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The Novel Corona Virus (“Covid 19”) came to light in December 2019 and by March 15, 2020 it has affected nearly every part of the world causing panic, confusion, frenzy and most important of all large scale disruptions to every industry and businesses around the world.
While medical experts suggest, Covid 19 is not as fatal as 2003 pandemic SARS, fearing yet another global recession, the global markets have tumbled, commodity prices have halved and investor wealth has taken a serious beating since the onset of Covid 19. China is already battling a major lock down and the epicenter of the virus has moved to United States and Europe where lock downs and emergencies have been declared as well. In the Indian context as well, central and state governments have taken extensive measures including closure of schools, colleges, malls and multiplexes to curtail the spread of this virus.
All of the above has brought the global economy to a grinding halt with cascading implications. China being a major manufacturing hub of the world has already started issuing “force majeure certificates” to its global customers in wake of this pandemic invoking “termination” or “stand still” provisions under the contracts executed. The Ministry of Finance, India has also recently, announced that Covid 19 could be treated as a “natural calamity” for contracting parties having force majeure provisions and having reference to acts like natural calamity.
While the contracting parties in India may not be immediately rushing to courts and tribunals or invoking arbitration clauses in agreements to seek immediate reliefs, in the coming months one could witness significant rise in litigation around these issues.
In light of the above it is extremely important to understand the existing provisions in Indian law and measures businesses should take while negotiating ongoing contracts in context of M & A transactions.
What the Indian Law says ?
Similar to the provisions under English law, the Indian Contract Act, 1872 (“Contract Act”) provides legal recognition to these concepts. As per the provisions of Section 32 of Contract Act, in the contract can be treated void if the underlying event of such contract become impossible to achieve. Similarly, according to Section 56 of the Contract Act, a contract to do an act which, after the contract is made, becomes impossible, or, by reason of some event which the promisor could not prevent becomes void when the act becomes impossible. Clearly the intent of the legislators is to provide protection to the contracting parties where one party cannot perform its obligations for reasons beyond his control.
Further, Indian courts have on several instances upheld these principles enshrined under Contract Act, however courts apply strict interpretation to the provisions of “Force Majeure” in existing contracts and the burden of proof in such matters will rest solely on the contracting party seeking the relief. Further in examining such matters courts are also likely to evaluate facts viz. (i) whether reasonable efforts were taken by breaching party to mitigate the breach; (ii) whether such act was entirely out of contract of breaching party; (iii) whether the obligations could be postponed or put on hold; and (iv) whether sufficient notice was provided by breaching party to for such event.
Businesses having ongoing contracts with customers/clients having “force majeure” provisions should revisit the provisions of such clauses and evaluate whether they can indeed seek protection under Contract Act or provisions of contract by virtue of onset of Covid 19. Parties should also carefully review commercial obligations in relation to their existing contracts, nature of services/scope under these agreements and evaluate whether fulfilling such obligations has indeed become impossible by virtue of Covid 19, before prematurely categorizing as “force majeure” event and triggering other provisions including that of “stand still” or “termination”.
How it may impact M & A transactions ?
Under any M & A transaction including a cross border transaction, the purchaser would typically seek certain remedies from the seller prior to conclusion of the transaction. These remedies inter alia include: (i) having provisions relating to material adverse change or effect on the business of Seller (“MAE”). MAE events usually are drafted in a manner to give purchaser an option to walk away from concluding the transaction if certain events affect the company and/or the overall transaction. A typical MAE clause would trigger in case of a company, upon termination of contract with key customer or key vendor; (ii) representations from the Sellers including business representations which include confirmation that no event or circumstance has occurred in business which may cause termination of any contract or affect any ongoing customer relationship; (iii) event of default (“EOD”) provisions which may again give the right to the purchaser to walk away upon occurrence of certain events or breach of obligations by seller including the seller being unable to achieve commercially agreed business projections; and (iv) pre-completion obligations to ensure business is continued in its normal course without any interruptions.
All of the above provisions are usually linked to the business operations of the company and would need careful evaluation on a case to case basis.
In M & A transactions where parties have executed binding documents, however are pending completion, both the seller and the purchaser should carefully review the terms of the binding documents especially in relation to MAE and EOD and evaluate any implication of Covid 19 on their business and whether it would trigger any provision of existing contract or make any representation untrue or inaccurate.
Typically the seller has to on completion of every transaction issue a certificate in favour of the purchaser confirming that: (i) between execution and conclusion of the transaction, no MAE has occurred; and (ii) all representations and warranties provided on execution are true and correct even on the date of conclusion of the transaction. In such cases, the seller should consider providing/issuing disclosure letter/updated disclosure letter to the purchaser disclosing specific areas or matters where Covid 19 has affected or is likely to affect any existing business arrangement of the company due to its impact on the business. This will help the seller reduce its liability by virtue of knowledge of the purchaser of such events.
Where seller has made such disclosure prior to conclusion of transaction, the purchaser should commercially evaluate the impact of such disclosure on the business of the seller/company and accordingly either seek specific indemnities to safeguard itself from any liabilities, demand a value adjustment or in extreme cases where impact is significant and cannot be offset even by value reduction, also consider termination options.
With the onset of Covid 19, there is a high likelihood that fulfilment of some of the conditions precedent may take longer than envisaged, especially the conditions linked to seeking approvals from third parties (including regulatory authorities). Parties should revisit the timelines agreed under the transaction documents and identify conditions which are likely to be impacted by Covid 19. Parties could consider extending the long stop date or waiving some of non-critical conditions precedent. In addition to the condition precedent items, both the seller and purchaser should jointly identify if any other aspect of the agreed obligations (for e.g. fund transfer process, physical exchange of documents etc.) are likely to get affected by Covid 19. Appropriate alternate solutions should be agreed and documented in form of amendment if necessary.
Key considerations for ongoing M & A transactions
Where parties are currently in process of negotiating transaction documents, each party should clearly evaluate the impact of Covid 19 on the business. In addition to legal and financial diligence, the purchaser should also consider conducting a business diligence and meeting customers, supplier and vendors as part of the diligence exercise to identify any adverse impact of Covid 19 on the business of the company or the transaction. If it is expected that the impact of Covid 19 are likely to surface in coming months prior to conclusion of the transaction, MAE and EOD clauses should be drafted accordingly. Purchaser should also insist on specific disclosures (if any) versus generic Covid 19 related disclosures. Termination clauses should be carefully and clearly drafted to ensure purchaser has the right to terminate binding documents if completion of the transaction would defeat the commercial objective of the purchaser. Dispute resolution clauses and mechanisms should also be carefully thought through and drafted as courts/tribunals may adopt a far more reasonable view than they would normally do in lieu of far reaching implications of Covid 19 across the world.
Depending on the nature of the business, sellers should carefully review the language of MAE and EOD provisions in the transaction documents. For certain businesses if required, it would be advisable to build carve outs in the transaction documents to specifically state that the onset of Covid 19 should not in any manner trigger MAE or EOD or breach of any obligations of seller under the transaction documents. Sellers should consider including provisions in transaction documents that purchaser would not be entitled to make any monetary claims on the seller upon termination of transaction documents any time prior to conclusion of transaction. Adequate disclosures and updated disclosures to be provided if business is likely to be impacted by Covid 19 or due to any related circumstances. Seller should also carefully review the language of representations and warranties and appropriate carve outs or materiality thresholds should be built to avoid breach of any warranty or representation provided by the seller in transaction documents. A careful evaluation on caps on liabilities should also be considered including ensuring that any Covid 19 related implications to the business do not form part of any fundamental representations or obligations of the seller.
While all the countries across the world battle to fight and curtail the effects of Covid 19, deal makers in India should take measured approach in relation to matters which are pending closure and especially in relation to transactions where negotiations are currently ongoing. Parties should take a more pragmatic approach while interpreting the term “Force Majeure” in context of their individual business operations and should take reasonable efforts to achieve the commercial objective.
Having said that, both seller as well as the purchaser should take additional precautions while drafting transaction documents to envisage scenarios like Covid 19 and other similar calamities to safeguard their rights their while keeping in mind the nature of the business and any impact such calamities including Covid 19 may have on the functioning of the business.
Views expressed in this article are personal in nature and should not be construed as legal opinion in any manner.
Jayesh Kothari is a Principal Associate with DSK Legal and is part of the Corporate / M & A team. The author can be contacted on firstname.lastname@example.org.