Contractual Provisions and COVID-19: What Clients Need to Know Regarding Material Adverse Effect and Force Majeure Clauses
March 17, 2020
In recent weeks, the outbreak of the coronavirus disease (COVID-19) has created fear and uncertainties that have affected the daily lives of people around the globe. While the size and severity of COVID-19 has yet to be determined, businesses are likely to encounter legal issues that they will need to address in real time.
One key concern that many companies are currently facing is how to manage the impact of a reduced workforce and supply chain issues on their ability to meet their contractual obligations. With those (and other) looming concerns in mind, it is imperative that companies review their existing contracts to determine whether they can terminate or suspend their obligations under an agreement due to a “material adverse event” or a “force majeure” event, if necessary – or, on the opposite end of the spectrum, how to protect themselves from a counterparty triggering those provisions. Further, if a company is currently negotiating a contract with a counterparty, it is critical that the company analyze these provisions with care.
MAC Provisions: Mergers and purchase agreements, along with general commercial contracts, set forth the terms of a deal and allocate various risks and responsibilities among the parties. One of the ways that a party may shift some of the risk to a counterparty is through “material adverse change” or “material adverse effect” provisions (both referred to here as “MAC” provisions). While there are some commonly seen formulations of these provisions, the scope and impact thereof are subject to negotiation. Accordingly, it is imperative that parties review and negotiate these terms with a critical eye, and not dismiss them as mere boilerplate provisions.
With this in mind, parties should note that courts determine whether a MAC exists on a case-by-case basis, and successfully establishing the existence of a MAC has historically been difficult for plaintiffs. In Hexion Specialty Chemicals, Inc. v. Huntsman Corp., for example, the Delaware Court of Chancery held that disruptions rising to the level of a MAC should have long-term consequences and not be, in the court’s view, short-term “hiccups”.1 It was not until recently in Akorn Inc. v. Fresenius Kabi AG that a Delaware court found the existence of a MAC that justified releasing a party from its contractual obligation to close a transaction.2 In Akorn, it became clear that a Delaware court’s determination as to whether a MAC is present will likely not only depend on the wording of the MAC provision itself (including any carve outs thereto), but it will also likely depend on whether “there has been an adverse change in the target’s business that is consequential to the company’s long-term earnings power over a commercially reasonable period, which one would expect to be measured in years rather than months.”3
With the rapid spread of COVID-19, parties may begin to inquire as to whether their specific circumstances rise to the level of creating a MAC that will permit parties to terminate their agreements. These issues may not be limited to the direct effects of COVID-19, but also those effects due to governmental restrictions on businesses and steps that are now being implemented to slow the spread of COVID-19. Since current forecasts of the effects of COVID-19 vary, it is difficult to ascertain whether a court would determine that the impact of COVID-19 will rise to the level of creating an MAC. Nonetheless, it is imperative that parties analyze the exact wording of the MAC provisions in their agreements to determine whether that wording could potentially bolster a party’s argument that a MAC did, in fact, occur due to COVID-19 or any governmental orders that have been issued to address the virus.
Force Majeure Provisions: In addition to MAC provisions, parties should closely review the force majeure clauses in their contracts. Force majeure clauses are contractual provisions that aim to “relieve a party from its contractual duties when its performance has been prevented by a force beyond its control or when the purpose of the contract has been frustrated.”4 Examples of typical force majeure events include war, acts of terrorism, labor strikes, changes in the law, and “acts of god.”
Business owners should review their agreements to see whether, and to what extent, these concepts have been incorporated into their agreements. Certain questions that should be analyzed during this review include: does the force majeure clause include “pandemics” or “epidemics” as one of the enumerated applicable events? If not, does it include “acts of god”? If it includes that category, are examples of what constitutes an “act of god” listed and, if so, is there a strong argument that the situation at hand is similar to one of those categories? Are there other categories that are listed that may or may not be applicable to the instant situation, such as “governmental orders or decrees”? If a force majeure event has occurred, what are the parties’ obligations and rights? Is there any duty to mitigate under the contract or applicable governing law? If the contract does not contain a force majeure clause, or if a party seeking to terminate the contact does not think that it has a strong claim that the event fits within a force majeure event, are there other provisions (such as termination rights) it can enforce or are there other doctrines that may be applicable in this instance (such as impossibility of performance or frustration of purpose)? These are only a sample of some of the questions that must be raised when reviewing these provisions. Business owners would be wise to consider what steps they can be taking now to put themselves in the best position to either seek to enforce, or defend against a party trying to enforce, a force majeure provision. Further, we note that the issue of “foreseeability” of the consequences related to the applicable event remains a major topic of concern with COVID-19 and its impact on force majeure provisions.
As COVID-19 continues to spread and issues related thereto continue to unfold, business owners would be wise to consider taking steps to mitigate their risk. As a multidisciplinary firm, Moses & Singer LLP has the capabilities and resources to advise clients regarding the broad spectrum of the issues that they may face in this climate. Our corporate group, assisted by various other attorneys, including litigators, can help clients by reviewing commercial agreements and advising on these and many other issues companies are facing in these uncertain times.
This article provides a brief overview of certain issues that may arise in the context of dealing with COVID-19 outbreak. The above noted issues are not intended to be a comprehensive list of the types of issues that clients may face. For additional details or to discuss issues that your business is facing regarding COVID-19, please contact Dean Swagert at email@example.com, Jeffrey Davis at firstname.lastname@example.org, Lindsay Kaplan at email@example.com or Mark Damiano at firstname.lastname@example.org.
1 Hexion Specialty Chemicals, Inc. v. Huntsman Corp., 965 A.2d 715 (Del. Ch. 2008).
2 Akorn, Inc. v. Fresenius Kabi AG, No. CV 2018-0300-JTL, 2018 WL 4719347, at *53 (Del. Ch. Oct. 1, 2018), aff'd, 198 A.3d 724 (Del. 2018).
3 Id. (citing Hexion, 965 A.2d. at 738).
4 Phillips Puerto Rico Core, Inc. v. Tradax Petroleum, Ltd., 782 F.2d 314, 319 (2d Cir.1985).