By Andrea Budano
The worldwide spread of the coronavirus (“COVID-19”) pandemic is heavily affecting human lives and businesses alike.
Before the World Health Organization (“WHO”) officially declared a pandemic, and at an increased pace afterwards, COVID-19 has been and still is disrupting global businesses, supply chains and the workforce. National, state, and local governments have been forced to adopt sudden and incrementally restrictive measures to contain the spread of the virus, such as travel limitations and travel bans, “stay-at-home” orders, and closures of all locations where people congregate in numbers greater than 10. In some countries, governments have forced closures of nonessential business and production facilities. Even those companies allowed to continue manufacturing essential goods have experienced severe disruptions, such as adapting to workforce reduction to diminish close contacts between employees or complying with more stringent safety requirements for the protection of customers’ personnel, for example when onsite assembly or construction work is required. The combined effect of these measures has caused entire industry sectors and their supply chains to critically slow-down, if not completely halt.
As a result of this unimaginable global turmoil, contracting parties have been inquiring about ways to excuse contractual nonperformance, including the possibility of claiming that the outbreak of COVID-19 would constitute a force majeure event to current contracts and may affect future contracts.
Can COVID-19 qualify as a force majeure event?
A proper answer may depend on a series of factors: including, but not limited to, governing law, whether an agreement included a force majeure clause, when the parties entered into the agreement, and the nature of the commercial relation between the parties, etc.
Every contract should be initially reviewed to see if it includes a force majeure clause. If the contract contains a force majeure clause, then the party suffering from the force majeure event may be relieved from performing its duties under the contract or allowed to terminate it. Force majeure is generally defined as an event that cannot be predicted and is beyond the parties’ control. The term includes both natural disasters, such as earthquakes, floods, tornadoes and hurricanes (the “Acts of God”), and human actions, such as wars, riots, strikes, and terrorist attacks. In order to qualify as force majeure, an event must be beyond the control of the parties, unforeseeable, and prevent a party’s performance, not simply make it more difficult or costly. Based on the language of the force majeure clause, in order to be excused, a party must show that COVID-19 is a direct cause of its nonperformance.
If a contract includes a force majeure provision, does the clause specifically mention the possibility of a pandemic? Does it need to?
The outbreak of a worldwide pandemic with the characteristics of COVID-19 is such an unexpected and unique event, that it is unlikely the parties expressly referenced it in the force majeure clause. However, some Courts (most notably, New York Courts) are quite literal when interpreting force majeure clauses, strictly adhering to the boundaries set by the definition of force majeure provided by the parties. Therefore, a force majeure clause, which does not specifically mention the risk of pandemic or does not include certain customary “catch-all” language to extend to unspecified circumstances, may not be sufficient to excuse the nonperforming party.
What are the remedies available in case of a force majeure event? Can its effects be mitigated?
Parties should read force majeure clauses carefully to determine the applicable notice period and the manner the force majeure event should be communicated to the other party. The specific remedies available to the nonperforming party will depend on the express language of the force majeure clause. In general, a party suffering from the force majeure event may be entitled to an extension of the agreed contractual time to perform under the contract or to suspend performance. However, if the duration of the force majeure continues for an unreasonable period, then the other party may be allowed to terminate the contract. As the widespread disruption brought by COVID-19 took the world by surprise, parties to commercial agreements are, in fact, trying – whenever possible – to renegotiate terms, mostly to extend the timeline of delivery or performance and/or reschedule payments.
Is there a stop date beyond which the parties might be prevented from claiming COVID-19 as a force majeureevent?
In order to qualify as force majeure, an event must be unforeseeable by the parties. While the risk of pandemic was arguably known over the previous months, the World Health Organization officially declared COVID-19 a pandemic on March 11, 2020. A party, who entered into a contract after that date, would not be able to claim COVID-19 as unforeseeable event and request to be excused for nonperformance of the contract. To avoid any uncertainty interpreting the parties’ intentions in contracts entered after March 11, it may be useful to explicitly indicate to what extent force majeure events will include – or not include – the effects of the COVID-19 pandemic.
What if the contract does not include a force majeure provision?
If a contract does not include a force majeure clause or if a force majeure clause does not cover the risk of pandemic, a party’s nonperformance in connection with an unforeseen event may still be excused. The parties may seek enforcement or excusal using specific provisions of the Uniform Commercial Code (“UCC”), United Nations Convention on Contracts for the International Sale of Goods (“CISG”) or the common law principle of “impracticability.”
Under the UCC, the seller[1] (or the lessor or supplier if the transaction is a lease[2] is not in breach of his contractual duties, provided that nonperformance was caused by an event, “the non-occurrence of which was a basic assumption on which the contract was made”[3], or if the seller has complied “in good faith with a foreign or domestic government regulation or order”[4], whether such regulation or order later proves to be invalid. For instance, a presidential executive order requiring a factory plant to shut down in order to limit the spread of COVID-19 would likely excuse the seller. However, the contract must have been made before the occurrence of an unforeseen event. Therefore, seller’s nonperformance occurring after March 11, 2020 would not be excused because government intervention is a foreseeable reaction to the WHO official declaration of the coronavirus pandemic.
While the UCC deals exclusively with seller’s nonperformance, the approach adopted by CISG – the default framework governing international contracts for the sale of goods, unless the parties have expressly agreed to a different governing law – is similar to a force majeure clause. As in a force majeure clause, a party claiming exemption should prove (1) nonperformance was due to an impediment beyond its control, (2) such impediment was not reasonably foreseeable at the time in which the contract was entered into, or (3) it should not be reasonably expected that the party claiming exemption should avoid or overcome the impediment’s consequences.[5] Also note that CISG applies to a party’s nonperformance caused by “the failure by a third person whom he has engaged to perform the whole or a part of the contract.”[6] This may apply to those circumstances in which COVID-19 disrupts the supply chain causing party’s nonperformance.
If neither UCC nor CISG provisions can be applied to a contract, contractual duties may be discharged under the common law doctrine of impracticability. The party wishing to invoke impracticability must prove the following elements: (1) an event has occurred that the parties assumed would not happen; (2) continued performance is not commercially practicable; and (3) the party asserting the defense did not expressly or impliedly agree to performance in spite of impracticability.[7]
Could COVID-19 excuse the performance of a loan or M&A agreement?
Material adverse change or material adverse effect (“MAC”) provisions have been routinely added to most loan and M&A agreements, especially after the downturn in the economy caused by the September 11, 2001, terrorist attacks. In general, MAC provisions afford lenders or buyers the possibility to terminate the envisioned transaction, between signing and closing, as a result of any effect or change that would be materially adverse to the borrower or target of an acquisition. While this is not an in-depth analysis of the application of MAC provisions, in short, a party arguing the case for a MAC, must prove that COVID-19 caused an effect or change that was materially adverse on a borrower’s or target’s business, assets, condition (financial or otherwise), results or operations.[8] Under Delaware law, the bar is very high for a buyer invoking MAC to terminate its obligation to close a deal, as MAC provisions should be interpreted “from the longer-term perspective of a reasonable acquirer”[9] and a “short-term hiccup in earnings should not suffice.”[10] Although certain industry sectors, such as the aviation industry, have already been heavily affected, it might still be too early to determine the long term effects of COVID-19 on the borrower’s or target’s business. However, it should be noted MAC “can have occurred without the effect on the target’s business being felt yet”[11] if a party can prove that an adverse effect is reasonably expected.[12] As a result, parties to a loan or M&A agreement are expected to engage in protracted negotiations in the upcoming weeks, even if COVID-19 has not yet caused an immediate decline of the borrower’s or target company’s business.
Conclusion
No one could or can foresee the unfolding of events in connection with the evolution of the COVID-19 pandemic. It is also not possible to predict the reaction and further measures that governments around the world will implement. In view of the current situation’s extreme uncertainty, it may be necessary to review current executed agreements and in-house contract templates as well as discuss and implement risk mitigation strategies for future contracts.
[1] UCC2-615.
[2] UCC2A-405.
[3] UCC2-615.
[4] Id.
[5] CISG, Art. 79.
[6] Id.
[7] 47 CRS Proppants LLC v. Preferred Resin Holding Co. (Del. Super. 2016).
[8] Osram Sylvania Inc. v. Townsend Ventures, LLC (Del. Ch. 2013).
[9] Akorn, Inc. v. Fresenius Kabi AG (Del. Ch. 2018).
[10] Id.
[11] Lou R. Kling & Eileen T. Nugent, Negotiated Acquisitions of Companies, Subsidiaries and Divisions (2018 ed.), § 11.04[9], at 11-60 n.102 cited in Akorn, Inc. v. Fresenius Kabi AG (Del. Ch. 2018).
[12] Frontier Oil Corp. v. Holly Corp. (Del. Ch. 2005) cited in Akorn, Inc. v. Fresenius Kabi AG (Del. Ch. 2018).