By Monica Cavalcanti and Bruno Dreifus, partner and associate of Mergers & Acquisitions and Corporate group of Trench Rossi Watanabe, respectively
Where previously the talks of the day were expanded local market opportunities, positive economic measures and reforms, and a potential for a relevant positive growth in the Brazilian economy, the growing, and still uncertain, impact of the Covid-19 pandemic in all major economies, including Brazil, has brought a significant shift in the M&A market outlook for Brazil.
Now, in a scenario of significant drop in stock prices, consumer demand, devaluation of the Brazilian real and general economic retraction, discussions on revisions of potential projects have become commonplace until a better understanding of the economic impacts is possible, when, similarly as in past crisis, new market opportunities could become abundant.
However, whilst new projects are revised and re-discussed, the various M&A transactions that have already been initiated or executed during the previously booming economic scenario now present new economic and legal challenges to both buyers and sellers. Thus, for such cases, discussions have now shifted on to material adverse change (MAC) clauses, price revisions and earn-outs, and walk-away rights.
Material adverse change. A relatively common practice in M&A transactions, MAC clauses provide a party the possibility to terminate an agreement (with or without the payment of termination fees), or request a price revision and/or indemnification for the benefit of a party upon the occurrence of an event, fact or circumstance that results in a material adverse change to the business.
In cases in which the agreement contemplates a MAC clause, it is important to conduct an analysis of the effects of the Covid-19 pandemic, as well as the terms and conditions of the MAC clause applicable to the transaction, in order to assess potential contractual implications.
Amongst such aspects, it is important to analyze any applicable thresholds for the application of the clause (e.g., monetary values, percentage of business deterioration), any excluded events (e.g., events that affect industries as whole) and the consequences defined in the agreement (e.g., termination right, price revisions, amongst others).
Price revisions and earn-outs. Another aspect of legal concern are provisions regarding price revision and earn-outs.
Price revision clauses, such as working capital adjustments, may demand a more cautious financial analysis to determine the applicable adjustment, in addition to cooperation between the parties in an attempt to mitigate potential legal disputes on the extent of the price adjustments due to reduced financial capacities, deterioration of revenue, and loss of value of inventories.
Likewise, in view of the expected economic retraction, earn-out targets are likely to be significantly impacted and difficult to achieve, which may lead to aggravated frustrations and a greater potential for legal disputes.
Therefore, it is recommended that the parties carefully document not only the impacts of the Covid-19 pandemic to their business, but also the efforts taken to mitigate such impacts, as well as of the performance, efforts and results of the business prior to the pandemic.
Such documentation will be crucial in eventual legal disputes alleging either fault or negligence in the management that made it impossible to reach targets despite the COVID-19 pandemic or that resulted in aggravated effects of the pandemic and consequentially, greatly reduced business performance.
Walk-away. Certain situations may, however, have become significantly aggravated that a walk-away may be a party’s best alternative given the deterioration of the business.
In such cases, a careful analysis of the agreement must be made in order to review potential walk-away rights and legal implications, such as whether a MAC clause has been triggered, a condition for closing has become impossible, or other termination events have been triggered.
Specifics must be evaluated on a case-by-case basis, considering the agreed upon contractual terms and the particularities of the case. However, it is important to highlight that even in situations in which an agreement may be silent, the parties may still find a recourse in either Article 393 or Article 478 of the Brazilian Civil Code.
Article 393 establishes the concept of force majure, which is legally defined as a necessary fact that occurs which effects are impossible to avoid or impede. Upon the occurrence of a force majure event, the law provides that the debtor of an obligation will not be liable for any losses arising from the non-compliance with an obligation, unless it has been expressly agreed otherwise.
Consequentially, a party may invoke, subject to a case-by-case analysis, a force majure event resulting from the global pandemic to justify its non-performance of a contractual obligation. Whether or not such line of argumentation is justifiable or applicable to a case will need to be assessed individually, but it is important to keep in mind that this generates an added uncertainty to contractual relationships.
On the other hand, Article 478 of the Brazilian Civil Code establishes that in agreements with a continuous or a deferred execution (e.g., a deferred closing), if an obligation becomes excessively onerous to a party, with a significant advantage to the other, and in view of extraordinary and unpredictable events, the debtor of the obligation shall have the right to request the termination of the agreement, provided, however, that the creditor may avoid termination if it offers to equitably review the terms of the agreement.
It is important to keep in mind that the application of this provision demands the verification of two conditions, i.e., that a party is substantially adversely affected by an event or circumstance and that the other party is substantially benefited. The occurrence of one of these conditions (burden or gain) does not satisfy the conditions of the article and, consequently, does not trigger such legal termination right.
Similarly to the previous case, the applicability of such legal provision must be evaluated on a case-by-case basis, as well as the consequences of such action, including the potential of a judicial revision of the commercial arrangement in the event that the creditor offers an equitable renegotiation.
Considering these uncertainties, it is recommended that the parties seek to: (i) document impacts of the Covid-19 pandemic and the actions taken to mitigate them; (ii) carefully review contractual terms; and (iii) to the extent possible, attempt to amicably resolve potential disputes in order to avoid potentially added costs with legal disputes.