The recent geopolitical tensions in the UAE and wider GCC region have introduced significant uncertainty into the business environment and, consequently, M&A transactions. However, this uncertainty should not in itself prevent transactions from proceeding. Rather, it alters the allocation of risk between the parties and increases the importance of robust contractual protections. This article considers these issues from a buyer’s perspective and highlights the protections that buyers may seek to prioritise in the current environment.
Set out below are 5 key contractual protections that buyers on UAE M&A transactions should focus on in the current environment.
In addition to these contractual protections, buyers should also consider whether it is necessary to carry out enhanced legal, commercial, operational or financial due diligence on the target’s business with a view to determining any particular weaknesses or risks in the context of the current geopolitical climate.
1. Earn-Out
An earn-out links a portion of the purchase price to the target's post-completion financial performance, allowing the buyer to pay a reduced amount at completion, with the balance contingent on how the business performs over a defined period. Where the business fails to achieve the relevant performance targets (whether due to regional conflict or otherwise), the earn-out payments will be reduced accordingly or may not become payable at all.
This is an important de-risking tool for buyers in the current market, where there may be a significant degree of uncertainty regarding future financial performance.
In the recent past, we have seen sellers in the market seek to introduce “pause” mechanics in earn-out clauses, proposing that the earn-out period be suspended on the occurrence of a force majeure event or geopolitical disruption until normal trading conditions resume. This is a risk allocation point to be negotiated between the parties, but buyers should resist such “pause” mechanics on the basis that the commercial rationale of an earn-out is to bridge a valuation gap based on the target's performance within a specific, foreseeable timeframe and extending the earn-out indefinitely may create severe integration drag and misalign operational incentives. Moreover, buyers can argue that if a geopolitical event permanently alters the market landscape, the buyer should not be forced to keep the earn-out window open indefinitely and the seller must bear the downside risk of failing to meet targets during the agreed period, ensuring the buyer does not overpay for an asset that has fundamentally deteriorated in value.
2. Deferred Consideration
Unlike an earn-out, deferred consideration is not contingent upon the future performance of the target business. Instead, a fixed portion of the consideration is payable on an agreed date following completion, irrespective of the target’s performance during the interim period. From a buyer’s perspective, such a structure serves two principal functions:
- deferred consideration preserves cashflow. By structuring, for example, 80% of the consideration as payable at completion and the remaining 20% on a deferred basis, such as twelve months later, the buyer retains capital during the post-completion integration period, pending greater certainty as to the financial and operational position of the target; and
- deferred consideration provides a practical source of recourse in respect of post-completion claims. Where the seller is liable for a breach of warranty, indemnity or other contractual provision, the buyer may, to the extent provided for in the transaction documents, set off the relevant amount against the deferred consideration rather than being required to pursue recovery proceedings against a seller (that may have already distributed the sale proceeds or otherwise be difficult to recover from). In this way, the deferred amount preserves the seller’s financial exposure during the period in which post-completion issues are most likely to crystallise. Post-completion claims may be more likely to arise as a result of the current geopolitical tensions and the ability to set-off against deferred consideration can be a highly effective tool for a buyer to ensure recovery of relevant claim amounts.
3. Material Adverse Change (“MAC”) clause
A MAC clause entitles a buyer to terminate the share purchase agreement where, between signing and completion, the target has suffered a significant deterioration which fundamentally affects the basis upon which the transaction was agreed. In stable market conditions, MAC clauses are invoked relatively rarely. However, in the current environment, MAC clauses assume greater significance as a mechanism for addressing material deterioration arising during the interim period.
From the buyer's perspective, the objective is to ensure that the definition of a MAC is drafted sufficiently broadly to capture a wide range of events or circumstances that materially impair the target's business, financial condition or operations. The seller, by contrast, will seek to narrow the scope of the clause through carve-outs and other mechanisms, on the basis that general market and geopolitical risk was assumed by the buyer at signing.
In the current environment, most sellers will seek to exclude regional conflicts from the scope of MAC provisions. Buyers should resist such blanket exclusions. and instead negotiate a disproportionate effect qualification. This ensures that the relevant event is excluded only to the extent that the target is affected in a manner consistent with other companies in the same industry or market, thereby preserving the buyer’s right to invoke the MAC clause where the target suffers a materially disproportionate impact.
4. Conditions Precedent
Conditions precedent specify the matters that must be satisfied or waived before the buyer’s obligation to complete is triggered. In the current environment, the conditions precedent regime is one of the principal protections available to a buyer to ensure that it is not required to complete a transaction where certain key matters have not been satisfied or waived.
In addition to customary regulatory and third-party approvals, buyers should consider conditions tailored to the target’s particular operational and commercial profile. These may include key supplier or contractual counterparty consents confirming that material agreements will remain in force following completion, or consents from lenders confirming that they will not invoke any rights arising from breaches of financial covenants or change of control provisions.
The long-stop date should also be negotiated with care. If set too aggressively, it may create undue pressure to complete within an artificial timeframe, whereas a long-stop date that is too remote may leave the buyer exposed to prolonged risk and uncertainty. Buyers should therefore consider negotiating extension mechanics permitting the long-stop date to be extended in defined circumstances, particularly where delays arise from regulatory processes or third-party approvals outside the buyer’s control.
5. Stronger Warranties and Indemnities
A standard warranty package may not adequately address the risk profile of acquisitions in the current environment. Buyers should therefore seek warranties that are specifically calibrated to the target’s exposures to geopolitical disruption.
The appropriate warranty package will depend on various factors including the nature of the business carried on by the target, the due diligence findings and the specific circumstances of the relevant transaction, but key areas of focus in the current environment include the following:
- the seller should warrant that all material supply contracts are in force, that no counterparty has given notice of termination or indicated an intention to terminate and that the target is not in breach of any material supply contract;
- the seller should warrant that the target maintains adequate business interruption and other insurance policies (and the buyer should verify this position independently through due diligence). The relevant policies should be confirmed to be current, in full force and effect, not subject to material dispute, and proportionate to the scale and nature of the business. A target that lacks adequate coverage may expose the buyer to a material and insufficiently quantified balance sheet risk on completion; and
- the seller should warrant the identity of any customer accounting for more than an agreed revenue threshold and confirm that no such customer has indicated any intention to reduce, suspend or discontinue future orders or otherwise materially vary its commercial relationship with the target. This protection assists in identifying revenue concentration risk that may not be apparent from the financial statements alone.
Where due diligence identifies a defined risk, the buyer should seek a specific indemnity rather than relying on the general warranty package. An indemnity creates a payment obligation and, unlike a warranty claim, generally avoids the need to establish loss and causation under the usual contractual damages principles, instead requiring only that the relevant loss falls within the scope of the indemnity.
While verifying business interruption insurance is critical, Warranty and Indemnity (“W&I”) insurance is a fundamental component of modern M&A risk allocation that has, in our recent experience, increasingly been used on UAE M&A transactions. W&I insurance will require careful navigation by buyers in the current environment, including in particular with respect to identifying and bridging any coverage gaps that may arise from broad exclusions which W&I insurers may seek to introduce (such as losses arising from war, regional conflicts and the like).
Conclusion
In periods of geopolitical disruption, buyers are not, generally speaking, prevented from transacting. On the contrary, such periods can present strategic opportunities in an environment of reduced competition to acquire distressed or undervalued assets from motivated sellers. Those opportunities, however, may come with greater uncertainty as to value and increased exposure to external factors that could further impair the business or give rise to new liabilities. Buyers will therefore need to be more deliberate in how transaction risk is allocated and managed.
The key protections set out above each play a distinct role in de-risking a transaction from a buyer’s perspective. If a seller wishes for a sale to proceed, it may need to accept a greater degree of risk than it would typically bear in a more stable business environment.
This article is intended for general informational purposes only and does not constitute legal advice. Readers should seek independent legal counsel in relation to their specific circumstances.