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Effects of COVID-19 on the M&A Market: Working Capital Adjustments; Due Diligence; Representations; Post-Signing Considerations

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| Legal Advisory

This is the second installment of a two-part series highlighting M&A transaction issues for buyers and sellers to consider in light of COVID-19. Read the first installment, Effects of COVID-19 on M&A Transactions: Economics of Buying and Selling.

1. Working Capital (WC) Adjustment

COVID-19 will impact how customary working capital adjustments are addressed:

  • Determining a WC target based on historical financial performance will be challenging due to interruptions that occur because of the nationwide shutdown.
  • COVID-19 related WC adjustments may be based on aged AR/AP.
  • After a WC target has been set, a separate WC holdback could be deducted from the purchase price to mitigate transaction risk for buyers while sellers may require a collar/range rather than a precise amount.

2. Due Diligence

Buyers and sellers need to carefully analyze business elements that may be affected by COVID-19 to assess target’s ability to persevere during economic uncertainty. Key diligence issues that could impact a transaction are discussed below.

Major Customer and Suppliers

  • Is target dependent upon suppliers from whom raw materials or manufactured goods will be difficult to obtain?
  • Are target’s customers reducing spending on products/services due to bans/restrictions or in anticipation of a prolonged economic downturn?
  • Are customers able to maintain purchasing levels of products/services?
  • What is required to return demand/production to pre-COVID-19 levels?

Supply Chain 

  • How will target’s supply chain – raw materials to finished goods – be affected by COVID-19 and resulting economic reforms?
  • Will a significant increase to COGS occur if target needs to obtain supplies from multiple vendors as a redundancy strategy?

Financial Statements 

  • For how long can target survive an economic downturn?
  • Will an additional infusion of capital be needed prior to 12 months of operations were there to occur a decrease in revenues due to COVID-19?


  • Will COVID-19 losses be covered by business interruption insurance?
  • Are such policies assignable and/or will they survive a change of control?


  • Do contracts contain a force majeure (FM) clause that references pandemics and excuses target’s, or counterparty’s, performance due to COVID-19?
  • Consideration should be given to the risk that some courts might enforce, if challenged, an ambiguously drafted FM clause due to the unique, widespread disruption to worldwide business caused by COVID-19.
  • An FM clause will generally be enforced if it’s shown that: (i) the pandemic is the immediate cause of nonperformance, (ii) a party took measures to mitigate damages, and (iii) performance is realistically impossible.

3. Representations and Warranties

Representations and Warranties (R&Ws) will come under increased scrutiny due to COVID-19. 

  • Sellers need protection against buyers making COVID-19 related breach claims while also seeking to be over-inclusive on disclosure.
  • Buyers should seek additional R&Ws related to emergency protocols, contingency planning, business continuity planning, and other internal activities crucial to continued operations during COVID-19.
  • Certain R&Ws that will be subject to increased scrutiny include:
    • Financial Statements. Financial statements during travel bans/nationwide lockdowns won’t reflect accurate activity; buyer will consequently evaluate target’s performance during this period.
    • AR/AP. Seller’s ability to effectively manage AR/AP during COVID-19 will be important to buyer.
    • Inventory. Do sufficient levels of inventory exist a/o is target capable of presenting the extent of shortfalls due to COVID-19?
    • Suppliers. Buyer will want R&Ws specific to COVID-19’s impact on seller’s supply chain and changes required going forward.
  • If parties have secured RWI policy, review policy exclusions as insurers will be expected to exclude COVID-19 related losses from coverage.

4. Post-Signing Considerations; Material Adverse Effect (MAE)

MAE: Material Adverse Effect is any event/condition that results in a material adverse effect upon the (i) ability of target to perform its obligations or consummate the transactions contemplated under the purchase agreement, or (ii) business, financial condition, liabilities, assets, properties, operations, prospects, or results of operations or cash flows of target.

  • It should include carveouts relating to factors outside target’s control that affect the economy/target’s industry without uniquely affecting target.
  • Industries relying on international production, large gatherings, or specialized manufacturing may be adversely affected by COVID-19.
  • Because COVID-19 may impact many industries, buyers may not be able to extricate themselves from a transaction unless they can demonstrate target is uniquely affected by COVID-19.
  • In light of COVID-19, provisions that specifically include/exclude pandemics in Material Adverse Effect definitions may become commonplace in definitive agreements.

Continued Operations. An agreement can prohibit certain seller actions during the executory period between signing/closing a transaction without the approval of buyer. Sellers should determine whether certain COVID-19 related actions outside the ordinary course may be necessary without such approval to provide for the (i) safety of its employees, (ii) financial stability of the business, or (iii) compliance with specific governmental orders.

5. Considerations for Buyers

  • Review financial statements/performance, especially during COVID-19, to determine a post-closing working capital adjustment.
  • Conduct vigorous diligence on target, including supply chain, inventory, and customers/suppliers, to identify weaker areas due to COVID-19.
  • Ensure comprehensive R&Ws in the purchase agreement, including emergency/contingency planning and remote working environment preparations.
  • Identify specific COVID-19 consequences related to target and include them in the definition of Material Adverse Effect to provide a termination right for buyer.

6. Considerations for Sellers

  • Conduct preemptive diligence to identify/mitigate deficiencies buyer could use to retrade deal consideration.
  • Prepare for more vigorous buyer COVID-19 related diligence on your business.
  • Strike forward-looking statements and, if possible, financial projections.
  • Be inclusive in disclosure for COVID-19 and, if the transaction is a sign/subsequent close, require ability to update disclosure via a bring-down certificate.
  • Exclude COVID-19 as a known risk from the Material Adverse Effect definition.
  • Consider non-ordinary course actions in light of a signed purchase agreement to ensure they do not require buyer’s prior consent.

This advisory was prepared by Shannon Zollo in Nutter’s Mergers and Acquisitions practice group. For more information, please contact Shannon or your Nutter attorney at 617.439.2000.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.

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