Covid-19 impact on M&A transactions in Colombia

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Juan Diego Martínez-García
Serrano Martínez, Bogotá
jmartinez@serranomartinez.com

Mateo Gómez-Mazuera
Serrano Martínez, Bogotá
mgomez@serranomartinez.com

María Gabriella Domínguez-Faillace
Serrano Martínez, Bogotá
mdominguez@serranomartinez.com

In all economic crises, there is a large percentage of stakeholders that may find opportunities. The Covid-19 pandemic crisis is no exception. As history recalls, the 2007-2009 financial crisis (caused by subprime mortgage lending), although difficult, also benefitted a wide range of companies and investors that sought to acquire target companies or assets which would have been out of their reach in normal market circumstances.[1] During economic downturns acquirers have greater opportunities to maximise shareholder value, given that the entry purchase price is much lower than in a regular market situation and will most probably produce higher long-term returns.[2]

In the aftermath of the 2007-2009 financial crisis, remarkable M&A transactions occurred, such as the Reuters Group acquisition of Thomson Corp; the DIRECTV Group and Liberty Media merger; the acquisition of Scottish & Newcastle by Carlsberg and Heineken; and the Kraft acquisition of the English chocolatier Cadbury, to mention just a few.[3]

Insofar as the Covid-19 pandemic is a health issue, its rapid spread and many unknown effects have led governments all over the world to apply extreme measures, such as long-term lockdowns, which have blocked productivity and consequently caused severe economic damage. Taking into account the 2007-2009 financial crisis precedent, the current widespread recession is ideal for acquirers to pursue and consider the Covid-19 aftermath as an M&A window of opportunity, provided that they have sufficient liquidity and risk tolerance.

Aside from sufficient economic resources and risk tolerance, the acquisition of a company or its assets entails a detailed and strategic M&A deal plan, which shall be responsibly conducted with thorough and precise due diligence and a well-structured acquisition agreement.

The due diligence phase of a potential M&A taking place during or after the pandemic must include an exhaustive investigation by the buyer that considers the economic effect on the target. This includes the effects on the supply and distribution chain risks; the workforce; health and safety policies and procedures; business continuity and emergency contingency plans; privacy and data security; the terms of material contracts; debt compliance; and employee pension plan deficits, among others.[4]

In Colombia, it is important that buyers that are in, or about to engage in, a due diligence stage are aware and properly advised of the Colombian Government’s issuance of a series of new decrees and regulations that may affect each target´s business. New measures include the compliance or implementation of biosafety policy manuals for the prevention of the spreading of Covid-19,[5] and compliance with stricter privacy and data security regulations, including the obligation for tele-mobile operators to provide the necessary personal data to public entities.[6]

As may be expected in a crisis situation, targets may be experiencing financial difficulties. As negative financial projections are usually used to negotiate prices downwards, it is important to keep in mind that many countermeasure regulations from the Colombian government directly impact the indebtedness of companies in an effort to relieve their financial pressure and maintain employment. Regarding indebtedness in the time of Covid-19, the Colombian authorities have created multiple mechanisms for employers to keep their bills and debts up to date, generate cash flow and alleviate their economic burden.

These include

• the Formal Employment Support Program,[7] which supports and promotes formal employment and grants employers 40 per cent of the legal minimum wage in order to pay for their employees’ salaries;
• grace periods and instalment extensions offered by public and private banks for the payment of debts;
• renegotiation of lease agreements and a ban on increasing lease prices for as long as the state of emergency continues;[8]
• an expedited procedure for companies who need to enter into judicial and non-judicial insolvency proceedings in order to restructure their debts with their creditors and continue with the ordinary course of their businesses;[9]
• a temporary measure allowing simplified stock corporations to negotiate their stocks in the public market;[10]
• and term extensions regarding the renovation of the mercantile registry for merchants[11] and tax declarations.

Additionally, the drafting and negotiation of the acquisition agreement will be precisely and cautiously negotiated to address the extra risks of acquiring companies that might suffer or have suffered the negative effects of the economic crisis.

One of the issues that will require special attention is the valuation of the target and, as a result, the purchase price provision. In this regard, as the valuation of targets during the crisis could be extremely difficult (due to the uncertainty of the effects of the pandemic and of governmental measures on businesses) it would be relevant for buyers to analyse purchase price adjustment or earn-out provisions, so as to protect themselves from uncertain negative effects on the target business.

In relation to Material Adverse Change (MAC) or Material Adverse Effect (MAE) clauses, it is important for the parties to determine the events that shall be considered as materially adverse, as well as the carve-outs to the clause. This is to specify whether Covid-19, and/or the effects derived from the restrictive governmental measures that gave rise to the economic downturn (mandatory lockdowns, air and land transportation restrictions, general suspension of extractive industries, etc), will be considered an MAE or MAC.

There is no relevant Colombian case law regarding MAC clauses, so it would be difficult to analyse the pandemic in the face of Colombian judicial precedent. However, it is important to consider that the Colombian authorities declared the emergency state generated by Covid-19 on 17 March 2020. In this regard, it is important to consider whether, in addition to the eventual applicability of an MAE or MAC clause, the pandemic could give rise to the application of a force majeure. Under Colombian law, force majeure is the occurrence of unpredictable and irresistible circumstances that may exempt the non-complying party from any liability.[12]

With regard to the tailoring of representations and warranties, parties will need to contemplate the secondary effects of Covid-19 and how these have affected the target.

Colombian case law does not directly address ordinary course of business covenants in private acquisitions. Nevertheless, for agreements in execution, it is important to recall the decision of the Court of Delaware in the United States in Akorn v Fresenius, from which sellers may argue that, in light of the Covid-19 governmental measures that have blocked business operations, if the seller has made a reasonable commercial effort to prevent any hampering of the ordinary course of business, there would be no breach of such covenant.[13] For parties negotiating an agreement, it is important to include, as part of the ordinary course of business covenant, the compliance of the target company with all the governmental measures issued as a result of the Covid-19 outbreak, given that these measures constitute the ‘new normal’ for business activities nowadays.

Lastly, considering the gradual ease of lockdowns worldwide and the progressive reopening of economies, the logistics for closing agreements could turn out to be more complicated than expected. Many countries´ filing offices have been temporarily closed to the public and, at least in Colombia, many have not yet implemented virtual procedures. Even if virtual procedures have implemented, the general public may not yet be familiar with them.[14]

In Colombia, as a result of the lockdown, public and private entities such as the Superintendence of Industry and Commerce, Superintendence of Companies, Chambers of Commerce and Tax Authorities were forced (at least initially) to close to the public and grant various term suspensions.

Even though the crisis will certainly affect Colombia, it is expected that the country will turn out to be one of the least affected economies in the region. This, together with a responsible governmental response to the crisis, provides potential investors with a unique window of opportunity to make acquisitions that would otherwise be very difficult or expensive.

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