2020 is becoming the most unpredictable and turbulent economic downturn of our lifetimes. The stock market plummets then soars; the unemployment rate is climbing beyond Great Depression levels. The present uncertainty has extended to the fate of corporate M&A deals set to close this year. If deals are delayed or cancelled, will involved parties have to pay fines for walking away? There isn’t a single answer about the fate of these deals, but a few useful clues.
Is performance still required on existing contracts?
The biggest question facing said deals are whether “material adverse effect (MAE)” clauses and/or “force majeure” clauses will permit parties to terminate or delay deal closure with protection from direct financial consequence, specifically due to COVID-19. (MAE and force majeure provisions contain language that can give parties the ability to terminate or limit performance on a contract.) The answer depends on (1) a contract’s terms, (2) a deal’s jurisdiction and (3) the specific impact COVID-19 had on each party’s ability to perform their obligations (e.g., was performing the contract truly impossible or simply very expensive?).
TERMS: “Force majeure” clauses often specify events that trigger the protection. This language can provide guidance on whether a pandemic or its indirect consequences (e.g., disruptions in labor force, transportation and supply chains due to quarantines, a national emergency and/or an ‘Act of God,’ etc.) apply. Parties must evaluate whether real world events affecting deal closure align with the clause’s specified events.
JURISDICTION: A force majeure provision is often treated differently by courts, depending on the deal’s jurisdiction. For example, it may be easier for companies to invoke a force majeure in Delaware or Texas, because local courts tend to (1) focus on the language of the contract’s efficacy, and (2) don’t demand that companies detail how it is impossible to perform the contract.
Meanwhile, in New York, companies may only be released from a contract due to force majeure if the act of performing the contract is deemed objectively impossible by local court. California tends to fall in the middle: it may release companies via force majeure if the act of performing the contract yields unreasonably expensive costs. It is advisable to reach out to an attorney to see how your jurisdiction may affect your contract.
How will Covid affect M&A deals?
There are two factors to consider when thinking about how COVID-19 will affect the outcome of deals:
- MAE provisions provide that if the ‘seller’ party suffers adverse conditions harmful to the initial terms of the deal, the buyer can walk away.
- The ‘buyer’ party in M&A transactions would benefit from a successful force majeure or MAE trigger, since they’d be able avoid massive payouts from walking away (termination fees average around 4% of transaction values).
It follows that if COVID-19 qualifies as an ‘adverse condition,’ buyers can walk away and avoid massive payouts. Courts have yet to make the decision on whether COVID-19 specifically will allow buyers to walk away, but researchers suggest that complications from COVID-19 will not suffice for a scot-free walk.
The Delaware Court’s historical reluctance to grant MAE exceptions indicates that local ‘buyers’ may not have much luck walking away. Delaware’s court held a MAE once, in Akorn v. Fesenius; because it was found that the target had intentionally manipulated data and engaged in illegal behaviour. Akorn’s holding was irrespective of a market crisis, which does not bode well for dealmakers looking to walk away from deals, due to COVID-19 and its effects.
Further, in Hexion v. Huntsman, Delaware’s court held that solvency was not a condition precedent to Hexion abiding by their end of the contract. Because the court has never held that a MAE existed due to broader macroeconomic or global trends, dealmakers should not rely on the court doing so moving forward.
Some existing contracts have specifically separated pandemics from other qualifying force majeure factors. This may indicate that pandemics will be discluded from force majeure scopes. BYU, Columbia, and Stanford Law School professors analyzed over 1,129 MAE provisions from 2003 to 2018 to assess whether MAE provisions could be used to dismantle deals during a pandemic. Researchers found that only 8.3% of these MAE provisions specifically “carve out pandemics from force majeure events.”
Furthermore, over 60% of MAE provisions fail to use ANY catch-all language (like “Act of God” or “Force Majeure”) that could challenge MAE provisions in court. While many references to pandemics here are carve-outs to circumstances that would constitute a MAE, research shows that the majority of these carve-outs are modified if the seller is disproportionately affected, in which the carve-out no longer applies.
The broader question that this research asks is whether the presence of some pandemic-specific carve-outs indicate that “Act of God” or “Force Majeure” language does not include pandemics, because parties elsewhere specifically address a pandemic. As there is no precedent for this question, dealmakers will simply have to wait for the courts to decide. However, these carve outs for pandemics may suggest that pandemics will be treated separately from force majeure clauses.
Next steps for in-house counsel?
With a high level of uncertainty regarding how COVID-19 will affect contracts, individuals and corporations should review existing force majeure and MAE provisions in their upcoming/current M&A deals.
PERSUIT can help clients reach out to external counsel and help save money on external legal spend with our sophisticated sourcing tools. We’ve even developed COVID-19 and force majeure-specific RFP templates to assist.
While we can’t know yet how courts will respond to the inevitable rush of force majeure and MAE claims this year, it is highly likely that these forthcoming provisions will include pandemic and COVID-specific language. Indeed, the recent public merger between Morgan Stanley and E*TRADE Financial Corporation stated that “epidemic, pandemic or disease outbreak (including the COVID-19 virus)” would not qualify for a MAE. As Morgan Stanley and E*TRADE have done, individuals and companies should be thoughtful about including COVID-19 or pandemic-related provisions in their future contracts.
Questions? Contact Laura Spalding at Laura.Spalding@persuit.com