COVID-19: Critical due diligence considerations for M&A, financing and strategic corporate transactions in the retail industry

The coronavirus disease 2019 (COVID-19) crisis has caused profound disruption to nearly all industries, but the retail sector has been particularly affected. While the full and lasting impact remains to be seen, it has become clear that parties to retail-related transactions must consider unprecedented issues. The purpose of this alert is to highlight specific areas of due diligence aimed at addressing these issues in connection with M&A, financing, and strategic partnership transactions.  This alert is geared toward acquirors, investors and majority joint partners, though target companies may use this list as well to bolster current practices and prepare for potential transactions.  The following topics may be included as a supplement to typical due diligence inquiries in order to provide a comprehensive approach to considerations specifically related to COVID-19:

• Workforce: Given the nature of this crisis, organizations are urged to place the health and safety of their employees as a top priority.   Diligence inquiries therefore may include the target’s overall focus on the health and well-being of its workforce, applicable COVID-19 employment-related regulations, compliance with such regulations, and internal corporate policies regarding healthcare, work-at-home, and general working conditions.
  
  Additionally, as companies are forced to reduce labor costs through furloughs, layoffs and other cost saving measures, diligence may cover such areas to ensure compliance with applicable law, and to determine the potential effect on the target’s future operations.
  
  See the Workforce and Employment section of our Coronavirus Resource Center for further resources and discussion. 

• Governmental financial resources: Federal, state, and local financial resources are being made available to assist organizations in dealing with the incredible financial strain many are experiencing.  Diligence areas may include a determination of which resources may be useful both post and pending closing of a transaction, qualification requirements for such resources, and which resources the target may already be using.
  
  See our Government, Regulatory, and Tax page for further resources and discussion related to The CARES Act, SBA programs, and other resources. 

• Shelter-at-home orders: Various governmental bodies have issued numerous shelter-at-home directives over the past several weeks.  The scope and application of these rules vary widely and require scrutiny.  Business activities considered “essential” are largely exempt from these restrictions, but making such a determination is often not straightforward. 
  
  Diligence inquires may therefore include any applicable orders affecting the target, whether any of the target’s business activities are exempt from such order, and whether the target is appropriately complying with such orders. 
  
  See our Workforce and Employment page and “essential business” analysis for further details on these regulations.  DLA Piper has also established a task force to provide guidance on such directives across the US, covering all 50 states, Washington DC and Puerto Rico.
  
  
• Real estate leases:  The highly contagious nature of COVID-19 and the resulting shelter-at-home directives have decimated retail foot traffic leading to a drastic decline in revenues for many retail companies.  A first order of business for most tenants and landlords in the retail industry has been addressing this dire situation.
  
  Diligence inquiries may include whether agreements have been made − or negotiations have begun − for rent reductions and/or rent deferrals, lease provisions regarding force majeure and other rights and obligations regarding the safety of the premises and access thereto.  Also, as discussed below, it may be desirable to include diligence inquiries designed to analyze the practical impact of not being able to timely enforce rights given potential delayed access to courts. 
  
  See our analysis of the US commercial real estate sector for a more detailed review of these considerations.
  
  
• Material contracts and insurance: Given the substantial declines in retail revenue, retailers, suppliers, distributors, licensees and other commercial parties are either unable, or may soon become unable, to comply with material contract terms.
  
  In addition to standard diligence inquiries regarding compliance with material contracts, diligence review may focus on whether any material contracts have been modified or material terms waived in light of COVID-19 that might affect future enforcement, force majeure and other termination provisions, defenses to contract breach, practical ability to enforce contracts, minimum guaranteed financial commitments, and consequences of breach and termination.
  
  The strain of this crisis may also cause third-party suppliers and vendors to perform contractual obligations below previously accepted standards – placing counterparties at higher risk of third-party liability, eg, product recalls and damages from product defects.   Diligence may therefore include a careful review of indemnification provisions in material contracts and insurance coverage for any such claims.   
  
  See our Insurance, Real Estate, and Commercial Contracts page for further resources and discussion.

• Global supply chain: Given the global nature of the COVID-19 outbreak, no links in the retail supply chain can be taken for granted. Supply chains can be carefully traced and analyzed, and diligence areas may include current (and predicted) effects of the virus in applicable geographically vulnerable areas, governmental intervention efforts (eg, labor, commercial contract enforcement), and ability to use alternative suppliers. 
  
  See our Supply Chain, Manufacturing, and Distribution page for further resources and discussion.

• Financing: As credit tightens and the liquidity of many borrowers is significantly decreased, it may be important to place a particular focus on a target’s financing arrangements and related agreements to identify potential issues.   Diligence areas may cover loan modifications agreements and/or discussions, communications with lenders and compliance with notification obligations regarding condition of business, material adverse change clauses that may implicate loan defaults or termination of lending obligations, financial covenants, cross-default implications, and status of any revolving lines of credit.  
  
  See our Finance, Restructuring, and Transactions page for further resources and discussion. 
  
  
• Solvency: In an acquisition scenario, the nature and extent of a target’s debt may hinder or prevent a transaction.  For example, if debt exceeds asset value, or the target is unable to meet its financial obligations, the viability of a potential acquisition may come into question.  In such a situation, the parties may wish to consider the benefits of conducting a sale of the target’s assets under Section 363 of the United States Bankruptcy Code. 
  
  See our overview of the benefits of US Chapter 11 relief in a time of economic crisis.
  
  
• Litigation: Courts and judicial bodies across the globe have taken strong measures to keep their staff and court participants safe and healthy. As a result, access to courts is delayed in many cases. Parties may therefore need to consider this risk when evaluating a transaction.
  
  See our analysis of such issue for a more detailed review of this consideration. 
  
  
• Corporate governance:  The enormous strain on the resources of retailers and organizations throughout the retail industry may prevent companies from properly focusing on important corporate polices and governance.  While such areas may understandably not be a top priority at this time, lack of compliance may lead to liability.  
  
  Diligence areas may include information technology and data privacy policies, personnel policies not directly related to COVID-19, contingency plans, and other important corporate policies that may have compliance issues give the current circumstances.  
  
  See our Corporate Governance, Disclosure, and Risk Management page for further resources and discussion. 

Find out more about the issues covered in this alert by contacting the authors, your DLA Piper relationship attorney, or any member of the Consumer Goods, Food and Retail group or Restructuring group.

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This information does not, and is not intended to, constitute legal advice.  All information, content, and materials are for general informational purposes only.  No reader should act, or refrain from acting, with respect to any particular legal matter on the basis of this information without first seeking legal advice from counsel in the relevant jurisdiction.