March 25, 2020
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With each passing day, the global economic climate plunges further into uncharted waters as the world attempts to construct a public health response sufficient to slow the progress of the COVID-19 pandemic. Companies are faced with attempting to carry on their business in what is perhaps the most uncertain logistical environment in modern history short of war. International borders have been closed; travel is increasingly restricted or cautioned against; and public health guidance urges that companies permit as many employees as possible to work from home and that the public practice social distancing. In some areas, “shelter-in-place” orders are in effect or under consideration as of this publication. Yet, notwithstanding this challenging logistical environment, companies that rely on A&D/M&A to grow their business, or generate needed capital, will attempt to proceed with certain transactions during this period. Transacting parties will be forced to identify and mitigate novel risks and challenges associated with the COVID-19 pandemic. This paper will discuss some of these considerations in the energy M&A/A&D context.
Perhaps the most impactful obstacle (other than the obvious economic disruptions) to progressing with an energy acquisition or divestiture in the midst of the COVID-19 pandemic is the ability of a seller to facilitate, and for a buyer to conduct, interim period due diligence in light of recommendations or governmental orders that (i) require employees work from home, (ii) close governmental institutions, and (iii) restrict travel between regions (internationally and domestically). At this time, it is unclear how long these restrictions will remain in place and if (or when) such restrictions may return after they have been lifted. Given this new reality, parties should consider one or more of several possible modifications to standard purchase and sale concepts relating to interim period access to account for this atypical landscape.
Depending on the assets or company being targeted, the current environment may pose varying degrees of risk to the due diligence process. Transactions which involve interim period title and environmental defect mechanics, such as upstream oil and gas transactions, and other transactions involving significant real property, may be particularly impacted, due to the importance of interim period diligence in such transactions to determine downward purchase price adjustments for title and environmental defects and the fact that in-person review has historically been a significant aspect of title and environmental diligence. In contrast, the diligence process for a relatively simple, balance sheet-focused, entity-level transaction that does not involve real property may involve little interim period diligence and may be less impacted.
Even in 2020, key records and documentation necessary for a buyer’s due diligence review are only available, in many cases, in physical hard copy maintained by sellers or by governmental institutions (such as in the county records maintained at a county courthouse). While not often the case, particularly in an upstream oil and gas transaction, if all records to be reviewed by a buyer are available in electronic format, it may be possible to conduct title and contractual due diligence remotely with little interruption from COVID-19-related restrictions. However, for any transaction in which (i) some portion of the records are available only in hard copy at the seller’s offices and/or (ii) some level of courthouse review is necessary or advisable, the pandemic may interrupt both the seller’s ability to provide due diligence access as typically required under a purchase and sale agreement and the buyer’s ability to conduct that diligence (including reviewing matters of public record). Further, if site access is to be provided for an environmental assessment, travel or staffing limitations may handicap the parties’ ability to conduct any such site assessment.
In order to account for the COVID-19 landscape, provision of records in electronic form should be provided for where possible. From a buyer’s perspective, an obligation could be put on the seller to provide all such records in electronic form. Whereas from a seller’s perspective, if any concerns about the availability of such records (and/or the manpower to get such records scanned and made available in electronic form) exist, the provision would be better written to refer to providing electronic records, if available.
Mitigating risk with respect to site assessments is more challenging. Ultimately, whether a site assessment can be conducted is out of the control of the parties (and there is often no meaningful electronic replacement for such in-person assessment). From a seller’s perspective, it may be important to qualify that access provided to the buyer shall be to the extent that the seller is not prevented from providing it due to COVID-19-related restrictions.
From a buyer’s perspective, it may be worth considering a mechanism by which the diligence period is extended in the event the buyer’s diligence (whether site assessment or other aspects of the buyer’s review) is interrupted by COVID-19. A negotiated tolling concept of the buyer’s due diligence period could be an effective way for parties to come to agreement on the terms of a transaction in this uncertain environment, while still providing some protection to the buyer in the event it is unable to conduct its diligence as it would in the ordinary course. Under such a concept, if there were to be a delay extending past a designated outside date, the parties could stipulate that either party would have the right to terminate the agreement.
However, it is worth noting that from a seller’s perspective permitting delays due to the COVID-19 pandemic is not without risk, as interim period extensions only increase the likelihood that a buyer’s equity or debt financing may fall through (especially if such delays are tied to worsening conditions due to the COVID-19 pandemic). As of the date of this publication, many lenders have already imposed temporary holds on financing additional matters pending further development of the COVID-19 situation.
Parties should consider including in purchase and sale agreements the option of a virtual closing (as opposed to an in-person closing), even if such transaction involves upstream oil and gas assets or other real property for which originals of signature pages need to be provided for public recording of documents. During the next several weeks (or possibly months) it seems likely that parties will not be able to guarantee participation at an in-person closing, and parties should be clear at the outset that the failure to facilitate such a closing is not a covenant breach given the foreseeability of the issue.
In light of the possible need for virtual closings, we recommend parties consider incorporating greater specificity into closing deliverable provisions with respect to any applicable recordable documents (and the means by which the parties will confirm the acceptability thereof for closing purposes), so as to provide greater certainty as to the manner in which the closing will be conducted.
Further, parties should recognize that certain standard closing deliverables may take longer to produce than would be the case in the best of times. For example, any required lender approvals (including releases of liens for borrowed money burdening properties to be sold) may take additional time due to constraints on lenders imposed by staffs working remotely. Parties should therefore plan with respect to closings accordingly, and begin the process of producing closing deliverables (particularly those that involve third parties) sooner than they would otherwise.
Parties should be prepared for the possibility of interruptions in the provision of governmental services related to county or parish-level recording of real property conveyance instruments. At the time of this publication many governmental offices around the country are closed to the public, including many county and parish recording offices. It seems highly likely that more county and parish recording offices throughout the country will close in the coming days and weeks, and that such offices will remain closed to the public for extended periods of time, due to COVID-19-related restrictions. Therefore, in an upstream oil and gas transaction or any other transaction involving significant real property interests, the buyer should consider modifying its obligation to record such conveyance instruments following the closing of the transaction to be only to the extent buyer is not interrupted in its efforts by COVID-19-related measures.
In addition, if buyers are using third-party debt financing to facilitate an acquisition or if the terms of their credit facility require that any new acquisitions be pledged as security to their lenders, it is important that they communicate with their lender to ensure that all parties are in agreement as to how to handle not only the recordation of conveyance documents but also the recordation of any mortgages or deeds of trust securing the lender’s security interest in the assets being purchased. Prior to the COVID-19 outbreak, lenders routinely handled recordation of documentation themselves when providing acquisition finance. That will likely continue to be the case, and it is possible that no changes to the current practice is necessary. However, as this situation continues to unfold, we recommend that buyers and their lenders communicate on this issue in advance of any closing to avoid unnecessary misunderstandings or closing delays.
In the current environment in which many companies’ and individuals’ attention is elsewhere, parties may find it more difficult to obtain the cooperation and attention of third parties that have an interest in, but are not directly a party to, a given transaction. In particular, to the extent that any third parties hold consents that must be obtained prior to the transfer of assets, contracts, or entities included as part of a transaction, such third-party consents may be more difficult to obtain.
Consequently, parties might consider providing for a longer interim period between signing and closing (if required consents are a material consideration in the implicated transaction) given the likelihood that, relative to the status quo, it may take longer to obtain responses to required consent notifications. Given the increased likelihood that required consents are outstanding as of closing, in transactions where ultimately obtaining consent is expected (albeit on perhaps a longer timeframe), it may make sense for the parties to consider mechanisms pursuant to which the seller retains title to, but passes through the economic benefits and burdens of, a property covered by an unobtained required consent as of closing until the consent can be obtained and the property can be transferred. In such situations, utilizing this approach (as opposed to excluding the implicated property from closing and reducing the purchase price only subsequently to assign the property and have the buyer pay for it once consent is obtained) avoids closing delays and allows parties to more fully achieve at closing the ultimate economic deal that was agreed at signing while dealing with COVID-19-related delays in obtaining necessary consents.
Likewise, the progression of governmental approvals may be limited by COVID-19-related staffing restrictions and other strains on federal, state, and county governments. While the impacts are hard to predict at this time, parties should consider whether delays to both routine governmental approvals (such as permit transfer applications) and non-routine government approvals (such as Hart-Scott-Rodino Act approval or approval from the Committee on Foreign Investment in the United States) might occur in the near or mid-term.
The impact of the pandemic on governmental approvals going forward remains fluid and uncertain. At a minimum, parties should assume that reviews by governmental authorities will take the full time period stipulated by applicable law and plan the timing between signing and closing accordingly. Additionally, given the evolving situation, parties contemplating a transaction subject to non-routine governmental approvals should frequently consult with regulatory specialists in the lead-up to the execution of a purchase and sale agreement memorializing such transaction so as to be properly advised of the logistics of obtaining the required approval at that particular moment in time.
In transactions where a representation is made, or a condition precedent to closing is included, to the effect that no “Material Adverse Effect” has occurred between the signing date and closing, or the effective date and closing, the parties should consider whether effects from the COVID-19 pandemic should be specifically included or carved out of the scope of the “Material Adverse Effect” definition. Without agreement or consensus on this issue, disputes could arise if one party does not want to close the transaction and argues that the COVID-19 pandemic is, in fact, a “Material Adverse Effect,” relieving it of its obligation to close even if all other closing conditions have been satisfied.
Given the interruptions to staffing that may occur during the COVID-19 pandemic, it may be possible that onboarding new assets and business units will prove more challenging for companies than would otherwise be the case. Buyers, thus, might consider utilizing transition services agreements with sellers to ease that difficulty, even with respect to assets they might otherwise be capable of integrating without such assistance. In contrast, it may be less of a burden for a seller to continue managing an asset that is already fully integrated for a period of time post-closing.
Force majeure provisions are uncommon in purchase and sale agreements as parties’ obligations under purchase and sale agreements are more administrative rather than operational and thus are not commonly understood to be impacted by acts of god, hurricanes, and the like. These are unusual times, however, and even administrative operations may be interrupted by present or future limitations arising in response to the COVID-19 pandemic. Given the day-to-day uncertainty of the economic and logistical landscape, parties may find it wise to consider a general force majeure provision with respect to COVID-19, providing that each party is relieved of its obligations under the agreement to the extent prevented from performance due to COVID-19.
The application of any such provision could cut against either party, depending on the circumstances of its exercise (e.g., the buyer is unable to remove the seller’s name from some of the properties within the designated time period following closing because of an outbreak in that area, or the seller cannot comply with an element of an interim covenant), but it presents one approach to mitigating logistical risks that are beyond the control of one or both of the parties. The incorporation of any such provision must be carefully considered as its application to any particular transaction is quite complex, and its effects may ripple throughout the document in innumerable ways; however, such a clause, thoughtfully applied, could provide the comfort necessary for parties to transact at a time when the presence of existing and future extreme disruptions is a known risk, but all of the details and practical implications of COVID-19-driven disruptions are not.
In a situation as dynamic as the COVID-19 pandemic, it can be difficult for transacting parties to identify and mitigate all possible logistical risks that might arise. However, at this stage in the crisis, some ability to anticipate potential pitfalls and problems, as well as to contemplate the resolution to such issues explicitly in the agreements memorializing a transaction, does exist. Measures such as those set forth above may help make purchase and sale agreements more flexible, and perhaps better able to facilitate transactions in the energy market, in this environment where many obstacles threaten parties’ ability to proceed with such transactions.