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M&A Agreements and Material Adverse Effect in the Wake of COVID-19

            Like almost all other aspects of our lives, the COVID-19 crisis is also affecting the ways in which parties approach the bargaining table in the context of mergers and acquisitions (M&A).  Buyers and sellers are now thinking about the effects this global pandemic has had on target companies the subject of M&A transactions and the respective negotiating leverage of the parties thereto.  Specifically, principals on both sides of the table are asking themselves whether COVID-19 rises to the level of a Material Adverse Effect (MAE) on a company’s financials and operations for the purpose of closing—or terminating—an agreement to merge or acquire. 

            There is no “one size fits all” MAE provision, but, in general, it is intended to allow an acquirer to opt-out of a transaction if, before the actual closing, unexpected events have taken place such that the financial health and stability of the target company has materially and adversely changed.  In essence, an MAE clause allows a buyer to pull out when it is no longer getting the benefit for which it bargained.  Customarily, systemic risks—such as market fluctuations, natural disasters, industry-wide downturns, responses to geopolitical and national economic shifts, or in some cases even pandemics—are assumed by buyers, while particularized exceptions are reallocated to sellers as a means of ensuring due diligence and continued best practices during the period leading up to the final closing of a merger or acquisition.  Such exceptions are tested against a foreseeability MAE standard in terms of whether the target company has been disproportionately affected by an incident (such as COVID-19) as compared to others in the market.   

            From a practical standpoint, it is critical that parties to M&A contracts be clear and precise with respect to exclusions and special conditions in an MAE context.  If a pandemic, or other such global catastrophe, and its potential effect on a business are not specifically provided for, an analysis will necessitate a fact-based investigation; and will turn on whether the residual effects of such a widespread occurrence would materially and disproportionately disadvantage a company’s earning potential for a substantial duration relative to other industry participants.  Some articulable company-specific considerations may take into account a business’s debt leverage, a unique supply chain model, a vulnerable location, or other conditions unique to that particular target company.  As such, the gathering and proactive tracking of operational data, documented production delays, and other operational records evidencing impact on income are paramount.  Such documentation can be utilized to trace the effects of COVID-19 on deteriorating financials, and potentially link the coronavirus to the materially altered valuation of the target company. 

            Aside from MAE provisions, there are other practical points to consider while negotiating M&A agreements.  First, even if it is unclear whether an MAE has occurred, and thus has changed the “essence” of a deal, its potentiality may create a scenario wherein increased leverage on one side could result in the loosening of contractual protections on the other.  Also, other sections in a contract to merge or acquire may come into play even if the high bar of an MAE is not implicated.  Thus, it is important to consider the impact of a global event, such as COVID-19, when negotiating and drafting representations and warranties, covenants, extension carve-outs, project deadlines, and the like.  Moreover, common law concepts such as frustration of contract, impossibility, or the duty of good faith and fair dealing may also serve as potential grounds to terminate a deal.  Lastly, it bears noting that the U.S. Department of Justice, through its Antitrust Division, announced on March 17, 2020 that M&A parties should tack on an additional thirty (30) days to any timing agreements for deals currently pending or proposed during the pendency of COVID-19.  This temporary announcement will facilitate the Department’s backlog in its review of M&A transactions.

Please contact the Updike, Kelly & Spellacy, P.C. attorneys listed below for any questions regarding this client alert or questions related to corporate matters, including but not limited to, mergers and acquisitions.

Gregg J. Lallier is a Shareholder whose practice primarily focuses within the technology, private equity and venture capital industries. Mr. Lallier has represented both mature and emerging growth companies in a variety of enterprises, including software, information technology, clean technology, 3D manufacturing, and health care services and equipment. He also regularly represents angel, venture capital and other institutional investors in all manner of corporate transactions, including mergers and acquisitions, debt and equity financing, joint ventures and strategic alliances. Attorney Lallier may be reached at or at (203) 786-8313.

Michael J. Palmieri is a Shareholder in the Firm’s New Haven office. Mr. Palmieri has substantial experience representing small and medium sized companies on a wide variety of legal matters, including, Corporate and Project Finance, Corporate Governance and Compliance, Securities Regulation, Securities Transactions, Mergers and Acquisitions and Commercial Agreements. Attorney Palmieri may be reached at or at (860) 548-2618.

Attorney John J. Alissi is a Shareholder currently serving as the Firm’s President. Mr. Alissi is a member of the Firm’s Commercial Lending & Banking Practice Group. Attorney Alissi represents commercial banks, finance companies and other debt and equity providers in all aspects of commercial lending. Attorney Alissi may be reached at or at (860) 548-2619.

Updike, Kelly & Spellacy, P.C. would like to thank associate Jason Martinez for his contributions to this article. 

Disclaimer: The information contained in this material is not intended to be considered legal advice and should not be acted upon as such. Because of the generality of this material, the information provided may not be applicable in all situations and should not be acted upon without legal advice based on the specific factual circumstances.