As COVID-19 strains business’ current and future cash flows, companies in many industries are examining whether a global pandemic and the resulting government ordered closures and shelter in place directives provide a right to terminate or excuse nonperformance of contractual payments and other obligations. While commercial and M&A agreements often allow for suspension or even termination upon a material adverse effect on or material adverse change to the business (“MAE”) or excuse a default due to a force majeure event, we recommend companies look to the specific language of the agreement to evaluate whether COVID-19 provides a legitimate “out” with respect to payment or other performance obligations.
Acquisition Agreements & “Material Adverse Effect”
In the context of a business acquisition, the MAE clause typically allows a buyer to terminate the acquisition agreement and/or abandon the transaction upon substantial deterioration of the seller’s business. At closing, the seller typically certifies that no MAE has occurred during the interim period between signing the acquisition agreement and closing. Sellers, however, often negotiate exceptions to the definition of an MAE that allow for certain material adverse events without giving the buyer a right to walk away, such as: (a) changes to general economic or political conditions; (b) changes to conditions generally affecting the seller’s industry; (c) if publicly traded, changes in the price or trading volume of the seller’s securities; (d) changes in geopolitical conditions, such as terrorism, acts of war, sabotage or calamity; and (e) natural weather disasters. According to a seller, the aforementioned exceptions are systemic risks outside the control of a seller that buyers should accept as a risk of making an acquisition. While some seller-friendly or recently-negotiated MAE definitions may exclude changes resulting from pandemics, diseases outbreaks, or similar language, such language is not a standard MAE carveout.
In response to the seller-requested exclusions to an MAE definition, buyers often negotiate a “disproportionate-effect” exclusion to the exceptions from the MAE definition, which eliminates each exception to the extent it has a disproportionate effect on the seller as compared to other businesses in the same industry.
In the past, courts have been reluctant to find the occurrence of an MAE and thereby allow a buyer to escape its contractual obligations. The Delaware Court of Chancery helpfully described an MAE as an adverse change to the seller that “substantially threatens” the financial potential of the entire seller business in a “durationally significant manner.” The Delaware court observed that a seller’s downturn was durationally significant when it had “already persisted for a full year and show[ed] no sign of abating.”
Commercial Contracts & “Force Majeure”
Similarly, force majeure clauses are often found in other commercial contracts such as leases, supply contracts and service agreements. These types of clauses can excuse the failure to perform contractual obligations caused by unforeseen events that are beyond the control of both parties. Force majeure events in commercial contracts typically include: acts or directives from governmental authorities (i.e., business closures, shelter-in-place orders, quarantines); labor lockouts, disruptions or shortages; and other “Acts of God”. If a valid force majeure event resulting from COVID-19 applies to your contract, a party could be excused from performing, potentially for the duration of the COVID-19 event and may even be allowed to terminate the contract all together without liability.
COVID-19 May Qualify as a Force Majeure Event, but Look Further Before Claiming MAE
Whether COVID-19 affects your M&A agreement or commercial contract will depend on the specific language of the clause. For M&A agreements, a buyer seeking to terminate due to an MAE will need to show that COVID-19 has caused a long-term and materially negative change to the seller’s business that does not reflect general economic or industry conditions (assuming no pandemic exception and with a disproportionate-effect clause). Likewise, a non-performing party seeking to invoke a force majeure clause in a commercial contract must also establish a link or causal connection between the underlying COVID-19 event and the inability to perform its contractual obligation. As of early April 2020, it is likely too early to predict the duration of the COVID-19 pandemic or, perhaps more difficult, the length of any resulting business downturn, closures or shelter in place restrictions. Furthermore, a disproportionate effect clause in M&A agreements is unlikely to help buyers as many sellers experience industry-wide financial issues.
Steps Companies Should Take Now
- Review yet-to-close M&A agreements for an MAE clause and your other commercial agreements for a “Force Majeure” clause.
- If these clauses exist, determine whether the specific language and any exclusions could fall within the impacts of the COVID-19 pandemic.
- Consider notifying the other party about possibly invoking the MAE or Force Majeure clauses, especially if formal notices are required by the agreement.
- For new agreements under negotiation, consider adding language to address the potential risks of COVID-19. For M&A agreements, sellers should push to add pandemics or wide-spread disease language to the list of MAE exclusions. While we expect many buyers will price in the uncertain impact of the COVID-19 pandemic, we would also advise buyers to resist a pandemic inclusion as well on the same grounds – we still don’t know the duration or depth of COVID-19’s impact.
 Akorn, Inc. v. Fresenius Kabi AG, C.A., No. 2018-0300-JTL (Del. Ch. October 1, 2018).