Covid-19: Anticipated impact on M&A transactions in South Africa

​Restrictions on travel, a fundamentally-changed business operating environment and the limited availability of regulatory services in the wake of the Covid-19 crisis will require buyers and sellers to review various aspects of M&A transactions

The global Covid-19 pandemic, and South Africa’s response in the form of a  national lockdown, raises some potentially deal-breaking obstacles to mergers and acquisitions (M&A) already under way. But it presents opportunities for acquirers, too.

According to a Financial Times article on 31 March, "Dealmaking grinds to a halt on coronavirus impact", M&A activity in the USA has plummeted, as executives have shifted their focus towards saving their own businesses and looking after their customers and staff, rather than acquiring other businesses. The article suggests that M&A activity in the USA in the week beginning 23 March totalled only USD12.5 billion, the lowest weekly total since the depths of the financial crisis in April 2009.

Although it is not yet clear whether the South African M&A environment will follow suit, it is probably to be expected.  We have set out below a high-level discussion of some of the challenges which South African M&A transactions may face as a result of the pandemic, highlighting certain risks and challenges that the M&A process may face during this time of uncertainty.

Data rooms and due diligence: the Covid-19 pandemic is likely to present several challenges to the traditional due diligence process.

Establishing data rooms may prove difficult for sellers, owing to the non-availability of key personnel and the inability of employees to access hard copy documents. Site visits and in-person meetings usually undertaken during the due diligence process, particularly in cross-border transactions, may be impossible owing to travel restrictions, national lockdowns and/or internal company policies.

From the buyer's perspective, it will be important to identify what Covid-19-related questions could be relevant in the due diligence, including, for example, whether the target remains capable of complying with existing contracts and/or whether any third parties are entitled to terminate their contracts as a result of the pandemic.

Sellers should consider the need to include information in the data room about the possible impact of the pandemic on the target as well as whether Covid-19-related disclosures will be necessary.

Regulatory approvals: transactions subject to already lengthy regulatory or merger approval processes may face additional challenges as a result of delays caused by the pandemic and consequent backlogs. For example, the Competition Commission issued a media statement on 24 March 2020 that, following the announcement of the lockdown period, it will be significantly scaling down operations and expressly discouraged the filing of merger transactions, except those involving failing firms or firms in distress.

Conditions precedent and long stop dates: where conditions precedent remain to be fulfilled, it will be important for parties to identify any difficulties in satisfying these, including potential delays as a result of the pandemic, and to agree on waivers and/or the extension of long stop dates, where appropriate. For example, the fulfilment of conditions precedent might take longer due to capacity restraints and the location and availability of key signatories or personnel.  The need to agree waivers and/or extensions may, of course, also present an opportunity for a party, who, following the pandemic, no longer wishes to proceed with the transaction, to refuse a waiver/extension and thereby cause the agreement to lapse.

Certain conditions precedent may be difficult to fulfil (e.g. the passing of directors' and/or shareholders' resolutions), due to the limited availability of directors or shareholders who are or may be hospitalised or subject to travel restrictions. Parties may have to consider utilising electronic signatures and virtual meetings, if allowed under the relevant law and constitutional documents.  For more information on electronic signatures, including the use of electronic signatures under the Companies Act, 2008 (the Act), click here.

Where the fulfilment of conditions precedent is delayed, it will be important to establish what new documentation, if any, will be required by the parties, including an agreement to extend the date on which the conditions precedent are required to be fulfilled and whether any regulatory or other third party approvals will have to be updated.

MAC provisions: parties proceeding to closing may consider relying on material adverse change (MAC) provisions in the existing transaction agreements which grant the buyer (and, in some instances, the seller) the right to walk away from, or renegotiate, a transaction prior to completion in the event of the occurrence of very specific, unexpected events that are detrimental to the value of the target.

MAC clauses, however, tend to exclude any events and changes that affect a specific industry or the global market generally. Whether the impact of the Covid-19 pandemic will qualify as a MAC will therefore depend on the construction and interpretation of the particular MAC clause in question.  We expect in future parties to a transaction may look to include events similar to the pandemic in MAC clauses.

If an agreement has no applicable MAC clause, the parties may have to look at the law regarding supervening impossibility, to establish whether one or more of the parties are and could in law no longer be required to perform under the agreement in question.  Another potential consideration could be whether the agreement allows a buyer or seller to exit the transaction, should there be a material breach of material warranties (which may well be the case following the pandemic) prior to closing the transaction.

Timelines and exclusivity: owing to the nature of the pandemic and the various steps taken, and proposed to be taken, by governments in many countries, it is likely that M&A transaction processes in the near future will become less predictable and follow a slower timeline. If the parties agree on a slower timeline, it will be important to consider extending any exclusivity periods on current transactions and negotiating longer exclusivity periods for future transactions.

Financing: it may become significantly more difficult in the near future for a buyer to secure debt financing, in which case parties may need to find alternative solutions, for example equity or vendor financing.  The inability to procure funding may also cause a transaction not to become unconditional and fail.

Purchase price: the impact of the pandemic may require parties to consider alternative approaches to purchase price valuations and adjustments mechanisms, with both parties seeking sufficient protection and certainty. It is also likely that purchase price negotiations, valuations and adjustments may proceed late into the transaction process, as a result of the potentially unpredictable effects of the pandemic on the target.

In transactions already signed, a buyer may find itself having agreed to a purchase price which is no longer realistic or commercial, following the pandemic.  Whether a party may exit will depend on the provisions of the agreement, including, as discussed, MAC clauses, supervening impossibility or provisions entitling exit if there has been a material breach of material warranties.

Warranties and Indemnities: it is likely that warranty and indemnity provisions in transactions concluded in the near future will be subject to more extensive negotiations in an attempt by both parties to reduce and appropriately allocate any potential risks posed by the pandemic and any potential new pandemic of a similar nature in the future.

When agreements have already been signed and are awaiting fulfilment of conditions precedent and closing, the seller may wish to revisit the warranties already given (prior to the pandemic), as these are normally given on the signature date and the closing date (i.e. are forward-looking).  Many of these warranties may no longer hold true and a seller would be in breach of the warranties, given the impact of the pandemic, entitling the buyer to a claim under the agreement.  The seller will have to consider whether it is entitled to terminate the agreement under the circumstances, to enable a renegotiation of the terms relating to warranties and indemnities.

Buyers are likely to consider seeking specific warranties and indemnities relating to the impact of Covid-19 on the target, as a result of which sellers are likely to be encouraged to disclose specific information in this regard. Sellers will also have to ensure that warranties are qualified by knowledge and materiality and that indemnities are appropriately capped and of limited duration.

Parties may wish to consider the availability of warranty and indemnity insurance for transactions entered into in the near future. However, as Covid-19 is a known risk, it may be that Covid-19-related losses will be specifically excluded by the insurer, as the insured's knowledge of a situation is typically excluded from policy coverage.  In addition, warranty and indemnity insurance normally does not cover profit warranties, looking to the future.  If an insurance policy is in place in respect of an existing transaction, the parties would be well advised to revisit the terms of the insurance policy and whether the insured is sufficiently protected.

Implementing the deal: the Companies and Intellectual Property Commission (CIPC) announced on 24 March 2020 that, from 1 April 2020, only limited electronic services will be available, with all other services only resuming at the end of the lockdown period. Certain services, pertinent to the implementation of M&A transactions, will therefore not be available, which may adversely impact upon the ability to implement a transaction. This could include, for example, the services relevant to the filing of any amendments to a company's memorandum of incorporation as well as for the creation of new securities.  Parties will have to consider in the circumstances whether, should the CIPC's email address for filings remain active during this time, submission in this manner (without being processed by the CIPC), would constitute filing under the Act.  For more information on the limited electronic services which are available during the lockdown period and what impact that has, click here.

Practicalities of closing: with the various travel bans, national lockdowns and restrictions on gatherings currently being implemented globally and in South Africa, it will be important to address the practicalities of any closing meetings, particularly the availability of signatories or personnel (or third parties) who are or may be hospitalised or subject to travel restrictions. It may be necessary for parties to consider utilising electronic signatures and virtual meetings to close transactions, as stated above.

Post-transaction integration: it will be important to consider the impact that travel bans, and various other Covid-19-related restrictions may have on post-transaction integration between firms. The practicalities of integration may be significantly impaired due to the inability of the buyer and the seller to physically combine their firms after a transaction.

Appetite for new transactions and de-risking transactions: although the pandemic is likely to impact the general appetite in the market for new transactions, it is also likely to present new opportunities in relation to both (i) businesses facing distress or financial trouble as a result of the pandemic and (ii) businesses in the health and related industries. As stated in the article "Covid-19: Takeaways for the private equity industry", in the private equity space there is an opportunity to exploit market instability and lower valuations. Fund financing may also be more attractive due to lower interest rates.