The impact of the coronavirus outbreak, now officially named “Covid-19”, on businesses in the Middle East is already being felt; the recent G20 summit hosted in Riyadh, Saudi Arabia discussed economic consequences, government responses are gathering a pace and stock market indices are tumbling.
One of the immediate impacts has been on global supply chains. Workforces have been quarantined, factories shutdown and restrictions have been imposed on the movement of people, affecting both imports and exports. The G20 discussed the projected impact the outbreak will have on growth in China and the rest of the world. It is predicted that China's growth outlook this year will be at 5.6%, constraining global growth to a decrease of 0.1% – down from previous forecasts. While governments are taking measures to support companies affected by the outbreak, knock-on effects in the Middle East can already be seen in tourism, travel and retail industries, as well as businesses engaging in construction, real estate investment and supplies.
There are already indications that a pandemic could contribute to, or result in, failures in the performance of commercial obligations, forcing parties to utilise fall back options under law or contract and seek the suspension or termination of legal obligations. In a financing context, borrowers may be entering discussions with lenders about the risk of default (which could either have the effect of preventing the borrower from making further draw downs or result in defaults or events of defaults). Parties to litigation and arbitration would be wise to be consider the procedural ramifications and how to deal with relevant defences or claims, particularly force majeure or frustration.
Commercial implications and practical considerations
Many commercial contracts contemplate the occurrence of an unforeseeable event which is beyond the reasonable control of the parties and may have the effect of rendering performance of the contract legally or physically impossible, or at least more difficult. During a health emergency or epidemic, a failure to perform contractual obligations may be excusable by force majeure, changed circumstances or the operation of the doctrine of frustration. Triggering such provisions requires care, not least because it has the effect of either suspending or terminating rights under the contract or can result in an adjustment of contractual terms.
In the Middle East, construction companies are already feeling the immediate impact of Covid-19, with many construction and site workers having been on vacation in China celebrating Chinese New Year when the outbreak occurred and (due to travel bans) have not been able to return from the Wuhan area. Failure to fulfil contractual obligations could result in performance bonds being called. Chinese manufacturers being unable to export supplies to the rest of the world has impacted Middle Eastern businesses whose operations are reliant on such imports. In the oil sector, as a result of the projected fall in consumption, commodity prices have been hit with a 4% decrease in demand for crude. The possibility of force majeure declarations, frustration or suspension of contracts under such circumstances becomes more immediate.
1. Force Majeure
There is no precise legal definition of force majeure. Its applicability therefore depends on the governing law of the contract and any specific wording in place on how the force majeure event should be characterised. Under English law, (the governing law of many international commercial contracts in the UAE), the operation of force majeure must be agreed upon by the parties, with contractual provisions detailing the definition of a force majeure event or the requisite criteria to be satisfied. In some civil law jurisdictions, and where there is no explicit reference in a contract, the operation of force majeure may arise from statute. For example, Article 117 and 118 Contract law of the People’s Republic of China (PRC) allows for legal force majeure resulting in the affected party being exempted from liabilities, provided that it serves notice to the other party about the force majeure event and provides evidence affirming its impact.
Breaking contracts over coronavirus is likely to be harder than it sounds. The challenge with force majeure is being able to show a causal link between the event and the non-performance. The China Council of Promotion of International Trade (CPPIT) has begun issuing force majeure certificates to companies needing to show a causal link and time will tell how evidentially reliable and effective these will be. Parties should consider the legal and commercial consequences of accepting or rejecting force majeure as a discussion will need to be had regarding the length of the suspension or delay once force majeure has been triggered.
Where force majeure is unlikely to be made out, parties can turn to the doctrine of frustration which may have the effect of discharging parties from their obligations in full. Frustration itself suffers from inflexibility, however, with a requirement to show that the event in question destroyed the fundamental purpose of the contract. It follows that when considering whether force majeure or frustration apply, a thorough assessment of the intensity and duration of the events will be essential.
- Satisfy evidential burdens. Force majeure and frustration are both likely to require an affected party seeking to rely on the clause to prove the occurrence of the force majeure or frustration event and an impact on performance. Any business impacted by Covid-19 should keep detailed records of knock-on effects of the epidemic on its business and make comparisons with outbreak-free periods.
- Notice requirements. Parties will need to consider any formal and/ or contractual requirements and timeframes when serving a counterparty to a contract with notice of the force majeure or frustration event. For example, postal services may be delayed, leading to questions about whether and, if so, when it is “deemed effective”. Consider negotiating grace periods with counterparties.
- Mitigation of loss. Part of the assessment of a successful contractual claim is satisfying the court that the affected party attempted properly to mitigate its losses – non-compliance with this duty may result in counterclaims. In the case of Covid-19, mitigating loss may involve seeking alternative supply distribution networks to counteract the effect of supply restrictions or workers facing travel-ban restrictions and making use of protection measures against price fluctuations or revenue and sales figures.
- Negotiation or settlement with counterparties. If possible, impacted businesses should consider postponing volume commitments under long term purchase agreements or triggering price review provisions in the case of long-term supply contracts. A review of all relevant contacts in place would be pragmatic.
- Review existing contracts. Finally, businesses should ensure adequate protection from non-performance – either of its own obligations or those due to it from others – in the event of a changed circumstance or unforeseeable events.
Financial implications and practical considerations
In the United Arab Emirates, the Central Bank has issued directives advising banks to adopt measures to mitigate the effects of Covid-19. Such measures include re-scheduling of loans, granting temporary payment deferrals and reduction fees and commission for affected customers. Arguably, a more straightforward situation for a borrower compared to the situation of approaching a lender to re-negotiate terms.
1. Event of Default and MAC clauses
For businesses relying on supplies from affected regions, there is a possibility of a material adverse change (MAC) in the borrower’s ability to perform obligations under a finance document being triggered, albeit with difficult criteria to satisfy. Likewise, negative financial results or tightened cash flow as a result of an epidemic or an adverse governmental measure could result in lenders calling an event of default. Technology and telecommunications sectors are facing significant challenges due to the high concentration of manufacturing operations in China, with Apple warning of shortages of iPhones.
The success of the operation of a MAC clause is a question of fact and often requires the change to be more than temporary. On the lender-side, there is the risk that key counterparties may become insolvent due to the impact of a MAC or cross-default, forcing the lender to join the queue with other creditors. To avoid a liquidity crisis where credit lines are switched off, borrowers should use this period to negotiate extensions to grace periods, an increase to the facility commitment or a reduction to interest payments.
2. Reporting requirements
Borrowers will need to pay attention to their reporting and disclosure requirements under information undertakings and financial covenants. Representations which must be repeated at the commencement of each interest period or prior to a draw down may no longer be true and accurate, requiring a disclosure and potentially leading to a block on further draw downs. An event of default may also be triggered as a result of financial covenant breaches or other technical or payment defaults.
- Review existing contracts. Borrowers should review existing loan documentation for force majeure, MAC provisions, and information undertakings/covenants to understand the full scope of their rights and obligations.
- Disclose and report. Make an assessment about the financial implications and whether the business is close to default (and be prepared for the possibility of making a disclosure to lenders).
- Approach lenders at an early stage, negotiating grace periods and a reduction in interest payments for a temporary period to obtain breathing room.
Litigation implications and practical considerations
The commercial and financial implications of an epidemic could certainly result in disputes arising for non or part performance, including parties contesting whether the threshold for force majeure or frustration are met or whether a MAC has been triggered. Disputes lawyers, advocating for commercial parties, will need to focus on identifying evidence of the epidemic’s impact on the usual performance of the business. Parties should also maintain records of steps taken to mitigate any losses suffered under the contract.
Guarantees, performance bonds or indemnities may be at risk of being called if the obligations securing them are not performed. Dispute resolution may be a resultant effect which would be costly and require the collection of evidence and data, often requiring witnesses and expert reports.
Losses caused by disruptions to interconnected supply chains may be covered by existing insurance policies and coverage under such policies will need to be assessed. The insurance sector is already reporting an increase in the notification of claims and potential claims. As a response, it appears that insurers are rushing to exclude epidemics from policies.
2. Preserve rights
All communications with counterparties – oral or written – should be conducted with care, particularly during the period of any dispute or where relief is sought from a failure to perform obligations. Ensure that no promises or assurances are made which may later amount to a wavier or variation of rights – preservation of rights in any communications becomes paramount.
3. Notice Requirements
Filing deadlines or notice requirements under contracts are typically prescriptive. Check whether physical delivery is required and be aware of delays in mailing and delivery, including due to travel restrictions, e.g. many performance bonds require physical delivery of the demand. The use of email (where contractually permitted) should prevent deadlines from being missed.
4. Record Keeping and detailed review of provisions
Disputes lawyers defending any assertion of force majeure or frustration would need to be able to secure documentation or records from the business on the impact and intensity of the force majeure or frustration event, as well as attempts to mitigate losses. Litigants arguing against the assertion of a force majeure or frustration need to review the contract carefully for how any notice is to be served, whether the parties have satisfied the specific wording of the contract in determining whether the epidemic is truly a force majeure or frustration event.
- Make use of opportunities to negotiate with counterparties through out-of-court settlements. Consider the legal and business implications of triggering relief provisions under contracts, as well as the impact of the dispute on other contracts and streams of business. Take care to protect the confidentiality or legal privilege of any such negotiations or discussions, where possible.
- Be vigilant as to notice requirements and external communications with counterparties – be sure to preserve rights.
- Take reasonable steps to show that there was an attempt to mitigate losses arising from the outbreak of the epidemic through alternative means.
What can King & Spalding do?
We are advising numerous clients worldwide in real-time who are grappling with issues, including:
- Supply chain impacts, including enforceability of force majeure agreements.
- Communications strategies with regard to key stakeholders – including employees, shareholders, customers, vendors – as well as the general public.
- Data security risks related to opening the workforce to remote working and to maintaining network resiliency.
- Navigation of public disclosure issues.
- Public safety issues, including quarantines, privacy and travel restrictions.
- Incident response plans.
- Action and protection with regard to actual and contingent regulatory and litigation issues.
The issues above are complex and give rise to a wide range of considerations. In addition, clients are already seeking advice on rights under insurance policies and King & Spalding has been working with leading hospitals to identify issues that should be addressed when faced with a pandemic in this Client Alert. We are also uniquely positioned to advise and guide on potential force majeure declarations particularly for a range of companies, including pharmaceutical and medical device companies. For more information, please refer to this Client Alert.