Novel Coronavirus (COVID-19): Considerations in M&A Due Diligence

Virtual Due Diligence Capabilities

As a general matter, the parties in an M&A transaction need to consider whether the target company has established sufficient protocols to enable due diligence to be conducted entirely virtually (including providing access to documents and key persons typically made available during site visits).

Material Contracts of the Target

• Whether there are MAE, force majeure, impossibility, frustration of purpose or termination clauses in the target company’s key contracts (including customer contracts) that could materially change the parties’ obligations, including potentially allowing a party to temporarily/permanently suspend its performance under the contract (See also Operational & Supply Chain Considerations).
• Whether the target company anticipates a failure to perform, or a failure of any counterparty to perform, obligations under any material contracts.
• Whether exposure of any material counterparty to the target company’s agreements (e.g., customers, suppliers, distributors, creditors) has been significantly impacted by COVID-19.

Operational & Supply Chain Considerations

• Whether material supply contracts of the target company (under which the target company is the supplier) contain force majeure clauses that may cover the COVID-19 pandemic. If so, a buyer would want to understand what steps are required to declare force majeure, for how long such clause excuses performance and what mitigation measures are required to be undertaken.
• Whether any of the target company’s suppliers have declared force majeure under existing material contracts or otherwise declared their performance impossible. If so, a buyer would want to understand whether the target company is able to obtain alternate suppliers, the cost of using any alternate suppliers and whether the target company has sufficient supplies to meet its present needs for the foreseeable future.
• Whether the target company has experienced, or expects to experience, an effect on end market demand for its products or services, including any revenue exposure to countries or regions under containment, lockdown, travel bans, border closures or similar restrictions and to what extent the target company expects COVID-19 to alter customer behavior.
• Whether the target company plans any changes to its supply chains in response to COVID-19.

Data Privacy Considerations

A buyer would want to ensure that the target company is complying with data privacy protections, and should obtain information regarding the types of health data (e.g., temperature readings, symptom information) the target company has been collecting from employees or non-employees in connection with COVID-19 (e.g., office visitors), how it has been collecting this information, how it has been using or sharing this information and any notices or consents the target company provides to or obtains from its employees when collecting this information. In addition:

• If the target company is a covered entity under HIPAA (e.g., it provides self-funded or self-administered health insurance benefits to its employees), the collection of certain types of health data may be subject to HIPAA.
• Whether the target company has implemented any other measures in response to COVID-19 (e.g., tracking its employees). Depending on the measures enacted, additional compliance may be required by the target company.
• If the target company operates in the EU, it will be subject to more stringent requirements due to the GDPR and the EU’s more stringent requirements regarding employee data.

Tax Considerations

• Whether the target company has taken any steps with respect to tax payments and deposits in light of COVID-19 (e.g., has it deferred payments of income taxes or employment taxes in any jurisdiction).
• Whether the target company has a net operating loss carryforward, and whether it has analyzed the impact of the CARES Act with respect to carryback opportunities.
• Whether the target company projects its interest expense to be limited in 2019 or 2020 and, if so, whether it has modeled the impact of the increased limitation.
• The target company’s distribution structure and plans to either push down COVID-19 costs to its affiliates or adjust intercompany pricing to temporarily reallocate profit or loss.
• Whether the target company has held or expects to hold video or telephone board meetings and the physical location of each of the directors at the time of the meeting.
• Identify physical location of target company employees working remotely and consider permanent establishment and state tax nexus implications.

Finance/Accounting Considerations

• The likely impact of COVID-19 on the target company’s future financial performance.
• The actual and potential liability exposure not yet captured by financial forecasts.
• Whether there is any solvency risk or risk of an inability to comply with covenants under any credit facilities.
• The impact of COVID-19 on the target company’s access to liquidity and whether the target company will be able to meet any conditions to borrowing.
• Whether the target company expects to disclose or incur any material COVID-19 related contingencies.
• The impact of COVID-19 on the target company’s ability to deliver its financial statements and audits in a timely manner.
• Whether the target company has experienced, or expects to experience, any adverse effects on the target company’s maintenance of operations, including financial reporting systems and internal control over financial reporting and related disclosure controls or procedures.
• If applicable, whether the target company anticipates making any public disclosures or updated risk factors concerning COVID-19’s impact on its business.
• If applicable, whether there have been any communications from ratings agencies affirming the target company’s ratings or taking ratings actions attributable to the effects of COVID-19.

HR & Employee Benefits Considerations

A buyer would want to get a sense of how COVID-19 has impacted HR (including changes in the target company’s work force attributable to COVID-19), as well as existing company benefits available to affected employees.

• Whether the target company experienced any reductions in force, layoffs or furloughs as a result of COVID-19. If yes, when and how many employees were affected and whether the target company issued WARN notices.
• Whether the target company has received any complaints or concerns from employees regarding leaves of absence, paid sick time, etc., related to COVID-19.
• The number of employees that are located in high-risk or containment areas related to COVID-19.
• Whether the target company or any of its affiliates took advantage of any tax credit, loan, loan forgiveness or other benefit under the CARES Act that would place limits on employee compensation or the issuance of dividends.
• The target company’s efforts to abide by OSHA and CDC guidelines, such as social distancing, cleaning, etc.
• See also Existing Coronavirus Protocols & Mitigation Plans

Existing Insurance of the Target

• Whether the target company has made (or anticipates making) any claims on existing insurance policies, including business interruption insurance, as a result of COVID-19. If any claims have been made, understand the nature and status of the claims.
• Whether the target company anticipates making any claims on existing insurance policies to cover losses arising from supply chain disruption as a result of COVID-19. If any claims have been made, understand the response of the insurance provider to-date.
• Whether the target company maintains any insurance coverage for matters related to COVID-19 activities, including whether the policies have pandemic coverage.
• Whether the target company has experienced, or expects to experience, any increase in workers’ compensation claims and whether such workers’ compensation and related insurance for employees is adequate.
• Whether any of the target company’s insurers have provided any communications relating to insurance coverage matters, premiums or risk management in connection with COVID-19.
• If the target company is a healthcare company, whether the target company’s medical liability insurance covers COVID-19 matters and whether its policies have pandemic coverage.

Remote Work Capabilities

• Whether the target company has a written remote work policy or practice.
• The impact of remote or stranded employees with respect to the target company’s decision-making (including holding board meetings and related functions, and availability of key personnel).
• Whether the target company has sufficient information technology capabilities to ensure productivity and provide network access to employees working from home or remotely, which includes understanding:
  • the capacity the target company has to support the maximum number of users on its system;
  • how the target company’s remote access platform is configured to protect the transfer of sensitive information;
  • the information technology support available during remote working situations;
  • whether remote access to business critical applications and services is available; and
  • what video and audio-conferencing tools the target company has in remote working situations.
• Whether the target company has enacted any new cybersecurity measures or identified any areas of exposure given moves to remote working.

Litigation Risks

• Whether there is any pending or anticipated litigation or a dispute that could lead to litigation regarding contractual or labor and employment matters arising from the COVID-19 pandemic.
• See also HR & Employee Benefits Considerations

Existing Coronavirus Protocols & Mitigation Plans

• Whether there are any contingency plans or mitigation efforts in place regarding supply chain or other operational issues arising from COVID-19.
• Whether the target company’s business continuity and disaster recovery plan include measures and controls for situations in which workers are not permitted to (or agree not to) access the target company’s facilities due to acts of force majeure, including risk of infection.
• Whether the target company has protocols in place to enable the target company to issue guidance to employees and customers on public health and safety matters as they arise and how such protocols are developed, who at the target company is responsible for dissemination of the protocols and responses to inquiries regarding the proposals.