Unless you have been blissfully detached from global news since December 2019, you are aware of the outbreak of a new coronavirus that has caused worldwide anxiety. What was first identified as a pneumonia of unknown cause in Wuhan, China on December 31, 2019, was declared a Public Health Emergency of International Concern by the World Health Organization (WHO) on January 30, 2020, christened COVID-19 on February 11, 2020, and surpassed 100,000 confirmed cases worldwide on March 7, 2020. On March 9, 2020, British Columbia confirmed the first COVID-19-related death in Canada. On March 11, 2020, WHO declared the outbreak a pandemic.
This growing global health emergency is already having very real impacts on the Canadian economy and affecting the operations of Canadian businesses, both domestically and abroad. Global efforts to stem the spread of the virus have created heretofore unseen restrictions on the movement of goods and people. Canadian businesses are now assessing their ability to mitigate operational risks under existing contracts. Force Majeure and Material Adverse Event clauses are two potential paths to refuge from COVID-19's effects in this respect.
What is a Force Majeure clause?
"Force Majeure" clauses provide that parties to a contract may be excused from performance, in whole or in part, or entitled to suspend or extend the time of performance, as a result of some specified event or condition. Obligations resume once the event or condition has been remedied or can be overcome. While parties are free to contract and define force majeure as they see fit, it has traditionally applied where an unforeseen and uncontrollable event or condition prevents one party from performing its contractual obligations.
Force majeure is purely a creature of contract. Clauses typically define triggering events, the notice required for invocation, and address the mitigative steps required of the party claiming force majeure. Force Majeure clauses may be specific and provide a finite list of triggering events – "Acts of God", natural disasters, war, terrorist acts and civil unrest, government action, such as expropriation, and labour unrest are typical in this respect. Epidemics and quarantines are also specifically included in some clauses. Either in addition, or as an alternative, clauses often have an open-ended "catch all" definition to cover "any unexpected eventuality outside the control of the impacted party".
How is force majeure established?
Force majeure litigation is relatively rare. Cases are highly fact sensitive, and approaches to interpreting Force Majeure clauses in Canada have not always been consistent or predictable. The scope and effect of a Force Majeure clause will always depend on the specific contractual language used. However, one can expect that certain basic principles will guide the interpretation, and will make establishing force majeure based on COVID-19 challenging, in most circumstances:
- Based on the traditional narrow scope of force majeure and the
presumption that contracting parties do not intend to exempt
performance unless clearly provided for:
- Force majeure language will tend to be construed narrowly; and
- Ambiguity will likely be resolved against the claiming party;
- Force majeure must generally prevent, and not just hinder or render uneconomic, contractual performance. One notable exception is where the event relied on as force majeure leaves a party with insufficient resources to perform all of its contracts, and is forced to pick between them and/or allocate among them the insufficient resources available to perform all;
- A force majeure event must be beyond the control of the claimant and beyond the scope of normal, foreseeable business risks;
- The claiming party must make all "reasonable" efforts to mitigate both the force majeure event and its impact on counterparties;
- "Reasonable efforts" to mitigate may include incurring financial losses, though the extent or quantum of loss that a party may be required to incur may be finite and dependent on circumstances; and
- The burden to demonstrate force majeure and compliance with obligations of mitigation will be on the party claiming force majeure.
Can COVID-19 qualify as a material adverse change or material adverse effect?
If a force majeure claim cannot be sustained, many contracts also contain a clause allowing termination or adjustment of obligations in the event of a "material adverse change" (MAC) or a "material adverse effect" (MAE) on the value of performance. MAC is often used interchangeably in contracts with MAE, although a MAE clause may be construed more broadly, as it can arise from any cause. Generally, such clauses appear in acquisition, sale of goods, financing and other commercial agreements, and are used to create parameters whereby a buyer may terminate a transaction because of an event that negatively impacts the nature or value of the target product, company or business.
Contracts often do not specify events that may give rise to a MAC or MAE, but utilize general descriptions of the types of impacts required for relief. For instance, in financial agreements, accounting for some variations in language used, a MAC is often defined as "a material adverse change in the business, assets, properties, liabilities (actual or contingent), operations, condition (financial or otherwise), or prospects, of the Borrower, individually, or the Borrower and its Subsidiaries taken as a whole". MAC and MAE provisions commonly exclude specifically the effects of market conditions, Acts of God, and similar events. The threshold required in order to be material is rarely specified, but Courts have consistently considered that any factor that would have induced a reasonable party not to enter the contract is material.
Invoking a MAC clause is difficult. Materiality will need to be demonstrated clearly and objectively. Given that MAC clauses tend to lack language that identify a particular event or loss as a MAC, determination of a claim for MAC relief often requires a detailed factual inquiry with an uncertain outcome. This risk is one reason why MAC clauses are more commonly invoked to renegotiate deal terms rather than as a basis for termination.
At this point in time, invoking a MAC clause due to COVID-19 issues may be difficult in most circumstances. The long-term effects of COVID-19 on financial and operational aspects are unknown. Further, there is always a variety of factors affecting market performance, such that proving a MAC or MAE attributable to COVID-19 alone, as opposed to general market or business conditions, may be difficult.
Conclusion
Determining whether a party will be successful in claiming force majeure as a result of the COVID-19 outbreak, or that the outbreak is a MAC under a transactional agreement, will require a careful review of the contractual terms, the surrounding circumstances, and the impacts of COVID-19 on the claiming party. If COVID-19 is adversely impacting your business, please contact Thomas O'Leary, Emily Shilletto or another member of Dentons Canada to ensure you are taking the right steps to protect your interests.
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