The Coronavirus: how to limit the impact?

February 26, 2020 | Blog

Companies should take the time now to evaluate existing contract terms and where necessary take risk-mitigation measures to limit the impact of the virus

The coronavirus looks set to have a major impact on the Netherlands and in particular on businesses that have supply chains reaching into China or that, like the port of Rotterdam, depend on the flow of Chinese exports. According to Statistics Netherlands, in 2018 the Netherlands imported EUR 39.2 billion worth of goods from China. Two thirds of this volume is re-exported. Many of these goods come in and leave the Netherlands through the Rotterdam port. In the other direction, the EU nations are collectively China’s largest trading partner and this trading relationship will also be hard hit by the consequences of the virus outbreak.

Companies should take the time now to evaluate existing contract terms and where necessary take risk-mitigation measures to limit the impact of the virus. Do your contracts on the purchase or the supply side have a force majeure or overmacht clause? Could a change of law clause, which allocates the risk of changes in government regulation, offer a way out from contractual obligations? We explain below that even if there is no explicit force majeure clause, you or your supplier may still be entitled to suspend or terminate performance. Another item to review would be material adverse change or effect (MAC or MAE) clauses in transaction documentation. As a last item on your checklist, we suggest items to consider for the future.

Force majeure

Force majeure (FM) refers to a situation where the performance of a contractual obligation has become impossible due to an event beyond the control of either party. Force majeure is sometimes referred to as an Act of God. FM events include earthquakes, hurricanes and closing of stock exchanges.

As a Dutch legal concept, force majeure – overmacht – arises when there is an impossibility to fulfil an obligation, which impossibility is not attributable to the person who has to perform the obligation. In such a case, the contracting party cannot, in principle, be required to fulfil its obligations or to pay damages and can, under certain conditions, free itself from its obligations by terminating the underlying agreement.

Often parties to a contract governed by Dutch law will have included a specific force majeure clause that lists the events resulting in force majeure (natural disasters, wars, closure of stock exchanges). The clause usually provides that the obligation to perform may be suspended by notice given of the FM event and that ultimately the contact may be terminated. The provisions of the contract therefore need to be carefully examined to decide whether the outbreak of the coronavirus will fall within the ambit of the clause. It is also critical that the procedures for notifying or challenging an FM event set out in the contract are followed to the letter. At the same time evidence should be collected and recorded as to the impact of the virus and mitigating measures that the parties may have taken, so as to fulfil the evidentiary burdens that may arise down the line both in opposing and in appealing to FM.

Under Dutch law, the interpretation of a clause in a commercial contract ultimately depends on the intention of the contracting parties. For a contract entered into by professional parties that were supported by (legal) advisers, the grammatical interpretation will weigh strongly in deciding what the parties’ intentions were. For most commercial contracts, therefore, the wording of the FM clause will be crucial in deciding whether the parties intended it to apply to an outbreak such as COVID-19, the disease caused by this coronavirus strain.

Even if there is no FM clause in the contract, the statutory force majeure provision of Section 6:75 of the Dutch Civil Code (DCC) may apply. The key question will then be whether the breach can be attributed to the contracting party.

On the basis of Section 6:75 DCC, any party invoking force majeure will need to claim (and substantiate) that, rather than an ordinary (business) circumstance, a special circumstance occurred that is beyond its control and that qualifies as force majeure within the meaning of Section 6:75 DCC. In that context, the contracting party will have to claim (and substantiate) that there are exceptional circumstances, which are not to be deemed to be for its own risk, on the basis of which – contrary to expectations – its obligations under the contract cannot be met.  

Unforeseen Circumstances

Another possibility for a party that is unable to perform its contractual obligations because of the coronavirus would be to rely on Section 6:258 DCC. This offers the possibility to amend or even terminate a contract due to “unforeseen circumstances”. This only applies if the unforeseen circumstances are of such a nature that the other party, according to generally held standards of reasonableness and fairness, cannot expect the contract to be maintained in an unmodified form.

For a successful reliance on Section 6:258 DCC, a high threshold applies. An appeal to unforeseen circumstances only works if the unforeseen circumstances are of such a nature that the other party cannot reasonably expect the original contractual obligations to be performed. An "unforeseen circumstance" must also be a circumstance that is not (tacitly) included in the agreement. Whether or not a specific circumstance is (tacitly) included is again a matter of interpretation. Naturally, the less predictable a circumstance was, the less likely it is that it was taken into account when drawing up the contract.

Change of Law

Although perhaps not as likely, a clause in a contract that specifies which party will bear the risk of a change in law could be of relevance in the COVID-19 outbreak. A broadly worded clause that refers to decrees and directives could be appealed to, given that many governments have and will in the future issue binding orders and guidelines. For example, the lockdown of certain Chinese and Italian cities and towns preventing movement in and out of specific regions could lead to contracting parties sustaining damage. Evidence should therefore be collected and recorded as to how such decrees are issued and whether these are to be seen as government legislation/directives or not. Again, this will be a matter of contract interpretation as discussed above to determine whether a change of law clause will apply to the consequences of the COVID-19 outbreak or not.

MAC clauses

Particularly in industries that are likely to be hardest hit by the outbreak, such as the electronic consumer goods and freight sectors, parties will be taking another look at their contractual position and considering whether the outbreak could be considered a Material Adverse Change (MAC). MAC clauses come in many shapes and sizes but in its simplest case, there are two places to look:

  • the conditions for closing (where the occurrence of a MAC will allow the purchaser to not proceed with the transaction), and
  • the seller’s reps and warranties, where the seller may have warranted the non-occurrence of a MAC, which in the case of breach gives rise to a claim for damages.

A so-called backdoor MAC – where the seller is required to bring down or repeat the material adverse change warranty – may also give the purchaser a way out of the agreement, having the same effect as a closing condition.

Whether the outbreak of the coronavirus could constitute a MAC depends first and foremost on the specific wording of the clause and the particular circumstances of the business that is the subject of the transaction. MAC clauses are generally narrowly formulated, meaning that an appeal to a MAC will not easily succeed. General changes in economic or business conditions may be specifically excluded.

In any event, both purchasers and sellers should maintain documentary records as to the impact of the coronavirus and assess whether any disclosure obligation has arisen towards contractual counterparties. In one of the few Dutch cases on Material Adverse Change clauses (the Phoenix /Philips decision of September 2007), the Supreme Court found that a MAC had occurred – the financials showed a steep decline in the EBITDA. The sellers, however, were found not to have had knowledge of the MAC at the closing of the transaction, nor could they have had such knowledge following reasonable enquiry. Sellers must therefore evaluate the potential impact on their business through enquiry with relevant managers and, where relevant, make the necessary disclosures.

What next

  • Reconsider standard force majeure clauses to exclude or include (depending on which side of the contracting table you sit) the effects of pandemics
  • Evaluate draft transaction documentation to consider whether MAC closing conditions or warranties should be adjusted in the light of the expected impact of the coronavirus and indeed to provide for any future global pandemics
  • Other contractual obligations should be reviewed. Business that are in vulnerable sectors may soon find themselves having to restructure debt, for example by rescheduling payments or resetting covenants. At the least, disclosure obligations may kick in on loan documentation. Investors may need to provide emergency funding (which may provide an area of opportunity for credit providers)
  • Contractual provisions that depend on business performance indicators need also be examined such as earn-outs or in some cases buyback and call option triggers. Even where such contractual provisions do not exist, shareholders that are strapped for cash may be willing to sell additional stakes in exchange for additional funding
  • Examine insurance policies – these may provide some recovery for coronavirus losses although epidemics may be specifically excluded


Employment

Employers have a duty of care regarding their employees. This duty of care is relevant in the current corona virus situation. It is questionable if an employer can instruct an employee to travel to or stay in a risk-area for work. The answer to that question will depend on the specific facts and circumstances of the case .

The duty of care may also lead to an employer becoming liable for damages incurred by an employee in the course of their work duties. If an employee is requested to travel to or stay in a risk area and the employee contracts the virus, the employee can try to claim damages from the employer based on breach of the employer’s duty of care. Whether or not such claim will be awarded again depends on the facts and circumstances of each matter. If an employer can demonstrate that an assessment was made of the risks for an employee that will strengthen the position of the employer. Such assessment should include an analysis of the specific reason to send an employee to the area, any negative travel advice issued by the (Dutch) government for certain areas, and details of possible precaution measures that are in place.

The employer can obtain permission from the government to apply temporary working time reduction for its employees if there is at least 20% less work for a period of at least two weeks due to the Corona-virus. While the permit for working time reduction is in effect, employees are still entitled to their regular salary despite the reduced working time. However, the employer is partly reimbursed by the government for hours not worked, subsequently reducing salary costs.

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