It is impossible at this stage to predict the full impact of Brexit on potential target businesses, but there are some practical considerations which buyers and their advisers can and should bear in mind when contemplating, negotiating and documenting M&A transactions.
Although 31 October 2019 ("Brexit day") is fast approaching, we face growing uncertainty as to how the UK will withdraw from the European Union (EU) and its future relationships with the EU. While the ongoing twists and turns of the Brexit negotiations, coupled with ever increasing tensions within the UK political landscape, make it impossible to predict the full impact a Brexit may have on businesses (in the UK and further afield), there are certainly some practical considerations which buyers and their advisers can and should bear in mind when contemplating, negotiating and documenting M&A transactions.
We highlight below some of the key areas for consideration during a buyer's due diligence process which will help ascertain the degree of a target's exposure to Brexit-related risks. We also consider Brexit-related issues that may be relevant to the negotiation of commercial terms on an M&A transaction and subsequent documentation.
Brexit due diligence
Contingency planning for Brexit should be viewed as an important part of the due diligence process on M&A transactions, although its significance will vary depending on the nature and footprint of the target business' operations as well as those of its customers and suppliers. However, as a general guide, a buyer's due diligence should focus on the state of readiness of the target company in key areas likely to be affected by Brexit. For example, consider:
- Geographic structure and potential for business interruption: dependence on EU markets for customers or supplies and the strategic, financial and practical impact of additional tariffs, border checks/border red tape and/or diminished market access on those trading relationships;
- Passporting/licensing: reliance on any EU passporting or licensing rights allowing supply across the EU from the UK (or vice versa);
- Key contracts: potential for termination as a result of MAC or similar conditions and impact on EU-wide contracts;
- Staffing: dependence on employees who are EU nationals and position of UK staff based in the EU, pending clarification of their immigration status;
- EU funding: any reliance on, or benefit from, EU funding or other EU advantages;
- Governing law and dispute resolution: governing law and dispute resolution mechanisms in contracts, particularly where there are overseas parties (for more on this see below);
- IP rights: dependence on EU-wide intellectual property rights, such as EU trade mark registrations, Community design right registrations, unregistered Community design rights, or database rights, held by the target company; and
- Data Protection: the target company's material personal data flows, identifying any personal data flowing into the target company from the EU/EEA which might be at risk as a result of Brexit,
and whether appropriate measures are being taken by the target business to minimise exposure to Brexit-related risks and ensure the effective operation of the business in a post-Brexit world. We can provide standard wording for due diligence questions on Brexit should you need it and, where issues are identified, we can explore contingency planning strategies. As noted above, some target businesses will have more exposure to Brexit risks than others, for example, if they are particularly reliant on labour or supplies of goods or services from the EU, or on regulatory passporting into the EU, and in those cases, we can provide a more in-depth analysis and DD report if required.
Issues to consider when negotiating and documenting a transaction
Limits on liability: For cross-border transactions, consider the effect of sterling fluctuations on various financial limits in transaction documents (e.g. de minimis, basket and gap covenants in the sale and purchase agreement and vetoes in an investment agreement).
Certain funds: Sellers should check that Brexit will not impact on the drawdown of bank or other debt funding and commitments of limited partners for equity funds, and that there will be certain funds at time of signing (unconditional except as to the sale and purchase agreement completing and no other conditions which the financing banks may use to try to avoid funding).
Merger clearance: Obtaining merger clearance for certain transactions may become more onerous (see Competition section).
Completion accounts and earn-out adjustments: Consider the impact of currency fluctuations where there is an exchange rate exposure, for example where a business has revenues in euros or dollars but the completion accounts mechanism is denominated, for example, in sterling. For the same reasons, care also needs to be taken when considering earn-out provisions.
Material adverse change: Whilst we have not seen this happening in practice, there is a risk that existing sale and purchase documents with MAC clauses may be tested by buyers and/or financing parties seeking to renegotiate or walk away from a transaction in view of currency fluctuations or general economic uncertainty. In public transactions, the Panel is unlikely to view Brexit as a MAC; in private transactions market MACs are rare. In any event, parties seeking to rely on a MAC cannot generally do so based on facts of which they were aware at the time the contract was concluded so parties to contracts concluded since the referendum will face an uphill struggle to trigger a market MAC based on Brexit. We have also seen little evidence of parties to M&A deals seeking to negotiate Brexit-specific MAC or termination rights.
Futureproofing M&A documents: In view of the continuing uncertainty as to the UK's status outside the EU, it will be difficult to provide for all eventualities. Some M&A contracts concluded prior to Brexit will have warranties, covenants and other terms which are intended to survive Brexit. Parties should also build in flexibility to amend terms to bring them in line with the resulting legal landscape post-Brexit. Also, consider if specific termination rights are required should certain events occur as a result of the Brexit process. We can provide standard Brexit-related SPA conditions and protective wording on request.
Deal timing: Transactions may take longer to sign due to more due diligence being done (including into the contingency planning of the target business around Brexit) and there is potential for difficulty in raising finance; to be taken into account when signing/closing date is time sensitive and when calculating projected IRR.
Governing law and dispute resolution: If the transaction involves r.EU-based parties or assets, and in particular if any judgment which may be obtained in respect of it is likely to need to be enforced throughout the r.EU, consider carefully which governing law and dispute resolution mechanism to include in the M&A documents. There is currently some concern that, in the event of a hard Brexit on 31 October 2019 or following the expiry of any transition period which may be agreed, English jurisdiction clauses will not be respected in the r.EU in the same way that they are now, and English court judgments will become less readily enforceable there. For more on this, see the Disputes section.
W&I insurance: Despite the increased risk and uncertainty in the markets, we have not witnessed any change in underwriting supply or the pricing and terms for W&I insurance. However, there is currently a question mark over whether EU-based acquirers will be able to enforce W&I policies written out of London in the event of a no-deal Brexit. Affected parties should discuss this with the relevant brokers to understand how this may impact them. The FCA has confirmed that this will not be an issue for UK based acquirers seeking to enforce policies written in the EU as they will continue to be enforceable in the UK in any event.