As the Covid-19 crisis deepens, and the number of positive cases and casualties continue to mount rapidly, governments across the world are enforcing stringent lockdown and social distancing measures. With the engines of economic growth grinding to a halt, the pandemic has mutated into an economic crisis, plunging the global economy into an unparalleled recession. India is no exception, and mergers and acquisitions (M&A) in India is sure to sniffle, snuffle and sneeze, at least in the short-term. From a legal standpoint, we believe that there will be consequent changes and fundamental shifts in the M&A landscape.
Covid-19 and on-going transactions – what to expect?
Covid-19’s impact has already started to affect M&A activity in India. Corporates are facing a tough strategic choice between jamming the brakes or stepping on the gas, with respect to ongoing deals. The key drivers of decision making range from change in business outlook, concerns regarding valuation, liquidity crunch due to reduced lending by banks and consequent reallocation of surplus funds. Cross-border transactions have been severely impacted due to the lockdown and closure of international borders.
In sectors such as aviation, hospitality and tourism, where there has been a direct business impact, parties may look to walk away from the transactions, amidst long-term uncertainties. In other sectors such as consumer goods, manufacturing, etc., where the impact is less severe, buyers may reconsider valuations or seek downward price adjustments. This becomes particularly relevant, given that January 2020 saw the Indian stock markets at an all-time high and buyers may wish to re-consider valuations.
In this context, we are likely to see the invocation of the ‘Material Adverse Effect / Change’ (MAE) clauses in the investment / acquisition agreements, which could allow purchasers the right to walk away from transactions. Whether or not the Covid-19 crisis has actually resulted in an MAE will have to be assessed on a case by case basis, based upon the scope of the MAE clause in the respective contracts, the industry / sector and geography in which the target company / business operates, as also specific exclusions to the MAE clause. Even where an epidemic, pandemic or health emergency are not specifically excluded, other exclusions (e.g. events having industry-wide impact, general economic conditions, change in law or force majeure) could potentially exclude the application of the MAE clause to the present crisis.
Where parties intend for the transaction to proceed to completion, the parties’ ability (particularly the seller’s) to fulfil the pre-closing covenants and conditions precedent will be significantly impeded on account of the lockdown. Significant delays can be expected in obtaining governmental, regulatory and third-party approvals (including from lenders and contractual counterparties), as offices, banks and government departments are either closed or are operating with limited staff. Courts (including the NCLT) are either shut or are only hearing urgent cases, M&A and group re-structuring through court-based schemes are also likely to be delayed, particularly given the existing backlog of cases. From a practical standpoint, physical verification of inventory for consideration adjustments for working capital may not be feasible and stamping and registration of documents would be an issue in the near-term, given the current restrictions. In view of these, parties would need to consider extending the ‘long stop date’ for closing under the agreements.
Additionally, parties may need to re-look at certain covenants, to be able to respond to the present challenges. Sellers may want to reconsider the standstill obligations and the various actions that require the purchaser’s consent, to enable a dynamic response to the crisis. Purchasers would need to bolster their right to seek information relating to the target business from the seller (including specifying detailed formats and negotiating specific warranties and indemnities), given that site access / audit may not be feasible. Purchasers are also likely to carefully re-consider the terms and conditions of employment, appraisal cycles, employee commitments, new hires etc.
In the event that the Covid-19 crisis and the lockdown conditions were to continue for a significant duration so as to make closing impossible, parties could consider flexible alternative interim structures to give effect to their commercial understanding, and proceed to close the transactions once the crisis abates.
Deals in the time of Corona
The lockdown period and the period immediately thereafter are most likely to see a downward trend in M&A activity in India. In our crystal ball gazing, we see the following indicative outcomes:
- Delays and Dropouts: Any M&A deals, which were at the structuring stages or on the anvil will most likely be deferred to a later date, to be activated once the crisis abates. Seller driven bid processes are likely to see bidders drop-out.
- De-Globalisation: Cross-border investments may be hit since MNCs and PE funds are likely to conserve cash in this uncertain market and become increasingly inward looking.
- Opportunities: Despite the grim outlook, the crisis may open up some buy-side opportunities, leveraging on the lower valuations in the short term to seek higher return on capital in the long term. A similar trend was observed post the 2008 recession where PE funds and MNCs with sufficient “dry powder” deployed their funds to pick up stressed assets on the cheap in the aftermath of the crisis.
- Stimulants & Catalysts: Financial stimulus packages and measures such as tax relaxations announced under the Union Budget 2020 (including rationalisation of provisions pertaining to dividend distribution tax (DDT) and exemptions on investments by sovereign wealth funds), and relaxation of compliance norms by regulatory bodies such as SEBI, RBI and MCA could be the catalyst required to ease the M&A process.
- Limitations: With respect to any M&A transactions that are entered into during this period, the approach to deal making will need to factor in the limitations posed by the present crisis, and will need to be recalibrated to address the prevailing risks.
- Due Diligence: The due diligence process will likely undergo a change — rely less on physical meetings and site visits, and more on virtual data rooms, and focus on, inter alia, consequences of the target’s failure to perform its obligations under crucial contracts (including indemnities, take-or-pay, force majeure and termination rights), its ability to pay off its debts and insolvency risk, liabilities towards the health and medical care of employees (including availability of insurance), compliance with the governments’ directives relating to Covid-19 and compliance with data protection laws (as any information collected by companies regarding the medical condition of their employees would be ‘Sensitive Personal Data’).
- Preferred Structures: Given the potential delays in obtaining regulatory approvals, parties may prefer structures involving the least regulatory interface. A share acquisition may, thus, be preferred over a court approved scheme or slump sale under a business transfer agreement. In view of the impact on business operations and consequent fluctuation in valuation, purchasers may consider acquisition in multiple tranches; or a structure involving acquisition in part by equity shares and in part by compulsorily convertible instruments; and / or other deferred consideration structures, with the back-ended component / conversion price / escrows linked to the target’s performance. Further, the consideration adjustment provisions linked to key business parameters may need to be hard coded in the transaction documents, so as to provide deal certainty as well as value certainty.
The Devil is in the Detail
Several clauses in the transaction documents (viz. warranties, conditions precedent, MAE and consideration adjustment) are likely to be heavily negotiated and the focus is likely to be on the following provisions:
- MAE: The parties would need to specifically agree on how the impact arising on account of the Covid-19 crisis would affect the transaction – buyers are likely to insist on enlisting events such as pandemics, lockdowns, closure of international and domestic boundaries as MAE events, whereas the seller will push for a narrower MAE.
- Change in Law: New measures are being announced by the government almost on a weekly basis. As such, the allocation of risks on account of a ‘change in law’ are likely to be keenly contested. Given the limitations on due diligence on account of the crisis, purchasers are likely to ask for inclusion of a satisfactory bring-down due diligence (including an on-site inspection and title due diligence for real property), as a condition precedent to closing.
- Warranties: Purchasers would need to assess the risks emanating for the target from the Covid-19 crisis and seek detailed warranties. Not only would the sellers appropriately qualify these warranties using knowledge and materiality qualifiers, they would also appropriately consider disclosing any specific facts, which are relevant to the Covid-19 crisis in the disclosure letter. There may also be a greater reliance on warranties and indemnity insurance, and the policy coverage would need to be negotiated.
- E-Signing: In terms of the deal execution, parties will place increasing reliance on e-execution and e-signing of the agreements, however, stamping and registration of the agreements will remain a concern during this period.
- Corporate Approvals: We are likely to see board and audit committee approvals being obtained through videoconferencing or audio-visual means, and shareholders’ approval, where required, by way of remote e-voting.
- Regulatory Approvals: While the SEBI and the RBI have permitted filing of applications electronically, the CCI in March 2020 permitted parties to file combination applications electronically and has also permitted pre-filing consultations in relation to inter alia combinations under the green channel route, through video conference. While these are welcome moves, approvals / consents required from state / local / municipal authorities may continue to pose a challenge.
Post-COVID world – What does the Future Hold?
While the short-term effect of the Covid-19 crisis on the M&A landscape will be drastic, it is expected that this crisis would also precipitate a change in the outlook of consumers and a realignment of priorities at the level of the government towards sectors such as healthcare and pharmaceuticals, as well as allied fields such as medical research, medical devices, etc. Not only would this spawn opportunities for increased localisation, but it is also likely to result in further consolidation.
Several measures being undertaken by the government as a response to the Covid-19 crisis, such as permitting the practice of telemedicine through video, phone, internet based platforms, and facilitating retail sale of drugs to the doorstep of the consumers, together with the innovations in technology and artificial intelligence, would result in newer business opportunities within the ‘health-tech’ space.
In addition, considering that a large proportion of India’s population is without any insurance of any kind, a crisis of this scale and nature is likely to underline the gravity of the need for obtaining insurance, including health insurance, thus potentially resulting in significant uptick in the insurance sector and consequently, increased M&A activity. Further, essential sectors such as healthcare, pharma, FMCG, IT, etc., are also likely to see a boom, and M&A activity is sure to follow.
The present crisis is a humanitarian one, but it has significant business and economic impact. One hopes that the crisis abates quickly with the discovery and delivery of a vaccine so that normalcy can return none too soon. In the meanwhile, stay safe and work from home.
 Among others, Moody’s, S&P and CRISIL have dramatically reduced India’s GDP projections for FY 2020-21.
 In order to increase the attractiveness of the Indian equity market, Finance Act, 2020 has amended the Income-tax Act, 1961 to allow dividend or income from units to be taxable in the hands of shareholders or unit holders and inter alia domestic company or mutual funds are not required to pay any DDT. To remove the cascading effect, the amendment has allowed deduction for the dividend received by holding company from its subsidiary.
 Section 7 of the Finance Act, 2020 amending Section 10(23FE) of the Income-tax Act, 1961.
 Rule 2 of the Companies (Meetings of the Board and its Powers) Amendment Rules, 2020 available at http://www.mca.gov.in/Ministry/pdf/Rules_19032020.pdf.
 CCI Notice dated March 30, 2020 available at https://www.cci.gov.in/sites/default/files/whats_newdocument/30thcircular.pdf.
 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.
 Ministry of Health and Family Welfare notification dated March 26, 2020 available at https://www.mohfw.gov.in/pdf/Doorstepdelivery26B.pdf.
 Press Release by Press Information Bureau dated May 8, 2015 available at https://pib.gov.in/newsite/PrintRelease.aspx?relid=121445.