How the Pandemic Has Changed Restaurant M&A

As in many industries, restaurant mergers and acquisitions are adjusting to the new risks caused by the virus, the resulting safety measures recommended (if not mandated) by local and state governments, and the hit suffered by the economy overall. The material adverse effect (MAE) provision commonly used in M&A agreements has taken on new meaning, and both buyers and sellers are struggling to negotiate a tolerable allocation of risk by specifying—or even removing—the impact of COVID-19 on M&A transactions.

Restaurant owners considering acquiring, selling, or merging with another restaurant or related business who understand how the novel coronavirus has impacted restaurant M&A negotiations are better prepared to protect their interests in these transactions.

How COVID-19 Has Impacted Pending Restaurant M&A Transactions

A transaction involving the purchase, sale, or merger of a restaurant often takes place in stages. The parties execute a purchase agreement that designates due diligence to be performed by a stated closing date. The purchase agreement records the terms of the sale as well as the parties’ agreed allocation of risk regarding occurrences that could affect the consummation of the deal on the closing date. The due diligence performed in the interim period between execution of the purchase agreement and the closing may include inspection of the premises, interviews with key personnel, and review of financial reports and records supplied by the seller.

Pending restaurant M&A transactions with closing dates set after the novel coronavirus took hold in the US ran into unanticipated roadblocks. Buyers alleged that sellers breached the purchase agreement’s requirement to operate the business in the ordinary course pending closing by laying off or furloughing employees or by modifying service options or even closing during state-mandated shelter-in-place orders.

Sellers alleged that buyers improperly relied on MAE provisions to back out of deals. Case law provides no clear prior examples for guidance because no prior nationwide event in modern history compares to the effect of the pandemic on the restaurant industry as well as other businesses. Going forward, both buyers and sellers have begun to acknowledge the changes needed to better protect both parties in the post-COVID world.

Restaurant M&A Parties: Contracting through COVID-Colored Glasses

MAE provisions in a merger or acquisition purchase agreement generally allow the buyer to terminate the M&A agreement without consequences for breach. Rarely anticipated to actualize, and rarely used successfully, MAE provisions (also called MAC clauses for material adverse change) serve as a failsafe if the unthinkable happens before closing. The coronavirus blanket that covered the US in early 2020 slowed or closed many restaurants, severely affecting earnings. Buyers in then pending M&A purchase agreements must decide whether to forge ahead or try to invoke their MAE or MAC clauses. But how has COVID-19 affected M&A negotiations going forward?

The economic shutdown in early 2020 was historically unprecedented and dealt a blow to the restaurant industry. Knowing that such apocalyptic events are truly possible outside of doomsday books and movies, restaurant buyers and sellers are finding new ways to protect themselves in future transactions. Following are some ways parties negotiating M&A transactions are attempting to protect themselves:

• MAE/MAC clauses may specifically include or exclude COVID-related effects on the restaurant;
• The “applicable law” definition in an M&A agreement may define and include COVID-related measures, with reminders elsewhere in the contract that COVID-related provisions do or do not apply to other provisions;
• The definition of the “ordinary course of business” in covenants may account for pandemic-related business disruptions;
• M&A agreements may allocate financial responsibility for participation in the Paycheck Protection Program or other emergency aid obtained during the pandemic crisis; and
• M&A agreements may specify alternatives to in-person or on-premises inspection of properties and records in order to deal with difficulties in realizing access to buildings, sites, equipment, individuals, or business records such as during periods of government-mandated shelter-in-place orders or social distancing recommendations.

Modifications like these to typical M&A agreements are now seen woven throughout M&A agreements, from the representations and warranties to the pre-closing covenants and closing agreements.

In the Representations and Warranties section of a purchase agreement, a seller generally represents and warrants that, from the date of the purchase agreement until closing, it has conducted its business in the normal and ordinary course and no events have occurred that will result in a material adverse change. As a result of the pandemic, sellers are commonly excepting from this representation any negative impact upon sales and operations caused by the 2020 COVID-19 pandemic to avoid the risk of a buyer having an easy out.

In the Covenants section of a purchase agreement, sellers often acknowledge their continued responsibility to pay liabilities that arose prior to the closing date. Post-pandemic, we often see specific references to any paycheck protection program loans made to sellers pursuant to the federal Coronavirus Aid, Relief, and Economic Security (“CARES”) Act.

And the Conditions to Closing section often contains a condition that no material change, effect, or development has occurred. Again, as protection against a buyer easily using this clause to walk away, sellers are now requesting that the pandemic, including its effects, not be considered a material adverse event for the purposes of this provision. However, so as to still have some protection, a buyer may request that this exception not apply if the severity of the pandemic or level of related governmental regulations significantly increases in the time between signing the purchase agreement and closing the deal.

These examples show how deeply rooted concern about pandemic-related business impacts has necessarily become.

Work with a Restaurant M&A Lawyer to Protect Your Investment 

The pandemic has shifted negotiations in restaurant M&A, requiring the contemplation of risks and roadblocks unheard of before 2020. To protect your current or future investment in the restaurant industry, you need a restaurant M&A lawyer who understands both the current state of restaurant M&A transactions and the restaurant industry itself. For a consultation to learn more about how the firm can help you, call (304) 523-2100 or complete this online contact form.