The COVID-19 pandemic has impacted just about every aspect of our personal and professional lives. From where we work and shop to how we stay in touch with family, friends and colleagues – nothing is the same as it was even just a couple of months ago!
M&A practices are also changing as businesses and their counsel carefully consider the impact of COVID-19 on, among other things, material adverse change, purchase price adjustment, regulatory approval, indemnity and force majeure provisions. These considerations apply to agreements signed prior to the pandemic, to agreements currently being negotiated and to agreements that will be negotiated in at least the near future.
As the title suggests, this blog post considers the impact of COVID-19 on interim operating covenants and the potential antitrust concerns that could arise if a purchaser becomes too involved in competitively-sensitive aspects of a seller’s business prior to closing.
Interim Operating Covenants
M&A agreements typically include interim operating covenants, which require that the seller operate the acquired business in a certain way between the time the agreement is signed and the time of closing. The purpose of these covenants is to help ensure that the purchaser receives the business in substantially the same condition at closing as it was when the due diligence was conducted and the agreement was signed.
While the nature and scope of interim operating covenants vary from agreement-to-agreement, they generally require that the seller (a) operate the business in the ordinary course consistent with past practice and (b) maintain relationships with key stakeholders, such as employees, customers and suppliers – except as otherwise agreed to by the purchaser or required by applicable law. In addition to these general requirements, agreements typically include detailed covenants describing specific actions the seller must take, specific actions the seller must refrain from and specific actions the seller must refrain from without the purchaser’s prior consent.
It is often challenging for sellers to comply with these covenants in the best of times. However, it is now even more challenging in the midst of the global COVID-19 pandemic – particularly because most existing agreements do not include exceptions to address the impacts of COVID-19. For example, in order to survive, sellers may determine that it is necessary to incur additional debt, delay the payment of invoices, revise budgets, terminate employees, defer capital expenditures or shut down facilities – actions that in most cases are inconsistent with past practice and require the consent of the purchaser.
While antitrust agencies understand the need for interim operating covenants and other pre-merger coordination, they may become concerned in certain contexts, such as where the merging parties are competitors and they engage in conduct that impacts competition in the marketplace prior to closing. For example, William Blumenthal, the former General Counsel at the United States Federal Trade Commission, previously stated as follows:
… merging firms have a legitimate interest in engaging in certain forms of coordination that would not be expected except in the merger context. The most common forms are due diligence and transition planning, both of which necessarily will involve exchanges of information at levels of detail that would not normally occur among independent firms. In addition, merging firms sometimes enter into covenants or engage in practices that would not normally be seen among independent firms. These forms of premerger coordination will often be reasonable and even necessary to implement the legitimate objectives of the merger agreement. Where the merging firms are competitors or are otherwise in a relationship that affects competitive interactions in the marketplace, however, premerger coordination can present issues…
In the context of mergers, antitrust agencies, including the Competition Bureau (the “Bureau”), are particularly concerned with pre-closing information exchanges, coordination and integration that could allow the parties to coordinate future conduct so as to lessen competition – concerns that are amplified if the contemplated transaction does not materialize. This conduct, commonly known as “gun-jumping”, can result in investigations, fines or injunctive relief under the Competition Act (the “Act”). While the Bureau has not been as active as the U.S. antitrust agencies in the area of “gun jumping”, it has expressed interest in pursuing this conduct in appropriate cases.
In Canada, gun-jumping may raise issues under either the civil pre-merger notification provisions or the criminal conspiracy provision of the Act:
- Transactions that are subject to pre-merger notification in Canada cannot be closed until the applicable waiting period has expired or been terminated or waived. Closing a transaction early may result in significant consequences, including orders requiring the dissolution of the merger, the divestiture of assets or shares and/or the payment of administrative monetary penalties of up to $10,000 per day.
- Where parties to a proposed transaction are actual or potential competitors, they may violate the criminal conspiracy provisions if, before the transaction closes, they agree to (a) fix, maintain, increase or control the price for the supply of a product; (b) allocate sales, territories, customers or markets for the production or supply of a product; or (c) fix, maintain, control, prevent, lessen or eliminate the production or supply of a product. The penalties for breaching this provision include fines of up to $25 million and/or imprisonment of up to 14 years.
In light of the above, merging parties must resist the considerable temptation to get on with integration and begin acting as one entity prior to closing. They must continue to compete against each other as they have in the past up to the date of closing. In other words, the proposed transaction must not influence the parties’ competitive behaviour in the marketplace – each party should strive to be as competitive as possible. Merging parties should also be mindful of the information and documents they share in the period prior to closing. For more information, including best practices, see “Mitigating the Risk of Pre-Closing Information Exchanges” and “Bad Documents – So What’s the Problem?”.
The merging parties may, however, engage in legitimate activities directed at completing the proposed transaction. For example, the parties may consider integration opportunities for non-competitively sensitive matters, such as the integration of computer systems, personnel and facilities. However, each initiative should generally be reviewed by counsel as the analysis of what is permissible is often very fact-specific.
Application to Interim Operating Covenants
As noted above, interim operating covenants requiring that a seller operate the business in the ordinary course consistent with past practice and maintain relationships with key stakeholders are unlikely to raise any meaningful antitrust risk. However, there is increased risk if the merging parties are actual or potential competitors and the purchaser’s consent is required in respect of matters that may fall within the scope of the criminal conspiracy provisions, such as decisions to set prices at particular levels, target certain customers, defer capital expenditures or shut down facilities. For example, if a purchaser consents to the seller’s request to shut down a manufacturing plant, this could potentially be viewed as an agreement between competitors to limit production capacity contrary to section 45 of the Act.
In contrast, concerns would not arise under the criminal conspiracy provisions if the seller unilaterally makes the decision to close the plant. In this regard, as noted by Mr. Blumenthal:
The spectrum of potential buyer control (from problematic to less so) runs from decisions (i) dictated by the buyer pursuant to powers under the merger covenants, to (ii) reached jointly by the merging firms during the planning process, to (iii) taken unilaterally by the seller after consultation with the buyer, to (iv) taken unilaterally by the seller entirely on its own initiative, although presumably with an eye towards the pendency of the merger.
To mitigate against these concerns, sellers could attempt, when negotiating the merger agreement, to include exceptions to the interim operating covenants requiring the acquired business to be conducted in the ordinary course to address the COVID-19 pandemic. For example, sellers could include a carve-out for any conduct required to comply with social distancing, closures, quarantine, “stay-at-home” or any other applicable law, order, recommendation or guideline by any governmental entity in connection with or in response to COVID-19. Sellers could also consider including an exception for actions or omissions taken in good faith to respond to any impact or probable impact on the acquired business due to the COVID-19 pandemic or measures taken to comply with directives from governmental authorities, including changes in relationships with key stakeholders.
It is important that merging parties operate independently and strive to be as competitive as possible prior to closing. Agreeing to fix prices, allocate markets or restrict output – even in the context of pre-existing interim operating covenants requiring that the purchaser consent to any and all conduct outside the ordinary course of business – could potentially raise serious issues under the criminal conspiracy provisions in the Act.
When in doubt, reach out to any member of Fasken’s Antitrust/Competition Marketing group. Our group has significant experience advising clients on all aspects of Canadian competition law.
The information and guidance provided in this blog post does not constitute legal advice and should not be relied on as such. If legal advice is required, please contact a member Fasken’s Antitrust/Competition Marketing group.