Pandemics

The English word “pandemic” derives from two Greek words: pan meaning “all” and demos meaning “people”. The Chinese word – 全球大流行 – is much more direct, meaning “great global spread”.

During the course of the COVID-19 pandemic, the social isolation measures, the closure of borders and the restrictions on business activity (including the provision of goods and services in the ordinary course of business) have seriously disrupted private contractual arrangements between commercial parties on both a domestic and cross-border basis.

As in other crises, such as the Global Financial Crisis of 2007-2008, contracting parties inevitably focus their attention on the terms of commercial contracts and their respective rights and liabilities. In terms of rights, the relevant questions include whether they have the right to terminate contracts, or to take steps to protect their financial and commercial interests. In terms of liabilities, the relevant questions include whether they will be liable for any delay or failure in the performance of contractual obligations, and what steps they can or should take to mitigate any losses that might be incurred.

Drawing on previous Lexicons, this article examines the contractual impact of pandemics on corporate and financial transactions in three areas: material adverse change clauses; force majeure clauses; and the doctrine of frustration. The focus is on the treatment of these areas in common law jurisdictions, but the article also makes comparative reference to the position in other jurisdictions.

Material adverse change clauses

A key purpose of commercial contracts is to allocate risk between the parties, and to identify what consequence should arise if any commercial or financial risks increase as a result of a change in circumstances, or the occurrence of an adverse event after the contract was signed. Often the change in circumstances or the adverse event was not foreseeable by the parties on the date on which the contract was signed.

In general terms, a material adverse change (MAC) clause allows one party to exercise certain rights in the event that a material adverse change occurs (for a discussion about MAC clauses, see China Business Law Journal volume 7, issue 1: MAC clauses). The clause might trigger the right of the relevant party to terminate a contract, or to choose not to perform, or continue to perform, its obligations under a contract. As a result of its potential impact, an MAC clause is often heavily negotiated between the parties and their lawyers.

MAC clauses are common in the context of loan agreements, where a material adverse change that affects the ability of the borrower to perform its obligations allows the lender to refuse to advance funds to the borrower, or to accelerate the loan and demand repayment of all of the funds that have already been lent. In addition to loan agreements, MAC clauses sometimes appear in underwriting agreements and acquisition agreements.

In the context of an acquisition agreement, the MAC clause can operate as a condition precedent to completion, under which the failure to satisfy the condition by the completion date allows the purchaser to terminate the acquisition agreement and to withdraw from the transaction.

In common law jurisdictions, an MAC clause will be interpreted in accordance with the general principles of contract law, namely, the courts will ascertain the intention of the parties primarily by reference to the words that the parties have used to draft the clause. As a result, the drafting of an MAC clause is of critical importance, as it will determine when the clause can be triggered.

If the agreement was entered into after the onset of a pandemic, it will be more difficult to trigger the MAC clause, as it could be argued that the impact was foreseeable on the date of the agreement. In addition, it will be a question of proof as to whether the pandemic-related event has resulted in a material adverse change as defined by the MAC clause.

Proving the likelihood that the event will have a material adverse change will be complicated by uncertainties about the duration of the pandemic and its impact, and other relevant factors, such as the availability of government measures (including grants and loans) to assist businesses to recover from the effects of the pandemic.

A former partner of Linklaters Shanghai, Andrew Godwin teaches law at Melbourne Law School in Australia, where he is an associate director of its Asian Law Centre. Andrew’s new book is a compilation of China Business Law Journal’s popular Lexicon series, entitled China Lexicon: Defining and translating legal terms. The book is published by Vantage Asia and available at law.asia