1               Where the issues arise

　In an M&A transaction, the buyer and seller will enter into a binding contract such as a Share Purchase Agreement (“SPA”), and then M&A transaction will be executed based on that contract. The execution of the M&A transaction is called Closing. It could typically take a few months to over a year from the signing of the SPA to Closing^[1]. In such period, there could be impacts arising from Covid-19. For example, movement restriction orders being put in place by the Government whereby stores and factories of the target company will have to inevitably close physically, large clients cancelling their orders, and acquirers from Japan are not able to travel to the country of the target company in cross border M&A, which makes it impossible to take the required steps for Closing. If the impact on the valuation of the target company is substantial, the buyer could be reluctant to pay the full price as per the SPA agreed beforehand. What steps then should be taken during negotiation of the SPA then, in order to mitigate such risks?

2               Price Adjustment Clause

　Even upon signing of the SPA, the seller still has control over the target company prior to Closing, and the buyer will only be able to take control of the target company after Closing. However as mentioned earlier, it could take months from signing of the SPA up to Closing. In the meantime, the seller could cause the target company to make losses which leads to reduction in the company’s valuation, or the valuation of the company could drop by external factors which are not controllable by neither party, such as Covid-19. To mitigate such risks, parties in an M&A transaction typically include a Price Adjustment Clause in order to determine a method to adjust the price at Closing from a reference date. Specifically, the clause will be included in the SPA and will contain calculation method for price adjustment, a reference date of indicative price, procedures and so on. This is called a Price Adjustment Clause and with this, it is possible to reflect the changes in the target company’s valuation up to Closing into the price, which reduces the possibility of the events occurring up to Closing becoming a ‘deal-breaker’.

3               Use of escrow

　However, Price Adjustment Clauses do not come without their imperfections. There may be dispute as to the final adjusted price as well as the payment method, and there have been instances where the buyer withheld all or part of the payment. When that happens, so long as the dispute is not resolved, an unfair situation arises where the seller is unable to receive all or part of the payment and bears the risk of the buyer defaulting their payment. To mitigate such risks, parties could consider adopting a method of transferring part of the payment sum not to the seller, but to an independent third party such as financial institutions or lawyers, for that money to be held on trust. This is called an escrow. By having the payment held on trust, the buyer is unable to deal with trust money freely, which allows the seller to avoid the risk of non-payment by the buyer.

^[1] A certain period of time is required in order to close the deal, such as remedying defects discovered during due diligence, making the necessary preparations to execute the SPA such as setting up a special purpose company, selling properties, and obtaining merger clearance from antitrust/competitions authorities.