Covid-19 has just cast a pall over ongoing fundraising operations. The market is perplexed… even at a standstill in some sectors since the recent government decisions aimed at combating the spread of Covid-19. While some deals are continuing or closing without disruption, others are on hold, postponed, or simply cancelled due to the exceptional circumstances.
Investors prefer to wait in order to gain a clearer picture of market developments; startups believe it's no longer the right time to raise funds: valuations are down, there are few active investors in the market, and business plans are complicated or unstable. Above all, bank financing has become increasingly difficult, if not impossible, to obtain since the start of the lockdown, making debt renegotiations, which are usually linked to equity investments, impossible.
This Covid-19 context reminds us in some ways of the 2008 crisis…while being very different in many other respects, particularly due to all the emergency measures and aid implemented in a very short timeframe (facilitated partial unemployment for employees, emergency cash release, the granting of guarantees by Bpifrance to promote loans during, and especially after, the crisis). But what about ongoing operations?
Operations in the audit or negotiation phase
Freedom is key: the parties can choose to continue or terminate ongoing negotiations at any time, particularly due to the Covid-19 phenomenon. However, limits may exist if the parties have framed their negotiations, in a more or less binding manner, by a confidentiality agreement or a letter of intent (LOI), or even a term sheet, a memorandum of understanding (MOU) or a memorandum of agreement (MOA).
These acts, which aim to organize negotiations or formalize the parties' agreement on essential points, are generally insufficient to form a comprehensive agreement.
Covid-19 can therefore be a reason allowing a party to end even advanced negotiations, without its responsibility being sought, subject to respecting, if they exist, the terms governing the end of negotiations that may be included in such pre-contractual agreements.
The operations that have been the subject of a firm investment offer
What if one of the parties has made a firm and precise offer of investment, in particular by transmitting draft completed documents (protocol, shareholders' agreement) which can be considered as such an offer or by delivering a LOI or a MOU which has binding force?
- If the investment offer has not yet been accepted
Such an offer must be maintained for a reasonable period or for the period specified in the offer.
The withdrawal of an investment offer by its author, before the expiry of such a period and, of course, its acceptance, allows the beneficiary, at most, to seek compensation for his loss, either on the basis of the general law of contracts, or by requesting the application of a clause appearing in the term sheet, the LOI or the MOU.
- If the investment offer was accepted and then withdrawn before the closing could take place
Upon acceptance of a firm and specific investment offer, the fundraising operation becomes final, an agreement having been reached between the parties.
Thus, the withdrawal of such an offer could be ineffective if it occurs after its acceptance by the partners of the startup benefiting from the investment offer; the latter could then choose to impose the forced execution in kind of the investment commitment made, subject to the advisability of such a decision, and to seek compensation.
- A question may then arise: who bears the costs of auditing and consulting incurred during this negotiation period?
If negotiations break down before a firm offer is made, each party generally retains responsibility for the costs incurred. However, it is not uncommon to find clauses in term sheets, letters of intent (LOIs), and other memoranda of understanding (MOUs) outlining the financial consequences of breaking off negotiations or rejecting a firm investment offer, requiring the party withdrawing to pay the costs incurred by the other party during that period.
If the amount of these fees is fixed at a flat rate and proves to be exorbitant or disproportionate to the financial capacity of the partners of the startup benefiting from the fundraising, it could be considered as an infringement of the freedom to continue or break off negotiations.
In the absence of such a clause, the general law of contracts will allow the party harmed by the premature withdrawal of the offer made by the other party to seek compensation corresponding, mainly, to the costs incurred in the context of the operation; French law refusing to extend the compensable damage to the loss of the profit that could have been obtained from the operation.
Operations governed by an investment protocol
If the negotiations have resulted in the parties formalizing an investment protocol, or even a shareholders' agreement, the impact of Covid-19 is likely to be, in theory, less.
- The investment agreement is final, even though the implementation of the investment operations is still underway
This memorandum of understanding is generally intended to organize the agreement reached between the parties and to schedule future operations: lifting of certain suspensive conditions (agreement of the lending bank), capital increase, issuance of simple or convertible bonds, etc.
The occurrence of a phenomenon such as Covid-19 is, in theory, incapable of calling into question the commitments made by either party, whether it be the partners of the startup or the investor under the terms of the signed agreement.
In practice, Covid-19 could have an impact on the lifting of certain suspensive conditions or prerequisites to the operation.
For example, organizing a general meeting or obtaining a banking agreement regarding the renegotiation of the startup's debts could prove complex for the parties to implement in the current economic context and in view of the emergency measures taken to combat the spread of COVID-19.
The outcome of the operation will then depend on the legal consequences foreseen in the event of non-compliance with one of the stipulated conditions.
Some memoranda of understanding will automatically become invalid if the investment operation is not completed within the scheduled time, while others will remain in effect to allow the parties to be able to carry out the planned investment.
- Is there, however, a solution to extricate oneself from the investment commitment undertaken?
The use of force majeure or unforeseen circumstances
The Covid-19 phenomenon is finally likely to lead some parties, a priori more the investor than the startup's partners or the startup itself, to invoke:
- either the concept of force majeure to suspend or call into question the execution of the investment operation
- either the treatment of unforeseen circumstances to renegotiate the terms of the signed investment agreement and, if this fails, to take legal action to have the judge revise the conditions or terminate it.
Each of these two mechanisms requires the fulfillment of conditions which are not, in absolute terms, easy to meet and which are not necessarily likely to be met with regard to the phenomenon of Covid-19 in the context of carrying out an investment operation, provided that the application of such mechanisms is not expressly excluded by the parties in the investment protocol.
The impact of "Material Adverse Change" (MAC) clauses, "Material Adverse Effect" (MAE) clauses, or so-called "significant/substantive adverse changes" clauses
The purpose of these clauses is to specify that one or both parties may decide to unilaterally suspend or terminate the ongoing transaction following the occurrence of an event likely to significantly impact the company involved in the transaction or an event having a significant negative effect.
These clauses may be included in the investment protocol, or even, in some cases, when the pre-contractual acts are quite binding, in a term sheet or a MOU.
The question will then arise as to whether the Covid-19 phenomenon meets the conditions stipulated by the parties, which is likely to be delicate and a source of dispute in this new and exceptional context.
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JULIETTE SELLIER
associate lawyer
Lawyer at the Paris Bar. Holds a Master 2 in general private law and a Master 2 in business and tax law from the University of Paris I Panthéon-Sorbonne (in partnership with HEC)
