Coronavirus: implications for commercial contracts and M&A agreements
The impact of the novel coronavirus (COVID-19) outbreak has been widespread, with implications for multiple sectors of the global economy.
What practical questions can I ask now to evaluate how COVID-19 may impact existing contracts and contracts under negotiation?
- Will your performance under a contract be impeded by COVID-19? Take reasonable steps to identify workarounds and discuss them with your counterparty. Where you can perform some, but not all, of your contracts, think carefully about which contracts you prioritize, bearing in mind applicable laws and relevant contractual provisions.
- For supply chains, which laws apply to different points of the chain and what does that mean for the overall performance of the contract? If your supply chain is exposed to the effects of the outbreak, line up fallback options.
- Does your insurance cover losses that arise from the outbreak or its knock-on effects?
- Do I need to give notice of a force majeure event, or if performance is impeded in some other aspect, to preserve my rights under a contract or insurance?
- Keep a detailed record of how the consequences of the COVID-19 outbreak are impacting your performance; however, bear in mind that any communication (electronic or otherwise) or record that is created may be read by other parties in discovery if litigation ensues.
- Consider the longer-term relationship with your counterparties, and whether force majeure, frustration, or the other principles discussed below might be used as leverage to negotiate a sensible commercial solution to COVID-19-related current issues.
- What obligations do you have if your company declares bankruptcy or becomes insolvent?
- What happens if a counterparty informs you it has declared bankruptcy or has become insolvent? Does the counterparty still have to perform? What rights will you have as a creditor in bankruptcy?
- What other commercial and/or reputational risks may arise from the outbreak, including HR/employment issues and the risk of counterparties becoming insolvent?
- Should you communicate with counterparties to pre-emptively find solutions to the issues raised?
Can I or my counterparty terminate a contract or be excused from performing because of the COVID-19 outbreak?
In short, it depends on what the contract says and the particular facts. Pay careful attention to the following potentially relevant provisions:
- Force majeure clauses:
- Relieves a party from the consequences of a failure to comply with an obligation where that failure is due to the occurrence of an event outside of the party’s control and may allow for termination of the contract without liability.
- Should be analyzed to determine whether the outbreak falls within its scope and the impact of the outbreak on the contract. Are there specific references to an epidemic, pandemic or contagious disease? (The World Health Organization’s declaration of the COVID-19 outbreak as a “Public Health Emergency of International Concern” may be relevant).
- Typically construed narrowly. Where the applicable force majeure clause specifically includes the event that a party claims to have prevented performance, there is typically a basis for a force majeure defense. However, in New York, for example, where the force majeure clause has general catch-all language that expands force majeure events to include further events that are not specifically listed in the clause, courts will generally limit the clause to include events of “the same kind or nature” as those explicitly listed and may inquire into the foreseeability of such further events that are not specifically listed to make their determination.
- Material Adverse Change and Material Adverse Effect: a “material adverse change” (a “MAC,” or sometimes, a “material adverse effect” or “MAE”) clause arises both in the context of ordinary commercial contracts as well as business acquisition agreements.
- In the commercial context, the occurrence of an MAE may excuse performance or permit a party to terminate the agreement upon the occurrence thereof. Often, sophisticated commercial parties will define material adverse effect in the agreement and specify the rights and obligations that follow. In general, the standard under which the event or occurrence alleged to cause an MAE will be reviewed is typically very high and parties should not simply assume that a global pandemic – even of the scale of COVID-19 – will automatically excuse performance or permit a party to terminate the agreement.
- In the context of M&A transactions, the occurrence of an MAE provides – at least in theory – the acquirer with a right to terminate the agreement (and not be required to close the transaction). In practice, however, the ability to terminate the transaction based on the occurrence of an MAE is incredibly rare, and the standard by which both Delaware and New York courts judge whether an MAE has occurred is incredibly high. Further, most acquisition agreements typically provide a comprehensive definition of MAE, which customarily includes a lengthy list of exclusions, the occurrence of which will not constitute an MAE (effectively, shifting the risk of one of the enumerated exceptions to the acquirer). It is common practice in the US for pandemics – like COVID-19 – to be so shifted to the acquirer as an exclusion to MAE. In other words, under current US M&A practice, COVID-19 will not likely give rise to a walk-away right for acquirers. (Indeed, in the recently announced Aon/Willis-Towers Watson and E-Trade Financial/Morgan Stanley deals, the MAE definition specifically allocates the risk of pandemics, including COVID-19, to the acquirer). The MAE definition in the transaction agreement may in some instances contain “disproportionate impact” or “disproportionate effect” language, which has the effect of shifting the risk of an excluded occurrence or circumstance that disproportionately impacts the acquirer as compared to other participants in the same industry back to the seller/target company. Based on market practice and recent precedent, M&A participants should assume that only in the most remote (and severe) of circumstances, which impact the target company differently from other participants in the same market, could the COVID-19 virus give rise to an acquirer walk-away right.
- Can be argued under Delaware and New York law if “after a contract is made, a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made.”
- The doctrine is narrow and will not be available (i) if the contract provides, expressly or impliedly, for the risk of supervening events that have occurred; (ii) simply because a contract has become less economically lucrative; or (iii) if the circumstances were foreseeable.
- Whether a party can invoke frustration as a result of the outbreak will turn on the length and intensity of the disruption, and whether this can be overcome with time.
- Excuses a party from performance when a supervening event has made the performance of a contract impossible.
- As with frustration, the doctrine of impossibility is applied narrowly. For example, under New York law, the impossibility doctrine excuses a party from performing its obligations “only when the destruction of the subject matter of the contract or the means of performance make performance objectively impossible.”
- Whether a party affected by the COVID-19 outbreak can invoke impossibility as a result of the outbreak will depend on whether the outbreak has made it impossible for the party to perform its obligations under the contract.
- Performance is impracticable when it could be done only at excessive and unreasonable cost.
- Under the New York Uniform Commercial Code and the Delaware Uniform Commercial Code Section 2–615 involving the sale of goods, the impracticability defense allows a seller of goods to be excused from delayed delivery or non-delivery of goods “if performance as agreed has been made impracticable by the occurrence of a contingency the non-occurrence of which was a basic assumption on which the contract was made or by compliance in good faith with any applicable foreign or domestic governmental regulation or order whether or not it later proves to be invalid.”
- Whether a party affected by the COVID-19 outbreak can invoke impracticability as a result of the outbreak will depend on whether the performance can only be done at an excessive and unreasonable cost due to the outbreak.
What other contractual points should I thinking about?
- Commercial terms: These may need to be renegotiated to reflect customs and excise procedures and tariffs, supply chain impacts or restrictions on movement of people. Consider whether the underlying economics of the contract may have changed as a result of the outbreak.
- Representations and warranties and covenants: Can representations still be given? For example, a representation that there is no default under a material contract, or no material contract which cannot be performed, should be given careful consideration.
- Severability: This standard boilerplate clause could become critical if there is a change in law. What if new legislation is passed seeking to restrict the outbreak which results in provisions becoming illegal or unenforceable? Parties may need to amend the agreement (or check to see if there is already “blue-pencil” language in the contract that addresses what happens when part of the contract is found unenforceable).
- Remedies: Does the contract provide for damages only for breach, or is specific performance expressly agreed as an available remedy? Are damages liquidated or capped?
- Currency fluctuations: Currency values may affect pricing, so in new contracts, consider how to allocate future risk through flexible pricing or hardship clauses.
- Business Day definitions: Where a definition of “Business Day” refers to a day “on which banks are open for general business,” consider the implications of mandatory bank closures, as seen in China.
- Regulatory review timelines/long-stop dates: Consider the impact on closing timelines for M&A transactions where a regulator whose approval is required to close the transaction is shut down due to the outbreak.
With over 200 lawyers in the US, Freshfields regularly advises clients on their most critical business and legal issues. We are happy to discuss any particular COVID-19-related issues that are impacting – or will impact – your business. Additionally, using Freshfields’ contract review AI tools, we can assist clients by quickly identifying and extracting key contractual provisions, including force majeure, material adverse change, and change in law. By leveraging this technology, we can deliver substantial time savings when compared to manual review of contracts – regardless of volume. If you would like to discuss any
COVID-19 issues, including technology-assisted contract review, please speak to your usual Freshfields contact.
For those with operations in Asia, our colleagues have produced a more detailed briefing, which you can access here.