Covid-19: Companies in financial distress - Practical M&A considerations in restructuring

The Covid-19 lockdown has battered the already ailing South African economy. Despite the pending lift of the lockdown, companies will likely battle to stay afloat as the full impact of the pandemic plays out.

Companies with insufficient liquidity face a high risk of collapse. The disposal of some or all of the shares in, or the business of, a distressed company, may become a necessary and valuable tool to help unlock liquidity to pay creditors and to secure the survival of the company or business.

Practical considerations for the disposal of a distressed company are slightly different from disposals in ordinary trading circumstances.

  • A distressed sale or dilution of equity typically includes very short periods for the negotiation and conclusion of the transaction to raise the necessary capital quickly.
  • The scope and extent of due diligence and management interviews is limited (caused, in addition, by the logistics impediments due to the pandemic).
  • Time constraints and market practice dictate that representations, warranties, covenants and indemnities are likely to be significantly limited.
  • Walk away rights for the buyer will typically be excluded, as the success of the transaction is essential to meeting the objectives of the restructuring.
  • Only very limited and essential conditions precedent for the effectiveness of the transaction are likely to be accepted, given the urgency and the critical need for a successful restructuring. These are usually only the mandatory regulatory approvals necessary for the sale, such as merger and exchange control approvals, if applicable.
  • The risks for the buyer are high as a result. This heightened risk is typically compensated by payment of a lower consideration for the shares or business.
  • Payment of the purchase price in a sale is usually made in full upfront (dictated by the commitments and needs of the company and urgency) or partly in cash, with the balance held in escrow (or in trust). The escrow funds can be agreed to constitute security for a purchase price claw back if warranties, representations, covenants or indemnities are breached.
  • A communications strategy for suppliers, customers and the media regarding the purpose and prospects of the transaction is a critical part of managing the post-transaction recovery of the business and any reputational risk.