Due diligence in M&A transactions in the Covid-19 pandemic

In the light of the Covid-19 pandemic, uncertainties regarding the legal and economic framework have become apparent in the market for M&A transactions. Over the past year, many companies have wondered whether a transaction is worthwhile in these times. Based on last year’s experience, when assessing this question in the context of transactions it is crucial to identify pandemic-related risks in order to be able to comprehensively hedge against them in contracts. In our next article One year of M&A transactions and company purchase agreements during the Covid crisis – What we have learnt, you can read about how these risks influence the drafting of a purchase agreement and how you can protect yourself in the company purchase agreement against the risks identified.

In order to identify risks, acquirers carry out due diligence in the form of a comprehensive examination of the company to be acquired. Due to the Covid-19 pandemic, certain aspects have been added to or have become more important in this process. Below we provide an overview of the various aspects of due diligence that are particularly affected by this development:

Employment due diligence

Are there any (imminent) workforce-related measures such as short-time work furlough schemes/plant closures and dismissals and related (imminent or ongoing) legal disputes? Is there any entitlement to continued payment of wages despite a loss of working hours (e.g. due to necessary childcare/quarantine orders/employees from abroad)? To what extent can data still be protected and hygiene concepts maintained when employees work from home? Has the target company drawn up concrete pandemic crisis management plans?

Commercial due diligence

Can customer and supplier contracts be fulfilled or continue to be fulfilled? Is there any dependence on (certain) suppliers and customers? Which important contracts allow for withdrawal or contain force majeure/change-in-law clauses, leading to a risk of termination or renegotiation of terms? Are there any (imminent) legal disputes with regard to contract performance/effects of production and delivery interruptions or due to the discontinuation or reduction of rental payments?

Financial due diligence

Are there any state subsidies that could result in conditions for use and possible repayment modalities? Have any special loans been applied for/approved to provide short-term liquidity? Is the company’s continued solvency ensured? Are there any short or medium-term suspensions of tax payments or payments from financing agreements? What effects does the applicability of the German Act to Temporarily Suspend the Obligation to File for Insolvency (COVInsAG) have on the company (such as suspension of the duty to file for insolvency/risk of the transaction being challenged due to insolvency)?

Public-law due diligence

Are there any official orders or is there a risk of official orders impairing business operations or making them impossible? Is it guaranteed that hygiene protocols are observed? Is it possible to file a merger control notification with the competition authorities at short notice? What effects will potential or existing export restrictions or travel bans have?

IT due diligence

Are there any negative effects of the comprehensive switch to working from home at short notice (security guidelines, data security, resilience of the IT system, software licences, etc.)?

Organisation of due diligence

Can all relevant documents for the due diligence be made available in the virtual data room? Is it possible to obtain physical documents (e.g. from official bodies) or is there a risk of delaying the due diligence? Is a site visit possible where it appears necessary?

To sum up, the impact of the Covid-19 pandemic on due diligence in M&A transactions is manifold. It is not a structural change in the corporate audit, but instead additional aspects are emerging alongside the usual audit, expanding its scope (enhanced due diligence) and shifting the focus.

Even after the end of the Covid-19 pandemic, which is not yet foreseeable, it is likely that the consequences of the crisis will have to be comprehensively identified and assessed in due diligence processes. It remains to be seen what impact the Covid-19 pandemic will have on different sectors of the economy. While some industries will be hit harder by the consequences of the pandemic and there could be an increase in distressed M&A transactions as a result, others will emerge stronger from the pandemic, not least due to digitalisation.