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Blogs - The M&A Perspective

Currency Risks and Interest Rates: Continuing Challenges for Contract Drafters

23.12.2015 – The sudden weakness of the Argentinian peso is only the last of many currency turmoils in the recent past. We shed some light on currency challenges in the M&A context in The M&A Perspective I/2015. These challenges will stay with us in the foreseeable future. Another financial defiance is the occurrence of negative and diverging interest rates. While the European Central Bank (ECB) decided that the interest rate on the deposit facility will be decreased by 10 basis points to -0.30%, the Swiss National Bank (SNB) confirmed the target range for 3-month LIBOR CHF to be -1.25% to -0.25 % and the interest rate on sight deposits to remain at -0.75%. Contrary to the developments in Europe, the U.S. Federal Reserve (Fed) initiated a "liftoff" and decided to raise the target range for the federal funds rate by 0.25%, bringing it to a range of 0.25% to 0.5 %. Monetary policy is expected to further diverge; certain professionals expect the Fed to increase interest rates to 1.25-1.50% by the end of 2016.

The odd interest situation also raises unfamiliar questions in the M&A process. For instance, in a locked box price mechanism, typically the purchase price should bear interest from the locked box date until closing. The argument is that the buyer receives the benefit of the target business' cash flows from the locked box date until closing, whereas the seller receives the purchase price only at closing. Deal point studies show that in roughly 20% of all locked box M&A deals, the seller is compensated for such "value accrual". In cross-border deals, this raises the question which interest rate is the right one: The interest rate applicable to the seller as only this compensates him fully for his (internal) financing cost? Or the interest rate applicable to the buyer as only this correlates to buyer's benefit to "pay the purchase price late"? Or should it be the interest rate applicable to the target company as this is the interest rate which most closely relates to the target company's cash flows? Or should it be a calculation of return on investment (ROI) within the target company as this is the most appropriate equivalent to what the buyer gets? What should apply if the most appropriate reference interest rate is below zero? Although it is obvious that in such a case a seller will vigorously fight a deduction from the purchase price, there is no magic formula and no standard which is suitable for every deal. As with many deal terms, it is up to the negotiation and the negotiation leverage of the parties to define the appropriate compensation for the buyer's value accrual. Just one thing is clear: The Parties are well advised to agree on an appropriate interest level for late payments under the contract. For if they do not explicitly provide for such a rate, Swiss statutory law foresees as fallback solution default interest on late payment to be a hefty 5% p.a. (Article 104 Swiss Code of Obligations).