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Natalia Garcia

Gomez-Pinzón Abogados, Bogotá

ngarcia@gomezpinzon.com

 

Alvaro Rueda

Gomez-Pinzón Abogados, Bogotá

arueda@gomzpinzon.com

 

The effects of the Covid-19 pandemic have also hit the M&A market. Not only has there been a slowdown in M&A deals around the world, but uncertainty around the future of many businesses is giving rise to new discussions in the negotiation field. Colombia is no exception to this new reality; after a three-month lockdown in which only certain industries have been authorised to continue their businesses under strict safety restrictions, many companies are in financial distress. As of today, it is not clear when the economy will be fully reopened, but no doubt certain measures such as social distancing, remote working and other measures imposed by the government to control the pandemic will remain in place for a long time.

How will this affect M&A deals? We will not refer to pending deals which were signed prior to the impact of Covid-19 in Colombia, since many discussions have been had around material adverse changes (MAE), force majeure or excessive onerosity of the contract (in Colombia, teoria de la imprevision) to avoid the closing of deals that may be under risk as a result of the pandemic's effects.

We will refer instead to some effects in the mid and long-term that may apply in M&A transactions. As uncertainty is the new normal, this will require lawyers to raise further discussions and create further safeguards on both sides of the table. Ultimately, it will largely depend on the negotiating leverage of the buyer and seller in each individual transaction.

New trends

According to Transactional Track Record, 120 M&A deals were reported in Colombia in the first quarter of 2019, while only 50 M&A transactions have been reported in the same period in 2020. The scenario is still uncertain as companies all around the country are facing difficulties in carrying out their businesses as they used to, while others are facing financial distress and others still are reviewing the viability of their business under this new scenario. No doubt some industries such as tourism, entertainment, retail and transport are facing more trouble than others.

Nevertheless, new opportunities may arise in industries such as technology, healthcare, logistics, e-commerce, e-education and communication as a result of the new consumer trends imposed by social distancing. According to Transactional Track Record, 56 out of the 120 M&A deals in Colombia in the first quarter of last year were related to technology. Considering that many companies are investing in technological solutions, tech companies providing these solutions will continue to be attractive for investors.

Since many companies are facing financial distress as a result of the lockdown and social distancing measures imposed by the government to control the pandemic in Colombia, we expect to see distressed assets changing hands in the mid-term. Private equity finance will most likely be the ones making the first moves, as investors willing to bear greater risks will play an important role by the end of this year. Companies under financial distress and with liquidity problems may be targeted by investors that are seeking to purchase at a discount price, aiming to restructure the company to recover its commercial viability. In Colombia, insolvency authorities estimate that, in a scenario in which the Colombian GDP falls by 1.9 per cent, approximately 2,676 companies (mostly small and medium-sized) could face an insolvency risk.

Different business approaches

Considering this new scenario, in which it is too early to know the changes that may impact the different kind of businesses and which ones may or may not survive, the element of uncertainty will take a more relevant role while reviewing a M&A deal target.

That said, purchasers will take a different approach when undertaking the valuation of a business, in which historical data may have to be re-evaluated and the current business will face unusual circumstances. Valuation will have to be reviewed in detail since variations will likely occur in times of uncertainty and volatility. Discussions from a business perspective should be made in more detail and analysing different scenarios, including unexpected ones.

New questions will arise when conducting a due diligence of the target. Will the business be considered essential under a pandemic event to allow its continuity? Is the business affected by social distancing? Which measures is the target undertaking to face that challenge? Is the target complying with the safety protocols issued by the government? How is the current supply chain affected under a pandemic scenario? Which ‘Plan B’ could be implemented under such circumstances? As some of these questions may arise, lawyers should be prepared to adapt their due diligence request lists to the Covid-19 impacts and be ready to analyse the impact of the governmental regulations issued to address the pandemic.

We will most likely see more deal consideration allocated to earn-outs than to upfront payments, and an extension of the earn-outs over a longer period of time. Lock box clauses will become less likely. Other deferred consideration structures, purchase price adjustments and closing conditions based on financial metrics and client retention may become more common. Since financial formulas to determine the final price of the transaction will be analysed under a completely different scenario, detailed methodologies are encouraged to be included in the transaction documents to help to avoid future disputes. The reach of milestones in earn-outs may also have to consider that external unpredictable events are likely to occur and a certain flexibility may be negotiated upon such circumstances.

Changes in M&A dynamics

M&A lawyers are used to negotiating some customary provisions, such as what constitutes a MAE, operations in the ordinary course between signing and closing, commercially reasonable efforts to undertake certain covenants, and other provisions that have become standard.

What is standard in the new normal? How do you calculate a ‘normalised’ working capital under the current scenario? How do you review the ‘ordinary course of business consistent with past practice’ representations and covenants when the government measures impose companies to adapt to a completely new scenario that has never before been faced by such companies?

The new normal of teleworking, social distancing and governmental restrictions on operations affects the ability to operate a business in the ordinary course. Unusual measures have been taken to ensure business continuity and many of these measures will have to be analysed vis a vis measures undertaken by companies of the same industry. Therefore, new definitions may be included in the transaction documents or interpreted ‘dynamically’. There may be further discussions on both sides of the table about unforeseen or uncontrollable events to better allocate the risks between the parties.

We expect to have:

• a set of additional and/or amended definitions;

• a heavier draft of the financial and business representations and warranties (ie, assets, operations and financial statements);

• an adequate disclosure of the effects, liabilities, risks and potential impacts of Covid-19 on the target;

• carve-outs of pandemics in the MAE definition; and

• more way-out provisions and break-up fees.

Given the uncertainty of the markets, buyers would procure to include more way-out provisions that will allow them to terminate the agreement before closing. In response, sellers would seek to include more break-up fees. Buyers may also consider requesting representations and warranties around risk assessments and contingency plans.

Furthermore, buyers could insist on including certain specific indemnities related to the ability of the company to comply with material agreements. A greater scrutiny of the deal before closing will likely take place.

The dynamics of a standard M&A deal will be different: provisions that were not very common under purchase agreements will become more relevant. M&A risk allocation in the era of Covid-19 may definitely change the practice as we know it today. It remains to be seen where the balance will land in terms of what the market is.

More M&A litigation

Considering this is a unprecedented situation that affects the business and financial results of certain businesses where M&A deals have been signed but not closed, some purchasers are trying to avoid closing – alleging a MAE, a force majeure or an excessive onerosity of the contract has occurred. Although there has not been any local judicial ruling in this respect, we believe this situation should be analysed on a case-by-case basis.

On the other hand, with respect to new deals executed post-Covid-19, there might also be more litigation considering we continue to face uncertainty in the near future and that negotiations may not allocate all risks adequately. It will be difficult to determine if losses that may be claimed by one of the parties are directly related to Covid-19, particularly if buyers do not get the benefit of the bargain.

Acquisition of participation interest of private companies by the Colombian government

Under the economic, social and ecological emergency, the Colombian government enacted a special decree (Decree 811 of 2020) authorising the Colombian government to acquire a participation interest in the capital of private companies in order to:

• stabilise their economic situation;

• contribute to warding off the crisis in employment; and

• mitigate the economic consequences caused by the Covid-19 pandemic.

In this sense, upon acquiring a minority participation in the capital of private, public or mixed companies, the Colombian government may require the company's shareholders to:

• repurchase the participation interest that the government acquired in the capital stock of the company within a certain period of time; or

• offer for sale, jointly with the government, at least a percentage of the company's controlling capital stock.

Measures like the one hereby depicted will create new M&A deals, opportunities between private companies and the government and, in the long term, the government seeking an exit from private companies.

Conclusion

The Colombian M&A market has been affected by the effects of the Covid-19 pandemic. We expect to see:

• new industry opportunities;

• the acquisition of distressed assets;

• a different business approach for valuation and negotiation of the consideration;

• a more detailed and heavier draft of the transaction documents;

• more M&A litigation; and

• new M&A opportunities as a result of the government’s acquisition of a minority participation interest in the capital of private companies in order to stabilise their economic situation.

 

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