In a recent IFLR webinar, lawyers from India, Singapore and the US shared their insights on how businesses should prepare for opportunities and challenges as pressures to cut costs loom and protectionist regimes prevail.
Akila Agrawal, head of M&A at Cyril Amarchand Mangaldas, said that the inability to plan ahead remains a top concern for businesses. “They’re grappling with supply chain challenges and there is a strong need for fundraising,” she said.
There is an emphasis on liquidity, with struggling businesses exploring fundraising activities such as rights issues and bond issuances. Companies are also looking into contracts and engaging with stakeholders such as vendors and distributors to renegotiate contracts.
“Covid-19 has brought about a change in mindset, especially in emerging markets like India, and with lockdowns and increasing trade barriers coming up, there is a change in priority,” said Agrawal.
Companies have to decide what fixed costs are essential, and this calls for a fundamental shift in how management decisions are made. She added that a positive change brought about by Covid-19 is that there will be more stakeholder engagement than ever before.
In India, there has been a shift in focus on self-reliance, as can be seen in policies for public procurement. “There is a push for goods to be manufactured locally. The desire to keep things local can also be seen in Japan,” said Agrawal.
She said that this isolation scenario being played out globally affects quality and costs in manufacturing. Entreprises are forced to diversify supply chains and partner with local people in the jurisdictions they already operate in.
“If this move continues in India, there will be more joint ventures with India majority shareholders and increasing collaboration between foreign and local players,” she said.
There will also be a silver lining for businesses in the form of vertical integration, as bigger corporations work with troubled micro, small and medium entreprises.
Trade barriers will only increase
Rod Hunter, partner at Baker McKenzie in Washington DC, said that Covid-19 has increased the politicalisation of markets in that governments have an increased involvement in businesses and are intervening much more in international trade and export controls.
“There is much more geopolitical competition, and Covid-19 has made plain the vulnerabilities and political nature of the international trading regime,” said Hunter. For instance, this can be seen in the US and Europe’s dependence on China for active pharmaceutical ingredients. Growing dependence on technology has also exposed a potential vector for espionage and disruption.
Hunter continued: “The growing awareness of these vulnerabilities creates a stronger justification for governments to intervene, making it increasingly difficult to agree on trade liberalisation.”
He added that geopolitical competition is not going to end and businesses will need to look closely at their supply chains and consider how reliable their suppliers are.
For investments, private investors and the lawyers representing them have to think through the risk factors in transactions. “These transactions have to be structured to mitigate risks and be mindful of the regulatory path that needs to be followed,” he said.
The Committee on Foreign Investment in the US (Cfius) rules will remain an issue in cross-border transactions and due diligence investigations will continue to be a significant component of negotiations in deals. Hunter said that the allocation of risk means that break fees will continue to be a trend for Chinese investments, as will reps and warranties insurance.
“Parties have to decide when a deal goes sour, who gets to walk way and under what conditions,” he said. “More importantly, avoiding eye contact is not a good strategy, so it is important to continuously engage with government.”
In the context of India, Agrawal said that it is important for investors to be aware of who their stakeholders are. Under revised foreign direct investment laws, any country bordering India, including China, will see its investments more carefully scrutinised by the government.
“This means investors such as private equity funds and strategic investors should better understand the perceptions surrounding who the investor is and what their intentions are,” said Agrawal. “There is a certain corporate diplomacy that is needed, and it is important to make a brand as entrenched in India as possible, as perceptions can go a long way.”
A recent controversy emerged when the government ordered that only local goods should be used in government staff canteens. Food brands such as Nestle were affected as there is a perception that they are not Indian – despite the fact that 100% of Nestle’s India products are manufactured in the country.
She added that risk allocations could also change. Longer gestation periods due to increased regulatory approvals and investment screening mean that it is more important to focus on conducting diligence on deals. “It is important to consider the risk transfers between signing and closing, and it’s no longer possible to use mechanisms like lockboxes anymore,” she said. Lockbox mechanisms will be challenging as price adjustments may be more common in this challenging environment.
Additionally, succession is an issue to consider in India for promoter driven companies. “For companies that are run by one person, mortality is an issue. Businesses that are dependent on a single person get questioned,” she said.
Disputes on the rise
As businesses continue to face a credit crunch and only the most nimble will survive, litigation will inevitably rise since many will not be able to fulfill their contractual duties. Shaneen Parikh, partner at Cyril Amarchand Mangaldas, said that force majeure and material adverse change (MAC) clauses have become much more important in contracts since Covid-19. “It’s important to negotiate contracts with robust dispute resolution clauses,” she said.
While forcemajeure and MAC clauses are being used, especially to extend timelines, mere hardship does not trigger these clauses, so parties have to look at the scope of the clause and the threshold parameters. Parikh stressed the importance of reviewing contracts with a fine-tooth comb and carefully negotiating clauses to proactively manage risk and make it clear which party bears the loss or liability.
As disputes crystallise, Parikh expects that fewer companies will want to see through long and complex litigation. “There will be increasing emphasis on settlements and mediation,” she said. “The pressure to pursue settlements will increase and there may be no choice but to accept an award for the survival of the business.” She also expects there to be more opportunities for third party funders.
Nandakumar Ponniya, principal at Baker McKenzie Wong & Leow in Singapore, said that businesses have been struggling to keep up with operational changes and that the business continuity playbook basically went out the window because of Covid-19.
Managing costs remains a primary concern, and companies are grappling with how best to handle employment and service agreements. For some sectors, such as aviation, viability is a concern, and many businesses have filed for insolvency protection.
Ponniya pointed out that for those with businesses and supply chains in China, it is important to consider any statutory recourse that may be available under civil law remedies. Various jurisdictions have also passed legislation in this area. Other options may be to consider business interruption insurance.
Many companies will look to build resilience by restructuring business operations and diversifying supply chains. Ponniya said that it is essential for businesses to make an immediate assessment of costs and exposure to third parties, and decide what the business-critical costs are.
Performance defaults will be inevitable, but these struggles have also posed an opportunity to build relationships. “How businesses deal with the stress and tension in relationships will shape the future of companies going forward,” he said. “There will be investors looking to exit and cut their losses, and this may lead to joint venture-related disputes. How these funds will be used will also drive investment trends.”
Ponniya also stressed the importance of relationship management. “Many are too keen to take the legal route and don’t consider mediation before escalation,” he said. He added that having mediation clauses in contracts can give parties time to pause and reflect on whether it is worth losing the relationship and fighting it in court, or just to get on with it.