Determining EBITDA In A Time Of COVID-19

• Published date: 28 January 2021
• Subject Matter: Coronavirus (COVID-19), Government Measures, Operational Impacts and Strategy
• Law Firm: Aird & Berlis LLP
• Author: Mr Sean Mason and Stan Fedun

Beyond the human toll that the pandemic has had on our lives, the COVID-19 virus, as well as our and our governments' responses to it, has had a marked economic impact. Many businesses have faced challenges and it is fair to expect that in a number of cases, earnings will have been affected in a material way. As entities look to report on the past year, it's worth considering how we calculate the impact of the pandemic on earnings.

EBITDA (earnings before interest, tax, depreciation and amortization) is the most commonly used stand-in for earnings and can be found in a wide array of agreements, from the financial covenants contained in loan documents, through earn-outs in M&A agreements, employment remuneration terms and long-term incentive plan awards, to pricing formulae in options and other contingent rights.

EBITDA is oftentimes defined in agreements to exclude "one-off," "non-recurring," "unusual" or "extraordinary items" or other special circumstances ("Adjustments").¹ Whether, and in what form, Adjustments are contained in an agreement could have a significant impact on the EBITDA calculation and, as a result, on the economics of the bargain that the parties have made. Similarly, pandemic-related government benefits and programs could also have a significant impact on EBITDA if such benefits and programs result in an unanticipated increase in earnings and cannot be excluded as Adjustments.

Considered in context, if EBITDA, as used in an earn-out provision, can be found to exclude the impact of COVID-19, a seller may satisfy its EBITDA targets by adding back any COVID-19 losses. From the buyer's perspective, this may seem like an unfair windfall for the seller. In a credit agreement, if the Adjustments in that agreement allow for EBITDA to be calculated without taking account of the impact of COVID-19, the borrower may be able to satisfy its debt-to-EBITDA ratio by excluding the impact of COVID-19 losses when the lender may have otherwise expected COVID-19 losses to be included in the calculation.

The most commonly used language for Adjustments is some variant of the exclusion of "non-recurring, unusual or extraordinary items." The meaning of these Adjustments in the context of COVID-19's impact on EBITDA calculations has not been judicially considered so we are left to consider the impact of these words using their ordinary meaning. Taking, for example, the exclusion of "extraordinary items," the Dictionary of Accounting describes an "extraordinary...