Post-Pandemic Corporate Contracts and Force Majeure
“Force Majeure”: unforeseeable circumstances that prevent someone from fulfilling a contract, relieving them of their otherwise liability.
“Material Adverse Change” or “MAC”: A MAC clause seeks to give the buyer of an asset or business the right to terminate the agreement before completion (or offer a foundation for renegotiating the transaction), if events occur that are critically damaging to the target assets or business being purchased.
Post this current COVID pandemic, any company that is looking to make a corporate acquisition (or significant merger) may potentially need to factor in a slightly higher cost to do so on account of the acquiring parties rightful choice to incorporate a higher “abandonment fee” in the event of a new outbreak.
A great example of a pre-COVID pandemic contract lacking a force majeure clause – which yielded unfortunate negative consequences – was the UK’s Easyjet who in 2013 completed an 18mth due diligence process after which agreed to purchase over 200 new jets from Airbus. The contract would stagger plane deliveries from 2013 and through to 2022. In its announcement to the market, Easyjet crowed that it had negotiated a substantial discount from the market price of each jet. However, understandably Easyjet did not disclose at the time what they had traded off in return for the steep discount. With the current COVID pandemic obliterating travel, Easyjet came under intense pressure from shareholders to cancel any remaining undelivered Airbus jets. Unfortunately, the company advised that it did not have an ability to cancel without incurring a large financial penalty. If it were to cancel the contract, Easyjet advised the market that it would be compelled by the original contract to pay back the discounts on all the already delivered jets plus compensate Airbus for all future losses. Easyjet declared they had no recourse to a force majeure clause – which allows a party to exit a contract because of some unforeseen catastrophe – like a global pandemic.
Exploring now more broadly, pre-COVID the overarching consideration in corporate contract negotiations was price, however this will surely pivot to risk minimization as the order of the day. Companies currently in the midst of negotiations are rightfully scrambling to include (or exclude) pandemics in force majeure provisions, not to mention placing a higher emphasis on “material adverse change” clauses. The newly coined term “pandemic premium” will force businesses to pay a higher price, or give up something else for the ability to walk away from a deal in the event of a second or third wave of the virus or some future unrelated outbreak.
Understandably, with companies increasingly seeking to upend pending deals negotiated in the pre-COVID era, contract disputes will start piling up. High profile international examples include SoftBank Group’s withdrawal of a $3bn investment in WeWork, and Sycamore Partners attempt to exit its agreement to purchase a 55% stake (~$525m) in L Brand Inc which owns the Victoria’s Secret lingerie chain.
In the aftermath of the devastating 9/11 attacks, companies sought to include acts of terrorism as a trigger that would allow the buying party an opportunity to walk away from the deal without penalty. After the GFC finance crisis, companies sought to include events of global meltdown. Now included on the list will surely be domestic or global pandemics which respectfully are neither party’s fault.
Pre-COVD, where large transactions involved complex considerations (regulatory hurdles, competition hurdles), such M&A transaction negotiation contracts have typically included termination penalties which averaged anywhere from 5-7% of the deal value. Commentators are now suggesting that “termination” or “break up” fees may become standard across all deals and not just the largest and most complex. This naturally will come with a trade-off. If the buying company seeks to include a “pandemic” or “material adverse change” clause as an event which triggers an opportunity to walk away from the deal, the selling party will understandably seek a larger termination or break up fee to create a sense of pain or hurt.
Negotiating parties on both sides of the transaction will no doubt stay very close to their legal and financial advisers. Beyond actually deciding to include “pandemic” or “material adverse change” in to a contract of sale, the second element of complexity will come in the form of defining “pandemic” and “material adverse change”. Likely post-COVID, the definitions will become more specific and complex as the word “pandemic” may offer little protection if the damage caused to the business is more a result of the economic downturn than the actual disease itself.
During and post-COVID, if you are looking to enter in to a busines sale, now is the time to seek independent legal and financial advice well. This should take place well in advance so as to allow appropriate time to consider appropriate due diligence and risk minimisation strategies. Equally on the converse – should you be seeking to purchase a business.
Spartan Partners have a strong reputation in supporting merger and acquisition transactions. Please do not hesitate to reach out should you wish to discuss your upcoming plans. We will always be by your side.
