May 5, 2020

M&A Agreement Updates for COVID-19

The COVID-19 pandemic has created uncertainty across the economy, including in mergers and acquisitions. Parties may suddenly find themselves in a buyer’s market compared to the pre-COVID-19 world, and target businesses may increasingly need support. Below are considerations for addressing COVID-19 uncertainty in M&A transactions.

Diligence and Timing

In order to better address COVID-19 risks, it’s important to understand as much as possible about how the target business has been impacted. This will mean increased diligence efforts, particularly in three key areas: customers, suppliers and human resources. Likewise, parties should plan for transactions to take more time as a result of increased diligence and potentially governmental, lender, landlord or other third party consents or permits which may be required. Below are some examples of diligence considerations that may be included in a buyer’s diligence request list and diligence-related calls, and which sellers should be prepared to answer:


  • Describe any changes to the target’s normal operations as a result of COVID-19
  • Have any counterparties been unable to fulfill their obligations under contracts with the target?
  • Please confirm whether any insurance claims or applications for government-aid have been or are anticipated to be made.
  • Has the business been deemed an “essential business” or similar designation by any governmental authority? Are there any consents, permits or licenses related to COVID-19 which the target needs in order to operate or enter into this transaction?


  • How have sales and distribution networks been affected by COVID-19? Have any customers breached, triggered a force majeure contract clause or given notice of the need to modify the customer’s relationship with the target?
  • How has the target implemented social distancing and “stay at home” precautions?
  • Have any target locations been closed or have hours or capacity been reduced? Has the target been able to ship its products to customers?
  • Do the key customers have the financial wherewithal to keep paying in a pandemic? Have they encountered payment or disruption issues in the past?

Supply Chain

  • Have there been any disruptions to the target’s supply chain?
  • Has any supplier asked to modify its relationship with the target or trigger a force majeure clause in a contract with target?
  • Where are the target’s key vendors located, and are there any backup vendors?
  • Does the target have multiple sources of supply in case one source is excused or delayed?

Human Resources  

  • Describe any policies, precautions and accommodations the target has in place or anticipates implementing regarding employee health, safety and compliance with protocols related to COVID-19.
  • Is the target able to operate its facilities or have its employees been forced or requested to work from home? How will it affect the target’s business if a significant number of employees become ill or must be quarantined?
  • Have the target’s IT systems continued working without interruption in the same manner as before COVID-19, even with increases in remote work?
  • Has the target received any complaints for failing to provide a safe work environment related to COVID-19?

Note that for target businesses that don’t have a significant brick and mortar component, a look at how the target business fared after the 2009 financial crisis may be instructive, but for the buyer that may require reviewing financial statements from an earlier date than may be typical. If the buyer will be relying on seller forecasts and projections, the buyer may consider performing a sensitivity analysis to understand how different facets of the target business may be affected by COVID-19 disruptions.

Valuation Considerations

Buyer Equity as a portion of Purchase Price

Issuing equity of the buyer to the seller as a portion of the purchase price can help buyers and sellers share COVID-19 risk by aligning their interests in the future of the buyer. Sellers typically prefer to be paid in cash to avoid being subject to post-closing risks of operating the acquired business. Likewise, receiving buyer equity as part of the purchase price may subject a seller to little-known risks within the buyer’s pre-transaction business. However, if completing the transaction is a priority, the parties will need to find common ground on valuing the target business, and using buyer equity as a measure of post-closing value is one tool that can help bridge the valuation gap.

Earnout as a portion of Purchase Price

Paying a portion of the purchase price to the seller based on the target business’s achievement of certain agreed upon metrics after the closing (i.e. an “earnout”) can also be an effective tool for sharing the risk and uncertainty caused by COVID-19. Prior to the COVID-19 pandemic, roughly 27% of private company M&A transactions included earnouts.[1] In the aftermath of the 2009 financial crisis, that number increased to approximately 38%.[2] Earnouts are a more flexible tool than buyer equity because an earnout allows the parties to identify and separate a particularly affected area (e.g. brick and mortar store sales as opposed to online sales) and use that particular measure to share a more specific area of risk as a means to reaching agreement.

Target Net Working Capital

Even though most M&A transactions value the target business assuming it has no financial debt and no unrestricted cash (i.e. valued on a “cash free / debt free basis”), the parties typically assume the target business will have a “normal level of working capital.” This “normal” or “target” working capital is commonly calculated using the trailing twelve months of the target’s business, although a shorter period (e.g. three or six months) may be appropriate if that would permit the buyer to operate the target business without having to infuse additional capital. The trailing twelve months (or shorter) average is typically “normalized” to exclude extraordinary or non-recurring events which the buyer would not be expected to experience. However, under COVID-19 circumstances, the needs of the target business are unlikely to be fully captured using historical averages, and “normal” working capital may be difficult to determine. The parties should consider how much additional working capital the business may need beyond its typical level, and how much support, if any, a buyer may be willing to provide the target business in the short term. The target net working capital amount for which the seller will be responsible at closing should be appropriately adjusted to reflect the target’s extraordinary needs and potential support which may be provided by buyer.

Material Adverse Effect


The buyer’s obligation to close on a transaction is typically conditioned on seller to making a representation to the buyer that no “Material Adverse Effect” or “MAE” has occurred with respect to the target business. Failure of that condition may result in the buyer not closing on the transaction. The definition of “Material Adverse Effect” is often negotiated and typically states that no MAE has occurred with respect to the business, assets, liabilities or capitalization of the target business, but typically excludes events which might affect an entire industry or economy as a whole, such as a war or recession. Under COVID-19 circumstances, the seller will want to ensure that disease/pandemic/COVID-19-related effects are excluded from the definition of MAE, with the aim of reducing the likelihood that the seller will be held responsible for such effects as they relate to the target business. Conversely the buyer will want to prevent such an exclusion or at least state that COVID-19 will not have a disproportionately negative effect on the target’s business relative to other businesses in the industry.

Akorn Inc. v. Fresenius

Few courts have allowed buyers to refuse to close on a transaction due to the failure of an MAE condition. In fact, in 2018, Akorn Inc. v. Fresenius KABI AG[3] became the first case in which a Delaware court found that a Material Adverse Effect had occurred with respect to a Target’s business, entitling the buyer to terminate a merger agreement.In the Akorn case, the Delaware Chancery Court found that after the merger agreement was signed but before it had closed, Akorn had a significant (at least 25%) and sustained drop in its business and it became known that Akorn had submitted falsified information to the FDA, constituting a Material Adverse Effect which entitled Fresenius to terminate the merger agreement. Akorn Inc. v. Fresenius was affirmed by the Delaware Supreme Court on December 7, 2018.[4]

Operation of Target Business Prior to Closing

Restrictions on the Seller prior to Closing

The seller in an M&A transaction is commonly required to represent that:

  • No Material Change
    • No material change has been made to the target business since an agreed upon date (often the date of the most recently provided financial statements)
  • Operation in the Ordinary Course of Business
    • The seller has operated the target business in the ordinary course of business until the closing; and
  • “Bring Down” – All Seller Representations Materially True as of Closing
    • All of the representations and warranties made by the seller as of the signing date are true in all material respects as of the closing date.

The Need for Flexibility

In a COVID-19 world however, the seller may need to take extraordinary steps in order to preserve the business or comply with applicable law. Examples may include drawing down lines of credit, closing offices and facilities, requiring employees to work remotely and negotiating payment terms with customers and suppliers. Sellers may need to give themselves the latitude to take these types of extraordinary actions, and buyers will need to consider how much flexibility they may be willing to give, and what limits should be placed on it. In particular, the parties will want to review each place in which the following terms are commonly used, in order to evaluate whether exceptions or flexibility is needed to preserve the business, comply with applicable law and reduce uncertainty between the parties:

  • “ordinary course of business”
  • “past practices”
  • “best efforts”, “reasonable efforts”, “commercially reasonable efforts” etc.
  • “material adverse change” and “material adverse effect”

Likewise, sellers may consider including language that allows the target business to manufacture supplies for COVID-19 and to comply with any government orders such as “stay-at-home”, quarantine, social-distancing and US Defense Production Act orders.

The recently settled lawsuit SP VS BUYER LP v. L Brands, Inc. C.A. No. 2020-0297 (Del. Ch. Apr. 22, 2020)[5] and countersuit filed the next day: L Brands, Inc. v. SP VS Buyer L.P., Sycamore Partners III, L.P., and Sycamore Partners III-A, L.P., (Del. Ch. Apr. 23, 2020)[6] demonstrate the need for language giving the Seller the flexibility to react to COVID-19 circumstances. Even though there was a “pandemic carveout” from the MAE definition (preventing pandemic-related occurrences from constituting a Material Adverse Effect), SP VS Buyer LP (an affiliate of the private equity firm Sycamore Partners) claimed that L Brands (the owner of Victoria’s Secret) store closures and employee furloughs in response to COVID-19 entitled SP VS to terminate its proposed purchase of 55% of the Victoria’s Secret business for approximately $525M.SP VS Buyer claimed that L Brands (as seller) was subject to other requirements in the transaction agreement to operate the business in the ordinary course and refrain from making material changes until the Closing. Since these lawsuits settled out of court, we don’t know how the Delaware Chancery Court would have ruled, but the fact that the settlement did not require SP VS Buyer to complete the transaction demonstrates the importance of sellers having the flexibility to react to COVID-19 in the transaction agreement.


Business Interruption Insurance

Buyers should request and sellers should check their business interruption insurance to check whether COVID-19-related interruptions are may be covered.

Representation and Warranty Insurance

While representation and warranty insurance has generally excluded coverage of COVID-19 issues, parties looking for such insurance for an M&A transaction should ask early on in the process how the insurance company treats COVID-19 issues, and whether they would be willing to narrow or eliminate exclusions which otherwise might apply to COVID-19 issues.

For additional information, please visit our COVID-19 Resources page.

[1] Private Target Mergers & Acquisitions Deal Points Study (including transactions from 2018 and Q1 2019 ). M&A Market Trends Subcommittee, Mergers & Acquisitions Committee, December 5, 2019

[2] Id.

[3] Akorn Inc. v. Fresenius KABI AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018)  

[4] Akorn Inc. v. Fresenius KABI AG, C.A. No. 2018-0300-JTL (Del. Sup. Ct. Dec. 7, 2018)  

[5] SP VS BUYER LP v. L Brands, Inc. C.A. No. 2020-0297 (Del. Ch. Apr. 22, 2020).

[6] L Brands, Inc. v. SP VS Buyer L.P., Sycamore Partners III, L.P., and Sycamore Partners III-A, L.P., (Del. Ch. Apr. 23, 2020).