Publication

The Impact of COVID-19 on drafting Commercial Agreements

Introduction

Coronavirus disease 2019 (COVID-19) has since been declared a global health emergency of international concern and has occasioned severe global socioeconomic disruption. As a consequence of this unprecedented disruption, the ability to do business and perform contractual obligations have been adversely affected.

Given the fact that parties to commercial agreements have been foisted with the reality that it may be onerous to meet their contractual obligations due to the pandemic or related measures imposed by the government, there is increased uncertainty as to the enforceability of commercial agreements.  By implication, parties facing such situations may seek to be excused from fulfilling their obligations and to escape liability for breach of contract. A significant number may seek to renegotiate the terms of their contracts in line with recent developments.

Whether any of the foregoing occurs will depend to a large extent on the wording of the relevant clauses and whether these clauses can be used to mitigate the adverse effects of the pandemic on business operations. Some of the legal tools that many businesses are asserting in an effort to accomplish these objectives are: Force Majeure, Business Continuity and the Material Adverse Change.  This article examines these tools and to what extent they can be effectively employed as well as some emerging trends in their wording.

Drafting Trends

1. Inclusion of the word “pandemic” in Force Majeure clause: Force Majeure simply means the occurrence of an unforeseeable circumstance that cannot be prevented or controlled[1] which prevents parties from fulfilling their obligations under a contract.

In Globe Spinning Mills (Nig) Plc v. Reliance Textile Industries Ltd, the Court of Appeal defined it as “a clause inserted in a contract which allows parties to rescind a contract upon the occurrence of certain specified events beyond the control of parties making performance unrealistic and impossible”.[2]

When force majeure clauses are contained in a contract, the parties include a list of circumstances they consider as unforeseeable such as acts of God; war, hostilities; acts or threats of terrorism; contamination by radio-activity from any nuclear fuel, or other hazardous properties of any explosive nuclear assembly or nuclear component of such assembly;” and end with an omnibus phrase “and such other acts or events that are beyond the control of parties”.

Force majeure clauses can be lengthy as they specify the events that can trigger the clause. In order to successfully plead force majeure, the party relying on it must show that:

1. the event is beyond the reasonable control of the affected party;
2. the affected party’s ability to perform its obligations under the contract has been prevented or hindered by the event; and
3. the affected party must have taken all reasonable steps to seek to avoid or mitigate the event or its consequences.

It is now imperative to include the phrase “pandemic, epidemic or diseases” when drafting a force majeure clause. This will make it easier to invoke force majeure, citing the effects of COVID-19 on the business. However, other criteria will still need to be established. For example, proving that the contract has become impossible to fulfil as a result of COVID-19.

Nevertheless, it must be noted that difficulty to perform, higher cost of performing the contract or that the contract is less profitable than initially envisaged will not be considered sufficient reason to invoke the force majeure clause and if invoked, may be unsuccessful in Court. It must be practically and legally impossible to perform obligations under the contract.

A force majeure clause typically specifies how the occurrence of such an event will affect the contract, which includes but is not limited to permitting the parties to suspend performance, requiring cost adjustments or the renegotiation of elements of the contract, precluding termination for breach where that breach is caused by the event, or in some cases, bringing the contract to an end.

2. Wider Business Continuity clause: This clause usually mandates one of the parties to develop a Business Continuity Plan to ensure that delivery of goods or services are not interrupted. Without a Business Continuity Plan, it is likely that the business will be adversely affected in the event there is an interruption to its operations. In view of current realities, the wording of this clause now typically mandates a party to the contract to develop system automation and enable virtual operations so that services can be provided remotely to clients, in times of natural disasters, pandemics or lockdown. The inclusion of these provisions in commercial contracts is vital in light of recent developments.

A business continuity event is usually defined in the contract as an event (whether a natural or man-made phenomenon or occurrence) which interrupts the normal business activities, including business functions, operations, or processes of the customer/client, (whether anticipated or unanticipated) and which prevents or delays a party from performing its obligations to third parties or receiving the full benefit of the provision of the services in accordance with the provisions of this Agreement.[3]

3. Extension of the Changes in Applicable Law clause to include Government Orders, Decrees and Policies: Due to COVID-19, there have been several developments made by governments to mitigate the spread of the virus which includes but is not limited to border closure, curfews, quarantine rules and restrictions on travel. This has impacted on the ability to deliver goods and services and in some contracts, time is of the essence. These clauses seek to tackle changes in the applicable law and may now extend to government orders, decrees and policies depending on the agreement of the parties.

4. Material Adverse Change (MAC) clause: MAC clauses allow a party to a contract to withdraw from a transaction (or to renegotiate part of the contract) if an event materially reducing the profitability of the transaction occurs after the signing of the initial commitment. However, in order to rely on this, it must be expressly provided for in the contract. This is usually used in Mergers & Acquisition (M&A) transactions where an event materially reduces the value of a company. It is also used in financing agreements to protect a lender against unforeseen changes in the borrower’s financial position, excessive market fluctuations, changes in ownership and generally any material changes in the position of the borrower.  If a MAC event occurs, a lender can ask for more security, freeze drawdowns, declare an event of default and/or demand early repayment.

The definition of a MAC differs from one contract to another as what constitutes a MAC in one contract is unlikely to be the same in another contract. To use this clause successfully, the adverse change must indeed be material, not temporal. The specific wording of the clause will determine whether the pandemic constitutes material adverse change.

First, if parties exclude general economic events, epidemics and other natural disasters from the definition of material adverse change, then the MAC clause cannot be relied on. Second, in M&A transactions, a purchaser might not be successful in arguing that the COVID-19 pandemic constitutes MAC if the target company is affected by the pandemic, but is not worse off than other companies in the same industry. Third, depending on how the clause is drafted, the MAC clause may exclude negative changes which were known to the purchaser or which the purchaser ought to have known. For instance, where the purchaser was aware of the reduced future prospects of the business due to the pandemic.

If the MAC clause does not exclude the COVID-19 pandemic, then the next step is to determine whether the effect of the pandemic reaches the threshold of MAC. An event will most likely result in material adverse change if it has a long-term effect or if the pandemic has such dire consequences on the industry in question, for instance, the travel or airline industry where a purchaser may be able to prove a long-term impact on the earning potential of the target company.

If the target company is in a bad position to deal with the effects of the pandemic, (for example, the company is already in crisis) then the argument of material adverse change may be successful.

Firstly, whether a purchaser can pull out of a transaction depends on the form and content of the MAC clause which will vary depending on the nature of the transaction and relevant jurisdiction.  Secondly, it will depend on the interpretation of the MAC clause by a Court or Tribunal. Thirdly, it will depend on the specific situation affecting the target company and the magnitude of the impact of the COVID-19 pandemic on the company.

Conclusion

The pandemic may well be with us for months or possibly years to come.  Parties wishing to enter new contracts must take into account the possibility, even likelihood, of periodic restrictions by governments or other pandemic-related interruptions of economic activity.

It is, therefore, advisable that contracting parties should give serious consideration to clauses that would be most appropriate incorporating the specific obligations of the parties in the event of these interruptions.  Consideration should be given to how the risks of pandemic related interruptions should be allocated among the parties, and what remedies are available in the event of any interruptions.

While the clauses discussed are not novel, the pandemic has brought about some emerging trends in their drafting.  The operations of each clause will to a large extent depend on the drafting, facts and circumstances of each case.

Meticulous drafting techniques by professionals are undoubtedly important in deciding what clauses are most appropriate in any given circumstance.

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Disclaimer:  The information, materials and opinions contained herein are for general information purposes and are not intended to constitute legal or other professional advice, and should not be relied on or treated as a substitute for specific advice relevant to particular circumstances.

[1] Blacks Law Dictionary

[2] (2017) LPELR-41433(CA)

[3] https://www.lexisnexis.co.uk/legal/precedents/business-continuity-clause