision allocating the risk of loss if performance becomes impossible or impracticable, especially as a result of an event that the parties could not have anticipated or controlled.”[ii] There is no proper definition of the term “Force Majeure” in the Indian laws, however, Section 32 of the Indian Contract Act, 1872 does hint at an explanation of the term, wherein it has been mentioned that if a contract is contingent on the happening of a particular event, however the happening of the event becomes impossible due to any kind of supervening factor, then such a contract is declared void. Many of the companies are using the Force Majeure clause in their contracts as a way of not performing their end of the contract without any legal repercussions.
Material Adverse Change/ Material Adverse Effect (MAC/MAE):
What if a contract does not have a Force Majeure clause? The next challenge faced by the Merger and Acquisitions sector is the presence of the MAC/MAE clause in a contract. This is a clause that renders it possible for either party to withdraw from a contract in cause of any form of material change after the contract has been signed. The occurrence of a MAC can be used both by the buyer or the seller to terminate the contract or render the contract void. This clause is basically a way of allocating the risks between both the parties. For instance, if in case there is an MAC on the end of the seller, the buyer can easily withdraw from the contract without facing any legal consequences. However, does COVID-19 come under the ambit of a Material Adverse Effect?
Let us take a gander at the following requirements for a particular event to come under the scope of MAC:
- Change in the market within which an entity was operating pre COVID-19.
- The existing legislations about the enforceability of the MAC clause.
- Language of the MAC clause. For instance, the MAC clause includes certain events like earthquakes, tsunamis etc., however, does not mention a pandemic or epidemic as an MAC. In this case, enforcing the MAC clause shall become comparatively tougher than it would have been if the language of the clause had mentioned pandemics specifically.
Overall, a pandemic such as COVID-19 would have to be specifically be fitting into the exception clause of MAC, in order to enforce an MAC during COVID-19. Therefore, both the parties should take to specific negotiations regarding the impact of COVID-19 in their deal if they are amidst Merger & Acquisitions talks and not rely on the universal terms of an MAC clause, in order to have a satisfactory mutual decision. Any such mutual decision should be documented clearly in order to ensure an airtight enforceability of the contract.
Eversince the pandemic, the pricing methods in the M&A deals have been under strict scrutiny. Due the COVID-19 pandemic, the viability of the markets has taken a significant blow and the parties should focus more on the liquidity assessment of their business, the impact on their revenue due to the impact of COVID-19 in order to be able to make proper assumptions and reach at viable prices during negotiations. Here, the goal is to avoid any form of fixed pricing and devise a proper mechanism in order to help the parties in adjusting the price post COVID-19.
Cross border transactions are suffering a lot due to the travelling and social participation restrictions being placed. In this situation companies are looking towards conserving as much cash and resources as possible as there is uncertainty in the market in the current situation. Also, with trade wars occurring between various countries is a significant factor affecting the Mergers & Acquisition deals between them wherein the parties are withdrawing from the contracts and not going forward with the performance of the contracts.
Due Diligence is the process that a buyer carries out to understand the selling business and to evaluate the risks of buying such a business and to check whether the confidential information relayed to the buyer by the target business is true to the fullest. To carry out the process of due diligence, an onsite meeting or interview with the owner and the employees of the target company plays a significant role. However, the process of due diligence is becoming tougher by the day due to the organizational lockdowns and the work from home programs. The only alternative now is the upgradation in the virtual data rooms by the party conducting the due diligence regarding various contracts, financial status of the target company, compliance of government regulations and data protection legislations etc.
Delays in deal:
Due to the new rules and regulations coming under affect due to the COVID-19 restrictions, the merger & acquisition deals which are still at their structuring phase have been deferred to a later date which has not been specified.
Representation & warranties:
The spread of Corona Virus and its impact on the world has also hindered with the legitimacy of certain representations and warranties made by either party. For example, any kind of indemnity or covering of losses offered before in a contract has been affected due to the pandemic as the spread of COVID-19 has affected businesses majorly in a negative way, thereby adding to their losses. So, such representation of indemnifying losses need to be negotiated again in light of COVID-19.
Even though SEBI and RBI have jointly permitted parties to file an application electronically[iii] and to get the pre filing consultations w.r.t. to inter alia combinations through video conferencing[iv], the approvals and consent required from the state, local or municipal authorities might pose to be a challenge due to the restrictions imposed during the pandemic.
The ordinary course of business clause:
The M&A contracts always include various Covenants and Undertakings which talk about how a company must carry out their “ordinary course of business”, insinuating that the business should be operational on a day to day basis in order to protect the value of the business. For instance, there should be no layoffs post-deal or no salary cuts of the employees. However, considering the fact that we are amidst a pandemic, the parties would have to renegotiate on such covenants and undertakings and come to a mutual satisfactory decision regarding indulging into such covenants and undertakings which are in the best interest of the business.
What does the future have in store for M&A transactions in India? – Post COVID predictions:
Though COVID-19 will have a negative effect on the M&A landscape, however, by the time it subsides, the world’s take on M&A transactions will have changed drastically, owing to the new rules and regulations that the governments/financial institutions have been imposing in light of COVID-19. The pandemic might open up certain avenues in order to acquiring various side junctures for companies and to gain high return on their invested capital. During the pandemic, the Health Care industry, telecommunication industry, education industry and consumer staples have been flourishing more than they already were. This has led to many business opportunities for players in the market. The sole focus of the parties should be on the regulatory issues and the framework of their deals post COVID-19. The valuations of businesses are seeing a low point at the moment, this is a factor that a buying company shall take into consideration in order to acquire businesses for peanuts and then gain high returns post pandemic.
Furthermore, the more stressed businesses are keen to sell at the moment and will be looking for an opportunity to close the deal with a potential buyer. Strategizing a proper due diligence mechanism should be another one of the goals of the parties. Due diligence will take longer during COVID-19, however, will be very accurate and shall help the buyer to gain high return on low investments. The various schemes and privileges launched by the Government of India under the Union Budget of 2020 and the exemption/relief in tax laws at the moment have come as a boon to the M&A deals and might act as a catalyst in closing the deals in question. In case of a financing issue, remedies for both the buyer and the target company is available. Given the current situations, buyers can back out of a deal without facing any form of legal consequence by claiming a lack of financing from the government or third parties. However, the seller can counter this by making requests vis-à-vis escrow in order to keep the deal on track and to not face any delay in purchase payment.
Although, the number of M&A deals have decreased by a massive 61% in the second quarter of 2020, yet, the deals in telecommunication sector have seen a tremendous rise by 220 times in comparison with the deal values of the first quarter of 2020. The primary reason for this increase has been the recent deal between Facebook and Jio Platforms, wherein Facebook acquired the latter company from Reliance Industries for $5.73 billion.[v] The travel restrictions have indeed been an issue for the cross border deals, however, the inbound and domestic deals have risen significantly and are rising at an unprecedented rate wherein a total value of $22.9 billion was recorded in the first half of 2020. The FMCG sector has also been able to maintain its balance in the M&A sector. With tensions rising between all the major countries and China, this is the time for India to experience a growth in its M&A transactions via her “Make in India” campaign. Most of the big companies are looking to move their business from China to elsewhere, therefore there is scope for an increase in the Cross-Border deals as well.
All in all, as the saying goes “if opportunity doesn’t knock, make a door”. In the words of Winston Churchill “A pessimist might seek difficulty in every opportunity, whereas an optimist sees opportunity in every difficulty”. Times are tough and the crisis has affected the biggest of powers around the world, but normalcy will soon return and the financial sectors and its players should be ready for it. A careful approach both in the domestic and business part of a person’s life is the need of the hour. Business deals might take a hit and get up again, in the meanwhile, stay careful, stay safe.
“The views of the authors are personal“
[i] See, https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf. (September. 28, 2020, 1:07 PM)
[ii] Force Majeure Definition, Black’s Law Dictionary (11th Edition, 2019), available at WestLaw.
[iii] CCI Notice dated March 30, 2020 available at: https://www.cci.gov.in/sites/default/files/whats_newdocument/30thcircular.pdf (September. 28, 2020, 1:30 PM)
[iv] CCI Press Release No. 48/2019-20 dated March 19, 2020 available at https://www.cci.gov.in/sites/default/files/press_release/PR482019-20.pdf. (September. 28, 2020, 1:32 PM)
[v] See, https://economictimes.indiatimes.com/small-biz/startups/newsbuzz/covid-19-gives-rise-to-opportunities-for-the-ma-sector-amidst-the-crisis/articleshow/76871498.cms?from=mdr (September. 28, 2020 5:45PM)