COVID-19: A pandemic, a force majeure and a material adverse change

Posted On - 20 March, 2020 • By - Mohana Roy

As another week passed
by, the utter state of bewilderment brought by novel coronavirus (COVID-19) pandemic continues to claim
lives across the world. The impact of COVID-19 is not limited to human lives
but also to operation of businesses eventually affecting a broad swathe of economy.
The stock valuations are going down as the stock market has come to a halt. Due
to supply chain disruption, performances under many contracts are in question.
Even M&A transactions and financing agreements may be affected as the question
now arises that whether COVID-19 would trigger material adverse change (MAC).

The growing health
emergency has led to various restrictions upon people and delivery/supply of
goods and services which is directly impacting the performance under business
agreements. In such a scenario, force majeure clause and MAC clause may come to
rescue the parties to a contract.

COVID-19 Material Adverse Change clause

Transactions such as
mergers and acquisitions remain under the cloud of vagueness until they are
closed. Generally, in an M&A transaction, the time between the signing of
the agreement and closure of the transaction is very crucial. It is when a MAC clause
comes to operation. MAC clause confers the parties to a contract with a right
to terminate the contract upon occurrence of any event which affects materially
on the viability of the transaction. However, to agree upon the materiality of
an event by both parties of a contract, is not an easy task, on one hand, the
seller in an acquisition transaction would prefer to narrow the scope of the
definition of materiality, on the other hand, the buyer would prefer to keep it
open and as broad as may be possible so that it is easier for them to walk out
of the transaction, and that is why often such transaction agreements shy away
from defining what is material to the transaction. Further, the courts in India
have failed to provide for any systematic guidelines for determining the
materiality of events and have limited themselves to opine that any event which
will restrict or make it impossible for any reasonable party to enter in to such
contracts will be a material adverse change. Further, the Indian laws also prescribe
that anything which in the eyes of a reasonable person becomes impossible or
prevents them from fulfilling their obligation due to reasons uncontrolled by
the parties under the contract can be deemed as material adverse change. Regulation
23(1) (c) of the SEBI (Substantial Acquisition of Shares and Takeovers)
Regulations, prescribes that “any open
offer can be +withdrawn in circumstances where any condition stipulated in the
agreement for acquisition attracting the obligation to make the open offer is
not met for reasons outside the reasonable control of the acquirer, and such
agreement is rescinded, subject to such conditions having been specifically
disclosed in the detailed public statement and the letter of offer”,
meaning
thereby that the parties can withdraw themselves from the obligations under a
contract if it becomes impossible to meet the conditions for reasons which are
beyond the reasonable control of the parties. Further, section 56 of the Indian
Contract Act, 1872, which entails the concept of doctrine of frustration of
contract prescribes that any act which by reason of some event if occurs after
the contract is made and such an event is something which the promisor could
not prevent then such a contract becomes void. In future, while dealing with
cases involving materiality of events, Indian courts may take cues from the US
court’s judgments which rely upon durational significance and long term impact
of the event before providing relief by invoking MAC clause[1].

COVID-19: Whether MAC clause can be triggered

While the outbreak of
COVID-19 pandemic subsists, the parties to a contract may resort to
renegotiations or avoidance of performance of their contractual obligations by
invoking MAC clause. The party invoking the MAC clause will have the ultimate burden
to prove that the pandemic has affected materially to the transaction. Say for
instance, disruption in the supply chain due to COVID-19 may be sought to avoid
performance of various business agreements or may also delay the performance.

Presently, the
durational significance and long term impact of COVID-19 is yet to be
determined. Thus, it is early to conclude that if MAC claims vis-à-vis COVID-19
will be entertained by the courts.

However, in case if a
party in future invokes MAC due to the impact of COVID-19, it is pertinent that
the party should take note and in fact double-check prior to invoking the MAC
clause that, whether any alternate means of performance of the contract is
available. If yes, then the parties should deliberate on such alternatives. The
Party shall have to strike a balance between what has been agreed under the
contract and its right to terminate the contract under the disguise of MAC
clause.

Further, it is
necessary for the party invoking the MAC clause to follow the due process and
serve a proper notice to the other party before taking any further action. If
the other party objects then the court will determine the materiality of the
impact of COVID-19 upon the transaction based on the specific facts of the
matter.  

Those who are
deliberating upon entering into any business agreements including M&A
agreements should consider including warranties pertaining to adverse effect of
COVID-19. While conducting due diligence exercise, a party must take in to
consideration the other party’s preparedness to mitigate the adverse effects of
COVID-19. Further, specific disclosures must be sought pertaining to COVID-19 from
the other party and COVID-19 may be included while defining the material adverse
change in the transactional agreements subject to the risks as may have come
out while conducting the due diligence exercise.  

COVID-19: Declared a force majeure

A corollary of MAC
clause can be equated with force majeure clauses. However, force majeure
clauses specifically prescribe the conditions or events which will excuse the
performance of the contract whereas, the MAC clauses are vague and do not
specify the triggering events. Further, MAC clauses intend to allocate risk
between the parties that may arise between the signing and closing of the
transaction. Whereas, force majeure can be claimed at any time when a force
majeure event arises.

Spread of COVID-19 is
impairing the abilities of parties of a contract to perform their obligations,
thus, leading towards seeking relief under force majeure clause and MAC clause.
However, the question here arises whether the pandemic will fall under the
guise of force majeure.  In India, the
Ministry of Finance on February 19, 2020, has issued an office memorandum which
effectively declares that COVID-19 can be treated as a natural calamity and
hence a force majeure. The same may be invoked following the due procedures.

Force majeure means
events which are beyond human control and hence extra ordinary. It is by and
large believed that force majeure includes an act of god, natural disaster,
war, labour unrest, epidemics and strikes, etc. It is an exception which may be
claimed by the performing party to a contract. 

In the case of Energy
Watchdog Vs. Central Electricity Regulatory Commission & Ors
.[2], the Supreme Court of
India, restated the law of force majeure and laid down the following guidelines
to be mindful of while invoking a force majeure clause:

  1. The very basis of such clauses is that the events are beyond the
    reasonable control of the parties and in such conditions parties cannot be held
    liable for non-performance of obligations under the contract.
  2.  While analysing the force majeure
    clause, it is also necessary to analyse if best endeavours have been taken to
    mitigate force majeure event.
  3. For an event to qualify as a force majeure, it is necessary that the
    same is unforeseeable by the parties.
  4. The event has actually rendered the performance impossible or illegal.

Thus, any impact of
COVID-19 may be covered as a force majeure event provided that the parties
invoking the same shows that reasonable steps towards mitigating the same have
been taken and as a result no alternate means for performing the obligation is
left.  

Further, in absence of
force majeure clause or MAC clause in any agreement, does not bar the party’s
right to invoke them. In such a scenario, a party may resort to section 5 of
the Indian Contract Act, 1872, which is the law of frustration of contract
under the Indian regime.

Conclusion

Since COVID-19 pandemic is already declared a force majeure, the parties are likely to resort to the same in case of any impossibility towards performance under a contract. In absence of force majeure clause in a contract, the parties may resort to MAC clause or frustration of contract under section 56 of the Indian Contract Act. However, even after being declared a pandemic by the World Health Organization and a force majeure by the Indian government, it is yet to gauge the long-term impact of COVID-19. Therefore, whether the impact of COVID-19 will trigger MAC clause is difficult to determine at this point in time.

The triggering of force
majeure or MAC clause actually depends upon case to case basis. The party
invoking the force majeure or MAC, should carefully review the wordings around
the clause prior to beseech the same, it is also pertinent to take in to
consideration such aspects under the contracts which can be performed so as to
avoid any dispute between the parties. Additionally, it is necessary that the
parties assess their business sustainability and take steps to reduce the
impact of COVID-19 upon the work and ability to perform the obligations under a
contract. 


  • [1] Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347, at *47 (Del. Ch. Oct. 1, 2018).
  • [2] (2017) 14 SCC 80

Contributed By – Rajesh Sivaswamy &
Mohana Roy

King Stubb & Kasiva,
Advocates & Attorneys

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